The Nitty Gritty: How To Prepare for Filing Your Taxes

Nobody likes filing taxes. But thinking ahead and getting your documents lined up reduce the stress of the process. Here are some key ways to prepare yourself for tax season, and get you ready to sit down to your own tax prep software or deliver an organized package to your tax preparer.

1. Download a 2016 tax year organizer. There are many available online. Mine is here. This will be your guide and checklist, and will help you see what you still need, and tell you when you’re done. Follow this guide.  Every accountant has a horror story about someone who, in the attempt to save themselves time, doesn’t read the organizer carefully, and causes no less than six follow up phone calls to chase down the information. Believe me when I tell you that a busy accountant in the heat of tax season will charge you extra for that kind of hand-holding. If you want to save yourself time (and money) on the tax process, have these materials fully prepared before heading to your accountant. 

2. Put your receipts, 1099-MISCs, W-2s and all your other tax documents in a folder. This can be virtual or manilla. But keep in mind...read more

Getting Organized: Financial Resolutions for Artists in 2017

As we enter a the new year, let’s take time to think about the priorities in our arts practices, and in our personal lives. You may roll your eyes at the idea of New Year’s resolutions, but there is evidence that writing down your goals actually helps you achieve them. So grab a pen, and let’s put some intention into 2017.

In my interview with artist Susan Crile about her eight year ordeal defending herself in US Tax Court, there was a lot of discussion about keeping records to prove the profit motive in one’s art practice. It brings up a good question for most of us: how are we doing on our own record keeping? If the IRS sent an audit letter tomorrow, would you feel good about the shape that your records are in? If the answer is not good, don’t panic. Here is a list of what you will need, and some thoughts on how to improve your record keeping going forward.

• Good Bookkeeping. Bookkeeping is important to any business. Without tracking expenses and growth, there is no way to improve your practice. It’s impossible to argue that you are actively trying to turn a profit when you don’t track your income and expenses. 

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

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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Your Miami Tax Guide: Yes, You Can Deduct That Pina Colada

After a few weeks diligently absorbing the dark, awful post-election news, I’m ready to turn my attention to fun, sun, and travel deductions for the Miami art fairs.

To review the basics, if you’re a professional artist with a profit motive, you’re reporting your income each year on a Schedule C (as part of your 1040 form), and the beauty in that is that it entitles you to list your income and your expenses. So as a self-employed person, you are paying taxes on the difference between those numbers (aka your “profit,” which is income – expenses), and not on the gross income you receive.

Travel expenses incurred in your arts business are one of the great deductions that you are allowed. A note of caution before you go expensing a bunch of luxury accommodations though: by law, your business expenses must be “ordinary and necessary” to qualify. This means that if the industry standard is a Motel 6, and you book the Ritz-Carlton, you may deduct only the Motel 6 amount. Further, travel expenses are a tempting area for tax abuse (along with meals and entertainment and home studios). If yours are out of proportion with the size of your business, or compared to your peers, you have an excellent chance of being audited.

Warnings aside, travel deductions are a great benefit, and here is how to make the most of them, in time for the Miami art fairs.

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How Donald Trump's Tax Plan Will Affect Arts Workers: There's Bad Stuff Coming

It’s been a terrible week. Tuesday’s election of Donald Trump has already damaged  the emotional wellbeing of our country and its citizens. He will do much worse in the long term.

Most immediately, many of us are feeling wrecked. I include myself in that group. I had  envisioned taking my daughters to the inauguration of the first woman President, and assured them that a bully and an abuser would not be chosen by the American people. Not only will we not see the inauguration of the first woman President, but a bully and an abuser has been chosen by the American people. This is not the history I’d hoped my children would live through.

In the long term, it’s less clear what this means for us as a nation. There’s no way to predict the future, but if we want to see any kind of positive outcome we have to start organizing now. There are a lot of ways to participate. We can join protests, reach out to our neighbors. My weapon of choice, though, is to begin with the process of self-education. We can’t fight against powers we don’t understand. As a tax expert, I intend to help.

With the upcoming push for regressive tax legislation, it’s important to understand what’s being proposed and how it will affect us both as individuals and in the professional field in which we’ve invested our lives. Some of these changes may have a profound impact on both the high and low ends of the art market and non-profit sectors, so we need to be prepared.

