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Taxation & tax deductions for the self-employed visual artist
By Peter Jason Riley, CPA
Artists and taxes don’t seem to mix very well. Taxes and administrating the business of art are often last on the list of concerns for the visual artist. The artistic temperament simply does not interface well with the exacting rule-filled world of federal and state taxation. Artists tend to avoid the whole matter and consequently leave themselves vulnerable to bad advice. The secret to overcoming this phobia is to develop an understanding of the mechanisms of the tax code and some simple, effective ways of complying with this onerous task. I often use the analogy that you may not need to know how to fix your car but it is helpful to know how it basically works. In so doing you will pay less in taxes and you will be less likely to fall prey to erroneous tax information and disreputable or ill-informed advisors.
A majority of visual artists are considered “self-employed” in regards to filing their taxes. In a legal and taxpaying sense this means that your “business” as an artist and you as an individual taxpayer are one and the same. There is no legal separation, such as one would have in a corporation, partnership, LLC or other legal entity. The artist usually files a “Schedule C” as part of their regular 1040 income tax form, which is where you report your art income and expenses. The artist may file a form 8829 for the home office (studio) deduction and will also be required to pay self-employment tax (Schedule SE) on your net income (profit) as well as federal income tax. All these forms are part of the year-end 1040 income tax filing. As a self-employed artist, you will usually be required to pay estimated quarterly taxes using Form 1040-ES if your Federal tax liability is over $1,000 for the year.
The goal is first and foremost to lower your taxes! The artist has a number of tax deductions that are unique. In the balance of this article I will try to break them down to their component parts to make the issues understandable. For the IRS all deductible business expenses are those that are:
- Incurred in connection with your trade, business, or profession
- Must be “ordinary” and “necessary”
- Must “NOT be lavish or extravagant under the circumstances”
It does not take much analysis to see that these guidelines are not an exacting science. The artist has a large group of basic expenses that easily fit the above criteria: travel (hotel, meals, etc.), vehicle and transportation costs, equipment, art supplies, home studio expenses, legal and professional fees, gallery costs & commissions, etc (see our attached list). Let’s review some of the more complex and contentious deduction areas.
Is Being an Artist a Business?
The first hurdle visual artists often have is the question regarding whether their “art” is indeed a business for tax purposes. The heart of this matter is whether the I. R. S. sees the endeavor as a real “business” or as a “hobby.” Because the artist’s ventures often (sadly) yield losses, the question then becomes when the tax code determines an enterprise to be a true business as opposed to a hobby. Here's how you may be affected by these so-called “hobby” rules.
Although you must claim the full amount of income you earn from your hobby, hobby-related expenses are generally deductible only to the extent of income produced by the activity. So if you don't generate any income from your hobby, you can't claim any deductions. What's more, even those hobby expenses which can be deducted are subject to an additional limitation: they are considered miscellaneous itemized deductions on Schedule A, which are deductible only to the extent that they exceed two percent of your adjusted gross income. In contrast, if your activity can be classified as a bona fide business, you may be able to deduct the full amount of all your expenses by filing a Schedule
C. In short, a hobby loss won't cut your overall tax bill because the tax law stipulates that you can't use a hobby loss to offset other income.
Converting your hobby into a bona fide business means you can deduct a net loss from other income you earn, such as wages and salaries. How does the IRS determine whether your activity is a hobby or a for-profit business? The Internal Revenue Service publications discuss these nine criteria:
- Whether you carry on the activity in a businesslike manner.
- Whether the time and effort you put into the activity indicate you intend to make it profitable.
- Whether you are depending on income from the activity for your livelihood.
- Whether your losses from the activity are due to circumstances beyond your control (or are normal in the start-up phase of your type of business).
- Whether you change your methods of operation in an attempt to improve the profitability.
- Whether you have the knowledge needed to carry on the activity as a successful business.
- Whether you were successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years, and how much profit it makes.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
The primary determinant is your ability to make a profit at what you are doing. If your efforts result in a profit in three out of five consecutive years, your activity is presumed not to be a hobby by the IRS. If you don't meet the three-out-of-five years profit rule, is all lost? Not necessarily, if you can prove to the IRS's satisfaction that you have made a genuine effort to earn a profit and that the reason you are not successful is related to special circumstances, the IRS might agree that your art is, in fact, a business. This is often true for individuals engaged in the arts, where profits and successes are difficult to achieve. To increase your chance of gaining the IRS's recognition of your business, I recommend that you run your activity in a professional, businesslike manner. Doing such things as having business cards and stationery printed, maintaining a separate business checking account and telephone number, keeping accurate records of the time you put in, and carefully documenting all business-related expenses. The Internal Revenue Service places great credence on computerized accounting records as evidence of the artist’s “businesslike” intent. Keep records of all show entries (even including ones that you don’t get into) and all gallery activity. In short anything related to attempts to sell your artwork.
Income for the artist includes amounts paid to the artist for their artwork. Income for the artist also includes prizes, awards, fellowships, and endowments received. There is also the concept of “taxable income other than cash.” This includes trades of art between artist and other individuals. For example: an artist agrees to “sell” a painting to another artist by exchanging artwork. The painting that the first artist gives up “costs” $75 (the cost of paint, canvas, and framing). The artwork received has a market value or price of $1,000. The first artist will have a taxable income from this transaction of $925 ($1,000 less $75). In other words the artist received something worth $1,000 but only paid $75.
Inventory is often problematic for many artists; I often get blank stares when I ask the question at tax time. The inquiry concerns the artists cost at year end of the artwork that has not yet been sold, this is the artist’s inventory.
Not to get too technical, but the calculation of inventory is primary in arriving at “cost of goods sold.” In other words, my direct materials deduction for tax purposes is (1) the direct cost of all material used in the production of finished art work; materials, framing, printing, etc LESS (2) the finished artwork held at the end of the year (ending inventory).
Some artists (being cash based taxpayers) can ignore this process altogether because the direct product costs are relatively minor (a potter comes to mind), but for most fine artists, photographers, etc. the cost of framing alone can be sizable enough to require addressing ending inventory.
On the tax return the calculation looks something like this: