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Hello
everyone it’s getting close to "that time"
again. The last time ( Guitar Maker Issues 46 & 48-last
year) I wrote an article on this topic I discussed what
type of tax entities were available and the pros and cons
of each. In this article I am going to talk more about changes
in the tax code for this year (2004 returns). As most of
you already know the changes are vast, and affect just about
everyone. I can’t go into all of them in this article
but I will touch on those that may have an effect on you
…the Musician / Luthier.
Individuals
Tax Rates – taxpayers with taxable
income less than $100,000 generally compute their tax using
tax tables published by the IRS. Most others with income
over $100,000 utilize the tax rate schedules also published
by the IRS. Depending on your Filing Status the rates range
from 10-35%.
Personal Exemptions – A taxpayer
usually can claim a personal exemption deduction ($3100
for 2004) for him/her self and for his/her spouse (if filing
a joint return) and for any qualifying dependents.
Standard Deduction – An Individual
taxpayer takes, either- a Standard Deduction, or Itemized
deductions (schedule – A). You can’t take both.
Generally you compute your Itemized deductions compare it
to your Standard deduction and take the one that is higher.
For 2004 the Standard Deduction has increased to $9700 for
married filing jointly and surviving spouses, $7150 for
heads of households, and $4850 for all other Individuals.
There are some other additional amounts for the aged, and
blind. There are also limits based on whether you can be
claimed on someone else’s return. So read the instructions
carefully.
Capital Gains – Capital Gains and
Losses are still reported on Schedule – D and tax
is computed using several different worksheets depending
on the type of Capital gain or loss. Most taxpayers with
net capital gain or qualified dividend income will use a
special worksheet. The rates, depending on the type of gain,
the holding period, and your income tax bracket range from
5% to 28%.
Sale of Personal Residence – Code
sect. 121 allows a taxpayer to exclude $250,000 ($500,000
if married filing joint) of the gain from the sale of his/her
principal residence. Ownership and Use tests must be met
for the exclusion to be allowed. There are some exceptions
such as unforeseen circumstances, change of employment and
heath issues which might allow the taxpayer to take the
deduction even if they don’t otherwise meet all parts
of the tests.
Above the Line Deductions – There
are many "above the line" deductions. This simply
means that these deductions are taken when computing Adjusted
Gross Income and without regard to Itemized deductions.
You can take these even if you Don’t -(bold) Itemize!!!
I won’t go thru them all in detail but some of these
are:
Educator Expenses:
- Performing
Artist Expenses
- I.R.A.
contributions
- Student
Loan Interest
- Tuition
and Fees
- H.S.A.
contributions
- Moving
Expenses
- Certain
Retirement Plans
- Clean
Fuel Vehicles
- Archer
M.S.A. contributions
- Alimony
paid
Itemized Deductions – Some are limited to
calculations/worksheets and Adjusted Gross Income they are:
* Medical and Dental expenses
* State and local income taxes
* Real Estate taxes
* Sales Tax
* Investment Interest (limited)
* Mortgage Interest
* Charitable Deductions
* Casualty ad Theft Losses
* Job related expenses
Personal Tax Credits – these are real savers
because they actually reduce your tax bill dollar for dollar
they vary and can be quite complicated to figure out. Some
examples are :
* Earned Income Credit
* Dependent and Child Care Credit
* Education Tax Credit
* Child Tax Credit
* Adoption Expense Credit
* First Time Home-buyers Credit (only in District of Columbia)
* Electric Vehicle Credit
Tax Benefits for Members of the Military – members
are entitled to several exclusions such as the exclusion
of combat pay and certain military benefits. Also, no income
tax is due if a member died in combat or from injuries sustained
while in combat. Congress has gone even further and allowed
the surviving spouse to claim for refund of all tax paid
on an already filed return.
These
are just some of the deductions, credits, exclusions and
other items that may have an affect on your Individual Income
Tax bill/refund this year.
