'Financial Management for Musicians' Author Offers
Tax Tips (Part I)
By Doak Turner,
Songwriters Guild of America Nashville Office recently hosted a
tax and accounting seminar with Certified Public Accountant Cathy
McCormack of Nashville, TN. Cathy McCormack is co-author of
the book, "Financial Management for Musicians," (Hal Leonard) by
Pam Gaines and Cathy McCormack. Many of McCormack's clients are
musicians and songwriters. "Financial Management For Musicians"
is the title of the book, but she says it is really more about organizing
your financial life for what she calls this business of music. Below
is a summary of her presentation:
McCormack Let's talk about the myths of money management and
audits, to start the event. The definition of a hobby has several
factors, and includes a test to determine whether there has been
a loss in three of the proceeding five years. That is just one of
the criteria in determining whether or not you have a hobby. A hobby
can exist with respect top raising horses, painting, writing or
anything that you can get involved in. They could be considered
a business or a hobby. There are a lot more criteria to consider,
and one important and significant issue is whether you have intent
to make a profit.
Most people who launch into something that takes eighty
percent of their time obviously have a profit motive. Your job is
to prove that you have a profit motive and to keep good records
to show how much time that you spend on the business. The time issue
is extremely important. Keep your calendar in outlook or a manual
calendar or on post-it notes, whatever that you do to document your
schedule. It is one of the leading ways to prove that you have spent
substantial time in trying to produce profit.
[Question] Should you
keep track of time and expenses after your first two years of losses?
Cathy McCormack This is something that you
should have for every year you are in business. When people first
start to write, they do not think of it as a business so they don't
track time or expenses very well. Some people knew from the minute
that they are born what they wanted to do and immediately launched
into it. When people get started in songwriting and have a different
career "day job," they tend not to keep good records. Then they
hear they cannot take losses for three years in a row, so they do
not even bother with keeping the records.
encourage you when you first start writing songs to keep track of
your expenses, keep a good calendar, and track of everything that
would help your accountant to support what you are doing for your
songwriting career. You can show losses your entire life. Many people
fear of getting audited and will not deduct their expenses. Don't
lose opportunities for fear of the audit myth. Take your losses
every single year.
I have had clients get audited because they have taken
losses over a period of years. I represented them, proving profit
motive and everything was fine. Two years ago a client was audited.
He has a studio in his home, has been writing all his life. He has
a wife who has made money and she off set her income with his losses.
He had a big hit and is going to start showing substantial profit,
which solidified the fact that he is a writer with profit motive.
In addition, he had a calendar and sufficient data to show that
he spent his life trying to launch this business.
There was a court case about ten years ago with respect
to a painter that was audited and the IRS agent ruled the painter
had a hobby. The painter had very good records; they went on to
tax court and the painter won, as the judge ruled it was a proven
fact that many artists did not become famous until after they died.
(Laughter in the room.) One time is all it takes to put you on a
map after all the years of working toward that goal. That court
case has been used several times in the music business and other
[Question] So you are
saying that you need a calendar to prove a profit motive?
Cathy McCormack You need a calendar to prove
the amount of time that you spent on your craft.
[Question] Is there a
minimum amount of time to prove you had a profit motive?
Cathy McCormack It is about you being a member
of organizations that support your efforts, keeping brochures and
pamphlets of seminars that you have attended, keeping records of
your co-writing appointments or interviewing people to get ideas.
You calendar is a support for the other things that you do with
your songwriting career.
[Question] The point
of the profit motive is for your taxes?
Cathy McCormack No, the profit motive is to
prove your songwriting is not just a hobby. It shows you are very
serious about it and you want to make money at the songwriting.
Make sure that you do act like a business, keep good records of
your time and expenses.
[Question] What happens
if you have many years of no income in the songwriting business?
Cathy McCormack That happens and that is OK.
You deduct it on a schedule C with your tax return and show your
losses against other income that you make during the year.
[Question] Is there any
rule about how much money that you can make and still have a loss
on your taxes?
Cathy McCormack You can have negative income,
but the thing that triggers an audit is to show an income below
the standards that the IRS has set that they feel you can live on.
To continue to show poverty level income on your return can trigger
an audit. They will audit you because they believe that you have
an income that you are not showing on your tax forms. I have represented
people in those categories. They ask how can you live and eat in
the kind of house and survive making this low amount of money? They
come in to make sure you are reporting all of your income.
[Question] I have been
living on inheritance in the past year. Is this going to trigger
Cathy McCormack If you have inheritance money,
you likely have it invested, and can show investment income. If
I were looking at your tax return, I would look to see how you have
been able to sustain those losses. If I saw that you had interest
and dividend income, then I would say this person has money saved
up that has sustained your lifestyle during the process of trying
to launch your business. Those kinds of things are taken into consideration
when the IRS triggers audits.
You would not get audited because you continue to
have losses. If you had no income at all and you showed losses and
carried those losses forward, then you would probably get triggered
for an audit because it looked like you had unreported income. If
they audit you, come in and find you clean, they put a note in your
file that says this was a clean audit. That establishes a good track
record for you. If you come back with those ratios mentioned previously
about audits, then they will probably skip you from an audit. If
they audit you and find errors, they can recommend that you be audited
in the future.
