The weeks leading up to Tax Day in the U.S. can be a flurry of stress and difficult decisions for just about anyone. This is particularly true for the artists and songwriters making a living in the music industry.
That’s because one of the most common tax mistakes artists make is simply not paying taxes on income made from their music. Artists often assume that (a) someone else is paying their taxes for them, as if it were a normal W-2 employment situation; or (b) they were paid cash and assume it won’t be reported to the IRS.
But self-employment tax is due if the artist earned $400 or more a year as an independent contractor. I’ve known several artists and songwriters that did not pay their self-employment taxes, and the result was that the IRS garnished their royalty payments.
This means royalty income bypassed the artist/writer and went straight to the IRS until the tax debt, penalties, and interest was paid in full. Willie Nelson is one of the most infamous examples, in which federal agents seized various assets to satisfy Nelson’s estimated $32 million tax debt.
Hiring a trustworthy, experienced accountant to help navigate the choppy waters of self-employment is highly recommended, especially in light of recent tax reforms. For now, here’s how you can prepare for Tax Day and avoid any unforeseen disasters.
Pay Estimated Self-Employment Taxes Throughout the Year Based on Gross Income.
Most of the creative workforce in the music industry is under independent contractor status. For example, artists are not employees of their record company or the concert venues they perform in. Therefore, each artist is responsible for their own taxes throughout the year, based on both income (tax brackets) and self-employment (FICA, Medicare, etc.) numbers.
If you wait to pay all your taxes for the year in your return, it can result in underpayment penalties, so many self-employed individuals pay estimated taxes.
Save 25% To 40% Of Your Quarterly Gross Income.
Payments not received or postmarked on or before their due dates will often result in late penalty fees and interest tacked onto the original amount. Unless an artist can pay all of their estimated taxes a year in advance, the IRS is not cool with one lump sum tax payment for the year. The consequences of taking that approach on April 15th may result in more penalties and interest that carry forward to the next tax year.
Since you’re responsible for paying estimated taxes, setting aside 25% to 40% of your gross income is always a good idea. If you’re expected to pay $1,000 or more a year in taxes, then quarterly estimated taxes are due. Plan ahead!
Keep Good Detailed Records of All Expenses.
Self-employed people typically file a Schedule C, which lists all the expenses of their business. If you’ve paid estimated tax throughout the year, it is much more likely you can break even or receive a tax refund based on Schedule C expense deductions.
If you paid any other independent contractors $600 or more in a year (e.g., studio musicians, producers, mixing, and mastering engineers), the IRS will require a 1099-Misc Form to qualify for those deductions. In other words, keep track of big expense items because you’ll need the documentation to get the deduction.
The most common mistake here is (a) getting greedy with expense deductions; or (b) taking deductions without proper documentation.
An example of the former is trying to deduct your entire mortgage if you only use one room for business purposes like recording and producing. You can only deduct a portion of your mortgage payment as a business expense based on the room’s square footage relative to the entire house.
An example of the latter would be paying a mastering engineer $10,000 in fees, but not issuing or filing a 1099-Misc to properly document the expense. Big expenses look suspicious without any proper documentation, which could trigger an audit.
What’s more, if you show a loss for several years in a row, the IRS can reclassify your business as a “hobby,” which means you can’t deduct losses as a business anymore.
So the moral of the story is:
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Set aside a nice cushion of estimated tax payments
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Pay them quarterly
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Keep good expense records
All under the guidance of a tax professional, of course. If these simple steps are followed with diligence and integrity, there should be nothing to fear on Tax Day.
This article was originally written and posted on Royalty Exchange. To make sure you're collecting all your mechanical and performance royalties globally, register today.