Tax reform – specifically, supply-side theory-based tax cuts for the wealthy and for corporations – is the one thing that Trump and Congress currently agree on. Our House Speaker Paul Ryan is a self-proclaimed “tax wonk,” (and he has already announced his plan to privatize Medicare). Trump’s plan has shifted over the course of the election, and his campaign speeches contradict his proposed policies. He has suggested that he would let Ryan take over the detail. There’s some bad stuff coming.

The details will shift as the President-elect and Congress hammer out their differences, but for now, let me provide an outline, and my assessment:

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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

image via c-monstah

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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The Second Best Time is Now

Or, investing for retirement, even when you’re not perfect

You’re having drinks with a friend after an opening, and the topic turns to money. Life is expensive, the city is expensive, and the distant menace of retirement? Forget it. You turn back to your $14 cocktail and feel depressed.

But wait. Aren’t you the same person who is taking charge of her career? Aren’t you setting new goals, prioritizing your studio time, building your network, learning how to market yourself? You’re smart, and you’re tackling the other hard stuff. So why are you cheating yourself on the bigger picture? You can do this. No need to let the perfect be the enemy of the good here. There is an apt proverb about planting trees: The best time to plant a tree was twenty years ago. The second-best time is now.

But first, a little digression about beauty. And compound interest.

Sara Jones, drawing on paper, 2016.

This is a drawing by Sara Jones. Beautiful, right? It has a lovely feeling of calm about it. Remember this feeling as you read on about saving.

I think saving for the long term can be intimidating, because it seems that we’ll need so much money that we just get overwhelmed. It’s easy to focus on the short term (My rent is so high! Childcare costs are ridiculous! How can I really cut any of my spending? How is $100 a week going to make a dent?). It’s easy to think “I’ll do that later, when I have more money.” But the difference between starting now or ten years from now is bigger than you think.

Now look back at Sara’s drawing. See the curve? That’s the image that should be in your mind as you think about saving. That’s what happens to your money. Why? Because of your friend, Compound Interest.  

There’s a lot of great explanation out there about the benefits of compound interest. But if you’re a visual person, like me, it’s really in the picture. So here’s another one, this time with numbers:

This is a chart showing what compound interest does to a one-time $5,000 initial investment. Don’t let the details throw you - the curve is the important part. The light orange part shows the money you put in. The dark orange part is all growth. When you put money in a savings vehicle (like an Individual Retirement Account (IRA), invested in index funds, which have a historic average growth rate of 8% - more on this in a future post), compound interest works to multiply your initial investment over time.

Here’s how it works: Your 5,000 earns 8% interest, so at the end of year 1, you have $5,400. The next year, you make 8% not on 5,000, but on $5,400, yielding $5,842. It doesn’t seem like much yet, but the magic happens near the end. So this little bit of money, after 40 years of compounding, turns into $108,622.61. Now we’re talking.

Now what happens if you make your $5,000 investment an annual habit? Basically, this curve gets steeper. That means you grow real wealth. Check it out:

It’s important to notice the numbers here. The chart reaches into the millions now, not hundreds of thousands. And the light orange part, which represents money you put in, is growing each year, as you make your annual contribution. So in forty years, you now have $1,507,527.81.

Compound interest is your friend. It means you don’t need to save as much as you might fear you do in order to retire.

But what if you wait ten years to start? On the first chart, your $5,000 is worth over $180,000 after 45 years. But after 35 years, ie, ten fewer years of growth, it’s worth about $90,000. That ten years cuts the money in half. Now you see why the first principle of retirement saving is “start early.”

And as a tax professional, I will tell you that your annual contribution limit to a tax-sheltered IRA is even a little higher than in my example. The 2015 limit is $5,500. And you have until April 15 to contribute for 2015 (yes, it’s retroactive). Opening one is as easy as opening a bank account. I recommend Fidelity or Vanguard.

So don’t let perfection stand in the way of action. Maybe you can’t put aside as much as you’d like, but you can put aside something. But don’t wait for some elusive “better time.” Remember the proverb about the trees? The best time to save was twenty years ago. But the second best time is now.

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.