[Question] What about
forming your own publishing company for business and tax issues?
Cathy McCormack The type of entity is very
important and heavily debated of whether you should incorporate.
When you incorporate or form another entity, you are complicating
your life. It does supply a limited liability, which should be the
only reason that you incorporate. Joint relationships require a
second entity, and that can be complicated if there are substantial
dollars at stake. Then you need to incorporate.
[Question] What about
self-publishing. Do I need a separate entity?
Cathy McCormack No, you don't need to incorporate.
It is best if you keep it simple, not incorporating or forming other
types of entities. Even as you start to make money, people think
they should immediately set up a business and incorporate. Unless
you accumulate substantial wealth and in a risky business, there
is really NO reason to incorporate. It would make your life more
complex. There is this myth out there that it will save you taxes
if you incorporate and it is absolutely false - it will cost you
more money! You would also have to prepare more tax forms. It would
involve more income for us accountants, but it is not in the best
interest of the clients.
[Question] To collect
royalties, you have to have a name for your publishing, but you
do not have to have a separate business - right?
Cathy McCormack Yes - you could have a "dba"
(doing business as) and that will work for you. You are a sole proprietor
and it does not add an extra level of complexity.
[Question] I started
getting royalties in about 1990, was doing my own taxes, and filed
my royalties under schedule E. I even called the IRS and the agent
said what I was doing was OK. Later when I hired an accountant,
they said that was wrong. Could you explain a Schedule E?
Cathy McCormack Schedule C is where you report
self-employment income, an activity that you are involved in as
a business like your publishing company. Schedule E is for passive
activities such as activities that you are not heavily involved
in or rental properties. If you were a passive owner of an oil well,
then royalties would get reported on a Schedule E. It is not subject
to self-employment tax - social security and Medicare.
If you are a songwriter, you are actively involved
with the production of royalty income and as a result, that is considered
an active activity, not a passive activity. You will not win in
an audit if you put it in a Schedule E. If you inherit a song catalog
from someone and you were not the one who generated that money,
then it is correct to report royalties on Schedule E. If you are
involved in the writing of the songs, then put it on Schedule C
of your tax forms.
If you have had income in the past and you generate
what we call a net operating loss, that loss can be carried back
to years where you had revenue and you can recover taxes for years
past. You may be a candidate for loss carry back. If you had a loss
in the 2002 year, you can go back to 1997 though 1998, 1999 and
up to that particular year. For losses in 2003 and later, you can
do a two-year carry back.
If you are looking at your 1040 and have a negative
number on that bottom line, you have what is called a net operating
loss, and that loss can be carried back - use that loss against
income in the future, forward or against income tax that you have
already paid. You can go back to previous years, report the loss
against the income you reported that year, and get a refund for
the tax you paid for that particular year. You can carry the loss
forward for many years before those losses expire.
Someday, when you have income, you can use your current
losses to offset those incomes. You have three years to amend your
taxes and show those losses that you were afraid to show in the
past. You can carry your loss forward and tell the government that
is what you are doing, if you do not want to carry it backward.
As soon as I see a client that has an operating loss, I stop right
there, call the client and ask what is going to happen next year.
If they are expecting to make money the next year, as they may have
a song on a popular CD that will make money next year, they may
want to carry the loss forward.
equipment - for instance software that comes with a rebate - can
I use my credit card record as proof that I purchased this equipment
or do I need the original receipt?
Cathy McCormack You have to have a receipt.
The government is getting very sticky about using credit card receipts.
They accept if you can show that those deductions are legitimate
in other ways, but they prefer you use a receipt. If you get an
agent that is rigid, he or she may not take the credit card as a
Many times I have clients who buy equipment at a garage
sale and need a receipt. We have the garage sale owner sing a piece
of paper for documentation, or the client will note in their calendar
that they bought a piece of equipment at a garage sale. Cut out
the clipping in the paper about the garage sale to prove there was
a sale on that date.
[Question] What about
using your computer to keep track of your records for the year?
Cathy McCormack One of the best computer software
programs is Quicken for keeping up with your personal business.
You can use it to even just keep track of your checkbook and credit
cards. At the end of the year, you can print out the report for
your accountant to do your tax return. I just recently represented
someone in an audit that used Quicken and because the client had
great records, it really went very smoothly and quickly.
[Question] What kinds
of receipts does the IRS want to see when they do an audit?
Cathy McCormack They want to see the actual
receipts. In Quicken, you can import your credit card records. The
client I referred to had gotten rid of several of their receipts,
but luckily, still had some of the receipts. In the end, the agent
let us use the receipts that we had to justify expenses for the
year. The IRS wants actual receipts from the stores where clients
buy their products. A statement form the checkbook or credit card
company doesn't meant anything to the IRS.
[Question] What kind
of receipts does a songwriter need to keep?
Cathy McCormack If you deduct it on your taxes,
you need the receipts. Money in a parking meter is a deduction;
you need to write it down somewhere to show how it is an expense.
I keep a log in the side of my car door with an ink pen in the middle.
If I am somewhere and pay an expense like a meter or something,
I write it down beside my mileage and total it up at the end of
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