artist audit

What's the Deal with Receipts?

Look at all these tax deductions! These are my actual studio tools.

Look at all these tax deductions! These are my actual studio tools.

Here’s the confusion: You keep hearing that the IRS requires you to keep receipts and documentation for all of your business expenses. So why is your accountant annoyed when you try to hand her your receipts?

Here’s the story. Yes, you are required to keep receipts and documentation to prove each and every one of the business expenses that you deduct. That is the law. And here is the actual gospel, from the IRS itself. And here is a comprehensive list of what New York considers to be legal proof of your expenses. In case it’s not clear - and I get enough questions from people to know that it isn’t - the reason that you need this documentation, besides being a good practice for your actual business anyway, is that should the IRS or your state decide to examine your tax return, this is the proof of expenses they will require you to show them in order for them to allow you to keep those deductions. If you can’t, then you have just lost your audit, you may have a bad experience, and you will owe them money. You need to save these receipts and documentation for 7 years.

So why is your accountant irritable when you hand over receipts? That is another story. Tax season is super stressful. Most people, despite their intentions, don’t get their tax documents organized until a few weeks before the tax deadline, so your tax accountant has a drinking-out-of-a-firehose situation from about March 1-April 15. A lot of inexperienced taxpayers with freelance income don’t realize that they have a fairly big job to do before they can get their taxes done - that is, they need to do their bookkeeping. They need to tally up their receipts and income, and put it into some basic expense categories. Here’s a beautiful chart to help you with that. If that’s intimidating to you, hiring a bookkeeper is a great idea. Your bookkeeper can help you put things in the right categories, teach you how to maintain your own books, answer your questions and set you up with a system that works well for you. A good bookkeeper is worth the money.

So keeping your books is a requirement if you run a business. And if you’re a freelancer of any kind, though you might not have realized it, you are running a business. My course The Ultimate Honest Guide to Understanding Artists’ Taxes is a great primer on the need for good books and records and gives great insight into what happens in an artist/creative worker audit. It’s one hour, and very worth it.

So showing your accountant your receipts says that you haven’t done your bookkeeping, that you probably don’t realize that you have a sizeable job ahead of you, and that you probably need some coaching about the basic tax rules.

This is totally understandable. You’re just a bespoke latex dog-costume designer, not an accountant! This might even be your first year freelancing. But your accountant is facing an immovable deadline with an obscene flood of work. So if she’s not keeping up with her loving-kindness meditation, she might get grumpy with you. As a person who was new at my arts practice once, and as a tax accountant, I’m advocating for understanding in both directions here.

So with that, here are some basic guidelines for you:

  • Bookkeeping. If you have a system that isn’t working, pay a bookkeeper to look it over for you, or take a bookkeeping course yourself. Good bookkeeping is a question of habit. So schedule a regular time to do it.

  • Saving receipts. The law says that if you can’t produce the receipt to prove it, it never happened, and you can’t deduct the expense. Your bank and credit card statements aren’t enough. For meals and entertainment, the documentation requirement is even stricter: the receipt must be accompanied by the name of the business contact you are meeting with, plus the reason for the meeting. A receipt alone will not suffice. Personally, if I don’t grab a pen and jot these things down at the moment I am handed the receipt, I will never do it. So that has become my personal habit – I write directly on my receipts, and the save them in a file folder.

  • Some people are handy enough with their phones that they snap a picture of every receipt (many accounting softwares integrate a receipt-saving feature like this, and there are stand alone apps dedicated to it). I am not fast enough with my phone for this to work for me, but if you are, it is a great method for keeping your receipts.

  • Keeping a calendar. In the days of Google calendar, you probably have one that is pretty good already. But you might not realize that this can be an important document to show your business activity in the event of an audit. Your calendar can be used to show the amount of overall time you spend on your arts practice — and that means everything from making the actual work to networking, marketing, and bookkeeping.  Your calendar can also show who you met with and for what purpose. This may corroborate other parts of your documentation, from travel expenses (your calendar shows the meetings you had set up in your travel location), to your meals expenses (meeting the strict substantiation requirement of who you met with and for what purpose).

  • Maintaining important correspondence that shows your effort to grow your career. You may still snail-mail out old-school introduction packets to museums (and be sure to save those receipts if you do!), but you almost certainly reach out to art world people over email. In the days of searchable email, this is a lifesaver. If you use an email folder system, consider saving this correspondence into one place (ie. “gallery + museum correspondence 2018”), so that in the event of an audit, you can produce this important evidence of your businesslike intentions quickly and without having to rely on your memory.