Now,
on to some BUSINESS PROVISIONS that have changed or may
have an affect on the Luthier. As you may remember in my
article (volume 46) on different business entities I highly
recommended that those of you with Large Gross profits or
Net Income consider forming a corporation and electing "S"
status. I also highly recommended that you seek a Licensed
CPA to help you determine which business entity best suited
you. If you have not done so I once again Strongly urge
you to do so. The beginning of the year is the time to take
positive action to minimize next year’s tax bill.
The
Luthier / Musician Business-man
Whether
you are a working Musician or Master Luthier the business
is no different than other businesses as far as the IRS
is concerned. Just like a Store Owner, a Roofer, a Candlestick
Maker or General Motors there are certain tax codes that
apply the same to all of us. Know that a regular corporation
(a "C" corp.) is no different from any other "C"
corp. when it comes to Income, Deductions, and Rate of tax.
So even a small "mom and pop" operation is expected
to have a set of books, keep corporate minutes, and act
like the "big" corporations due (no co-mingling
of funds etc.) The I.R.S. is ever increasingly asking owners
of these small corporations to produce all these items/documents
(minutes of board meetings, corp. resolutions etc.) to see
if a true corporate atmosphere exists. When one does NOT
exist great peril falls upon the corporation and its’
owners. Usually the I.R.S. will attempt to constructively
dissolve the corporation and treat it like a Sole Proprietorship.
This can really cause serious hardships tax-wise on the
owners/shareholders. SO A WORD TO THE WISE…DO WHAT
IS REQUIRED. Don’t put yourself in that position.
I
am often asked what is Deductible? My answer always is "everything
as long as". As long as there is a business/profit
related connection. If I attend the ASIA Symposium or NAMM
to learn and see the new (or not so new) techniques of my
fellow luthiers/musicians… my expenses and the cost
of the symposium is generally deductible. If I bring my
wife, who is not employed by my luthier business or my band
and has no other connection…, her portion of the expense
is NOT deductible. If I buy new tools, machines, certain
parts they are all part of my business and therefore deductible.
The METHOD of deduction might be varied however depending
on what it actually is that I bought. For instance, I build
a new spray booth that is a room in the back of my shop.
Is that deductible?…yes, BUT because it is attached
to the building and is a "room" it is considered
as being a 39 year capital asset (27.5 if in your house).
Therefore, it cannot be expensed, but must be depreciated
over 39 years. If however, I build a jig to align the drilling
of holes for tuning keys in my headstocks, that is a tool,
and would probably have a life of say 5 years (category
wise). Because I made it, I could not add my labor to its
cost…only the materials used to make it. If I bought
the same jig from a vendor/maker the full cost including
shipping would be deductible. So when looking to whether
or not an item is deductible ask yourself is it related
to the production of income. If it is, it is generally deductible.
Remember taking your CPA to lunch or dinner is deductible
if you discuss business. So is the cost of delivering your
instrument to the performing artist. You personally deliver
the instrument and attend the concert to make sure all is
in proper working order as well as to determine that the
instrument is functioning to the artist’s specs. Deductible.
Now if you order a case of Dom Perignon and throw a big
party afterward that might be questionable although could
be defendable especially if other artists were there and
able to peruse the instrument and or others that you brought
along. A lot of these things are not absolutes. The IRS
can and does win when some of these things are pushed to
the limit. So use your noodle and think before you leap.
Some recent and not so recent tax laws affect the Incorporated
as well as the Un-incorporated (sole proprietor) some of
these are as follows:
Self
Employment Tax – Every non-incorporated taxpayer
who has self-employed income / profit for the year must
pay self-employment tax in addition to any other "income"
taxes. Self-Employment tax is a tax that is the Social Security
and Medicare taxes that would normally be paid by employers
and their employees. It doesn’t matter how old you
are. Just because you are now old enough that you can work
and not have your Social Security check reduced you are
still subject to S.E. tax. You must file Schedule SE and
compute and pay the tax if you had profit of $400 or more
for the year or if you had church employee income of $108.28
or more for the year.
