Tax Shelters for the Working Artist

What is a tax shelter?

The term “tax shelter” may conjure offshore accounts and shell companies, but in fact it is just a way of reducing your taxable income. Abusive tax shelters are illegal, but there are many legal ones that are actually set up by the US government to encourage Americans to set aside money for important things, like health care, child care, college, and retirement. I want to discuss a subset of these tax shelters, the Flexible Spending Accounts (FSAs) and the Healthcare Savings Accounts (HSAs) which came up in my previous piece on artist taxes. These accounts allow you to set aside up to a certain dollar amount tax-free to pay for qualified expenses. What you set aside gets subtracted from your taxable income, reducing your overall tax liability. Many of these programs have open enrollment periods in November, so just in time, here is a primer on this group of tax shelters for the working artist.

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What Makes An Artist Special? Nothing, According to the IRS

Being poor for art has a shelf life. It’s important to be brave enough to sacrifice potential revenue and follow your dreams, but to make a career in the arts happen, eventually a sustainable income and lifestyle has to be secured. Part of getting there, is knowing how to handle your taxes. Learning the ins and outs of this part of your practice will help you get through the tough times and the boom times.

We’ve had our fair share of both over here at AFC, so we thought a few questions to an accountant might be useful not just for our readers, but for our own, self-serving purposes. In the following Q&A with accountant Hannah Cole, we tried to discern what, if anything was unique about artists taxes, how creatives can get the biggest tax breaks, and whether they should attempt to do their taxes on their own. The answers were eye-opening. 

AFC: Are artist taxes unique?

Hannah Cole: Not really. If you’re receiving money from your work as an artist, you are running a small business. As such, you file a Schedule C (aka Profit and Loss from Business), which is an attachment to your regular individual tax return.

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Can I Get a Tax Deduction For the Artwork I Donated? Short Answer, No

Here’s the scenario: Your friend at Charity X wants you to donate one of your paintings to their upcoming fundraising auction. You’re on the fence, but she mentions the tax deduction, and so you agree. After your painting sells at the event, you get a letter from Charity X, intended for your tax records, stating the price your piece sold for.

This scenario is misleading to the artist. The charity is implying that you can take a tax deduction that you are not actually entitled to.

I want to pause and say that I think most charities are doing good work and don’t intend to mislead artists. But many of them hope the rosiest possible scenario is true, and haven’t checked the facts.

So here they are.

Your painting is what the IRS calls a “self-created asset.” As such, the rules are clear: you can only deduct the cost of the materials. And let’s face it — for most artists, much of the value is in the labor — the materials by comparison are minor.

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Estimated Quarterly Taxes for the New Freelancer

Last Love Song, Silica and Pigment on Linen, 24" x 20", 2014, by Matt Phillips

In my last post, I addressed a common dilemma for the new freelancer - an unexpectedly large tax bill in April. I explained self-employment tax, and why it catches so many people off guard. In this post, I’ll explain estimated quarterly taxes, which are the solution to that huge April tax bill.

You’ve newly struck out on your own, and you had your first profitable year as a freelancer. Congratulations! But when you prepared your taxes, you were blindsided by the enormous tax bill. You got a crash course in self-employment tax, and now you’re ready to set yourself up better for next year. It’s time for estimated quarterly taxes.

ESTIMATED QUARTERLY TAXES – WHAT THEY ARE

Our tax system is called “pay as you go.” If you’re employed, your employer withholds taxes from your paycheck each pay period, so that at the end of the tax year, you should have already paid in approximately the amount of taxes that you owe. When you overpay, you get a refund, and when you underpay, you owe some more tax on top. But the idea is that you don’t pay all of your taxes for the year at one time - for almost everyone, setting aside that much money would be difficult.

When you freelance, there’s no employer to withhold tax for you, so it becomes your job. (Yes, another burden of the gig economy). Everyone knows, and that includes the IRS, that it’s much harder to pay one big bill than several small ones. So to approximate the withholding situation of an employer, the IRS requires freelancers who owe at least $1000 in tax to make estimated quarterly payments.

It may seem yucky to have to pay taxes four times a year instead of just once, but it’s a good thing. Breaking it up into quarters makes the payments much easier to handle. And you avoid an unpleasant surprise in April.

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Self-Employment Tax for the New Freelancer

Rikki and Carrie, Dining Room. Carrie Will, 2008

From the series entitled, I am redundant, half of a whole, a freak, identical and lucky.
Courtesy Novado Gallery, Jersey City

SELF EMPLOYMENT TAX IS TWO IDENTICAL PIECES, EACH 7.65%, TOTALING 15.3%

You’ve dreamed of quitting your job and striking out on your own. You’ve gathered some clients, or sold some artwork, and suddenly this year, you’re making some real money. But then you hit a speedbump. You file your taxes this year and discover that you owe money - a lot of money - that you didn’t expect to owe. Uh oh. This is a rude surprise that many freelancers encounter when starting out. The good news is, you’re making money. But the bad news is that anytime you make money, the government wants its share. And for a lot of freelancers, that share is a lot bigger than they realized.

Here’s why.

SELF EMPLOYMENT TAX, EXPLAINED

Our tax system is “pay as you go.” Everyone is supposed to pay taxes all year long, as they earn income. When you work as an employee, your employer takes care of the logistics for you - they withhold 7.65% from your paycheck for Social Security and Medicare (also known as FICA). In other words, you are paying the Federal government 7.65% of your paycheck towards Social Security and Medicare, but you don’t have to think about it. In addition, your employer pays, out of their own pocket, another 7.65% towards Social Security and Medicare, on your behalf. This is called “payroll tax.” If you’ve ever wondered why so many businesses try to pay people as contractors (reported on a 1099) and not as employees (reported on a W2) - this is the reason. It automatically costs them 7.65% extra to treat you as an employee. (And it is fair and contributes to a healthy society, if I may say so).

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