  • Maintaining your arts inventory. In Susan Crile’s drawn-out audit, her professional inventory system weighed heavily in her favor to prove that she was a professional artist and not a hobbyist. How do you track your art inventory? Having an up-to-date document that shows what you’ve produced and where everything is is an important tool in your arsenal.

  • Tracking mileage. I went over the details of mileage tracking in my Miami travel expense post. But here’s a tip: go out and record your car’s odometer reading right now. And while you’re at it, set an alarm on your calendar to do this the first day of every year. Because tracking your business mileage means not only tracking the number of business miles you drove this year, you also must record your total miles for the year. By recording your odometer on day one, you have both your ending mileage for last year, and your beginning mileage for this year. Two birds. One stone.

MileIQ is one of several mileage apps that use the location detection on your phone to automatically record your mileage. Similarly to Xero Taxtouch, you swipe left or right to categorize drives as business or personal. You can also track the things people often don’t – volunteer miles driven (deductible at 14 cents/mile, if you itemize) and medical miles driven (ditto, but 17 cents/mile, with a high threshold before it’s useful). The free version doesn’t capture everything, so it’s useful to get the full version. And it’s a deductible expense! You can get a 20% discount by using this code: HCOL124A

 

DISCLAIMER: True tax advice is a two-way conversation, and your accountant needs to hear your full situation to apply the rules correctly in your case. This post is meant for general information only. Please don’t act on this alone.

Here’s the confusion: You keep hearing that the IRS requires you to keep receipts and documentation for all of your business expenses. So why is your accountant annoyed when you try to hand her your receipts?

Here’s the story. Yes, you are required to keep receipts and documentation to prove each and every one of the business expenses that you deduct. That is the law. And here is the actual gospel, from the IRS itself. And here is a comprehensive list of what New York considers to be legal proof of your expenses. In case it’s not clear - and I get enough questions from people to know that it isn’t - the reason that you need this documentation, besides being a good practice for your actual business anyway, is that should the IRS or your state decide to examine your tax return, this is the proof of expenses they will require you to show them in order for them to allow you to keep those deductions. If you can’t, then you have just lost your audit, you may have a bad experience, and you will owe them money. You need to save these receipts and documentation for 7 years.

So why is your accountant irritable when you hand over receipts? That is another story. Tax season is super stressful. Most people, despite their intentions, don’t get their tax documents organized until a few weeks before the tax deadline, so your tax accountant has a drinking-out-of-a-firehose situation from about March 1-April 15. A lot of inexperienced taxpayers with freelance income don’t realize that they have a fairly big job to do before they can get their taxes done - that is, they need to do their bookkeeping. They need to tally up their receipts and income, and put it into some basic expense categories. Here’s a beautiful chart to help you with that. If that’s intimidating to you, hiring a bookkeeper is a great idea. Your bookkeeper can help you put things in the right categories, teach you how to maintain your own books, answer your questions and set you up with a system that works well for you. A good bookkeeper is worth the money.

So keeping your books is a requirement if you run a business. And if you’re a freelancer of any kind, though you might not have realized it, you are running a business. My course The Ultimate Honest Guide to Understanding Artists’ Taxes is a great primer on the need for good books and records and gives great insight into what happens in an artist/creative worker audit. It’s one hour, and very worth it.

So showing your accountant your receipts says that you haven’t done your bookkeeping, that you probably don’t realize that you have a sizeable job ahead of you, and that you probably need some coaching about the basic tax rules.

This is totally understandable. You’re just a bespoke latex dog-costume designer, not an accountant! This might even be your first year freelancing. But your accountant is facing an immovable deadline with an obscene flood of work. So if she’s not keeping up with her loving-kindness meditation, she might get grumpy with you. As a person who was new at my arts practice once, and as a tax accountant, I’m advocating for understanding in both directions here.

So with that, here are some basic guidelines for you:

  • Bookkeeping. If you have a system that isn’t working, pay a bookkeeper to look it over for you, or take a bookkeeping course yourself. Good bookkeeping is a question of habit. So schedule a regular time to do it.

  • Saving receipts. The law says that if you can’t produce the receipt to prove it, it never happened, and you can’t deduct the expense. Your bank and credit card statements aren’t enough. For meals and entertainment, the documentation requirement is even stricter: the receipt must be accompanied by the name of the business contact you are meeting with, plus the reason for the meeting. A receipt alone will not suffice. Personally, if I don’t grab a pen and jot these things down at the moment I am handed the receipt, I will never do it. So that has become my personal habit – I write directly on my receipts, and the save them in a file folder.

  • Some people are handy enough with their phones that they snap a picture of every receipt (many accounting softwares integrate a receipt-saving feature like this, and there are stand alone apps dedicated to it). I am not fast enough with my phone for this to work for me, but if you are, it is a great method for keeping your receipts.