The tax itself is 15.3%. This means if you had $5000. profit
for the year and owed NO INCOME TAX you would still owe
$765 SE Tax! There is a ceiling on the Social Security portion
(12.4% of $87,900) the Medicare portion (2.9%) continues
on without out limitation. These laws are not new but need
to mentioned because they are one of the biggest parts of
the Small Business mans’ tax bill.
Which
form do I use? – Individuals who are un-incorporated
use form 1040 Schedule-C to report all income, expenses,
depreciation and other related information. I will discuss
these in more detail:
Income – all sources of income received by you for
the goods or services you provided. Some taxpayers are on
an Accrual basis of accounting and must report all income
even if they have not been paid. Cash Basis taxpayers, which
most S.P.’s are , report income when received. But
don’t be fooled…you get paid for a guitar you
delivered or a gig you played on 12/26/xx and decide to
deposit it into the bank on 1/1/xx thinking you have shifted
income from one year to the next. WRONG! IRS says no way…penalties
and interest if they catch you!
Deductions – This is a big category and probably
should/could be a whole book. Briefly:
1. Auto/truck use – keep track of all mileage. That
means business miles as well as personal miles. What’s
business mileage ?– you guessed it any mileage related
to the business…lumber yard, hardware store, delivering
a guitar, post office, or any other business related destination.
What is personal mileage ? – going to the grocery
store, picking up the kids from school, driving to your
shop from home and vice versa. The reason we keep a Log
of mileage is because the IRS wants us to produce one if
they audit that part of the return. They specifically ask
the question on the return…do you have evidence?...is
it written? Answering no to either or both of these is one
big jump toward an audit. The best reason for keeping the
log is that we get to take a deduction for the amount /
percentage of business use. Compare total operating costs(
plus depreciation) for the year (after applying the business
use percentage) to the Standard Mileage rate ( 37.5 cents
per mile) applied to the business miles and which ever is
higher is a deduction against the S.E. income . Good deal
when considering we want to get S.E. income as low as possible
to avoid paying S.E. tax.
2. Depreciation – This is usually
the largest and most important deduction on an Individual’s
Schedule –C . It is computed on form 4562. Depreciation
is simply the expensing of an asset that has a given life,
over that assets life. For instance…most hand tools
or other similar items might be considered 5 year property
and therefore written off ( expensed) over a 5 year period.
This is true for all other assets. The IRS has description/asset
classification tables and based on these class lives we
write off the assets against business income over given
periods of time. This can work out quite well in some years
and actually create a "paper only" loss. We get
to deduct the "paper" loss against other income
that we may have. There is also a form of depreciation that
is called accelerated depreciation or Section 179 depreciation.
This is a great deduction in that we can take the full depreciation
all in one year, depending on the class of the asset. Section
179 is tangible property that is acquired by purchase and
for use in an active trade or business. There are many limitations
and qualifications that must be met in order to use this
portion of the code. Suffice it to say that you can NOT
create a loss using 179. You can however take enough to
bring your Schedule-C income down to zero. Thereby eliminating
SE tax.
3. Other Expenses – these are as previously
discussed but here are just a few:
* Advertising
* Office supplies
* Insurance
* Loan interest
* Professional fees
* Rent
* Material used
* Supplies
* Wages paid
* Payroll taxes
* Other taxes/licenses
* Bank fees
* Travel
* Entertainment (limited to 50%)
* Other employee benefit programs
* Auto cost
* Dues / subscriptions
* Telephone
* Guitars and Strings
* Internet fees
* Anything else directly related to the production of income
This
should be enough to get your head spinning (mine is). In
my next article I will discuss some of these deductions
in greater detail as well as talk about something that most
Luthiers and Musicians don’t give enough attention
to: RETIREMENT PLANNING and plans!
In
the mean time … HAPPY LUTHIERY! HAPPY MUSIC MAKING!
GBWYA
David
S Bland, CPA, Luthier, Musician and other things...
Contact me:
cpa@siestakeyguitars.com
snail mail to:
David S Bland, CPA, Luthier
2100 Constitution Blvd. Suite 118
Sarasota, Fl. 34231 |