  • Keeping a calendar. In the days of Google calendar, you probably have one that is pretty good already. But you might not realize that this can be an important document to show your business activity in the event of an audit. Your calendar can be used to show the amount of overall time you spend on your arts practice — and that means everything from making the actual work to networking, marketing, and bookkeeping.  Your calendar can also show who you met with and for what purpose. This may corroborate other parts of your documentation, from travel expenses (your calendar shows the meetings you had set up in your travel location), to your meals expenses (meeting the strict substantiation requirement of who you met with and for what purpose).

  • Maintaining important correspondence that shows your effort to grow your career. You may still snail-mail out old-school introduction packets to museums (and be sure to save those receipts if you do!), but you almost certainly reach out to art world people over email. In the days of searchable email, this is a lifesaver. If you use an email folder system, consider saving this correspondence into one place (ie. “gallery + museum correspondence 2018”), so that in the event of an audit, you can produce this important evidence of your businesslike intentions quickly and without having to rely on your memory.

  • Maintaining your arts inventory. In Susan Crile’s drawn-out audit, her professional inventory system weighed heavily in her favor to prove that she was a professional artist and not a hobbyist. How do you track your art inventory? Having an up-to-date document that shows what you’ve produced and where everything is is an important tool in your arsenal.

  • Tracking mileage. I went over the details of mileage tracking in my Miami travel expense post. But here’s a tip: go out and record your car’s odometer reading right now. And while you’re at it, set an alarm on your calendar to do this the first day of every year. Because tracking your business mileage means not only tracking the number of business miles you drove this year, you also must record your total miles for the year. By recording your odometer on day one, you have both your ending mileage for last year, and your beginning mileage for this year. Two birds. One stone.

MileIQ is one of several mileage apps that use the location detection on your phone to automatically record your mileage. Similarly to Xero Taxtouch, you swipe left or right to categorize drives as business or personal. You can also track the things people often don’t – volunteer miles driven (deductible at 14 cents/mile, if you itemize) and medical miles driven (ditto, but 17 cents/mile, with a high threshold before it’s useful). The free version doesn’t capture everything, so it’s useful to get the full version. And it’s a deductible expense! You can get a 20% discount by using this code: HCOL124A

 

DISCLAIMER: True tax advice is a two-way conversation, and your accountant needs to hear your full situation to apply the rules correctly in your case. This post is meant for general information only. Please don’t act on this alone.

Bio: Hannah Cole is an artist and Enrolled Agent. She is the founder of Sunlight Tax.

 

 

An Audit Nightmare Turned Artist Victory: An Interview with Susan Crile

Susan Crile in the Studio

Susan Crile in the Studio

American businesses sometimes lose money. Those losses actually create a tax shelter for other income. While the tax code explicitly provides this incentive for businesses – to encourage investment for growth, and to allow for unpredictable events – losses that go on for too long tend to draw scrutiny from the IRS.

If your arts practice loses money for more than a couple years, they may question the legitimacy of the business – specifically, the profit motive. Typically, they reclassify such a business as a hobby, and disallow the artist from expensing deductions past the point of their income from the activity. That’s bad news for any artist, but it was a near nightmare scenario for artist Susan Crile.

Crile spent eight years in tax court (from 2005-2013), defending her right to take losses. She is an accomplished artist by any measure. She has had over 50 one-person exhibitions, and her work is represented in dozens of museum collections, including the Guggenheim, the Metropolitan Museum of Art, The Hirshhorn, and the Cleveland Museum of Art. She is also a tenured professor of art at Hunter College.

However, despite this decades-long professional history, the IRS threatened to reclassify her art as a hobby, disallow her losses, and force her to pay over $80,000. In the end, Susan Crile won on the question of being considered a professional artist, and the precedent that her case set is that her day job was clearly judged to be a separate profession—not the reason for her art. But the judge did not rule on the allowability of her large deductions—that piece was sent to a settlement, and not all of the deductions were allowed.

In this interview, we discuss how she proved her case, what it took, and what she recommends for artists in a similar position.

Hannah Cole: First I wanted to thank you for putting yourself through what you have. You set a precedent that really helps other artists.

Susan Crile: I’m still recovering from it! I was very lucky that the law firm Cravath Swaine & Moore took it on pro bono, but my accounting was not taken care of pro bono. So I’m still getting my feet back from that.

HC: How did the audit start? I assume you got a letter in the mail and I want to know what went through your mind. (PSA to readers: an IRS audit always begins with a notice in the mail. If you receive a phone call announcing an audit, it is a scam.)

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