New IRS Rule Spoils SEP-IRA for Musicians

The SEP-IRA has been a key retirement tool for self-employed and 1099 musicians, but its value just got unexpectedly reduced last month, buried in the details of a 249-page release of new IRS regulations. I’m afraid that many self-employed musicians who read this may want to fund a different type of retirement account or may decide to stop their SEP contributions altogether going forward. If you’re a W-2 musician, this doesn’t apply to you, and if you are strictly a W-2, you weren’t eligible for a SEP anyways.

The new regulations don’t directly change a SEP contribution – it’s still a tax deductible contribution. Self-employed musicians are also eligible for a new 20% tax deduction, called the Qualified Business Income or QBI deduction, officially IRC Section 199A. The QBI Deduction is new for 2018 as a result of the Tax Cuts and Jobs Act put into law in December 2017. 

The QBI Deduction is available to pass-through entities, including S-corporations, LLCs, and sole proprietors. You do not have to be incorporated, anyone with self-employment income (including 1099 “independent contractor”) is eligible. For “Specified Service Businesses”, including performing artists such as musicians, the QBI deduction is phased out if your income is above $157,500 (single) or $315,000 (married) for 2018.

(I’ve written about the QBI Deduction for musicians previously on my site HERE, as well as for the International Musician.)

What was a surprise announcement in the January 2019 regulations, some 13 months after Congress signed the new law, is that all self-employed people have to subtract any “employer paid retirement contributions” from their Qualified Business Income. It was previously thought this would only apply to S-corporations. This was not mentioned or hinted at in the legislation or in the regulations the IRS published in August. In fact, many tax software programs are having to be rewritten because of the January announcement. The SEP-IRA, even for a sole proprietor, is considered a type of employer-sponsored retirement plan, even though the employer and the employee are the same person.

It may be easiest to explain this with an example. Let’s say you make $60,000 as a self-employed musician and choose to contribute $10,000 to a SEP IRA. (In this example, I am assuming that your taxable income and your Qualified Business Income are the same, but in some cases, they will be different.) Now, instead of getting the 20% deduction on the $60,000 of Qualified Business Income, worth $12,000 off your income, you have to subtract your SEP contribution of $10,000 to reduce your QBI to $50,000. Now your QBI deduction will be $10,000, $2,000 less than if you had not made the SEP contribution.

Your SEP contribution reduced the value of your QBI deduction by $2,000, so instead of adding a $10,000 benefit, your SEP contribution only increased your deductions by $8,000. Another way of looking at this: if you are eligible for the QBI, you are only getting 80% of the value of a SEP Contribution, but 100% of your SEP contribution will be taxable when you withdraw it in the future.

And that’s a problem. The $10,000 you contributed to a SEP only provided an increase of $8,000 in deductions, but the full $10,000 will be taxable when you withdraw it later in retirement, plus the tax on any growth. Who wants to get an $8,000 deduction today and immediately have a $10,000 future tax liability? 

You might pay less in lifetime taxes by not making the SEP contribution, receiving 100% of the QBI deduction and then investing your $10,000 in a taxable account. The growth of the taxable account, by the way, could be treated as long term capital gains, which for most taxpayers is at a lower rate than the ordinary income rates applied to growth of your SEP (when withdrawn).

There are three additional solutions which you might consider rather than a funding SEP, given this new rule.

1. Traditional IRA. The Traditional IRA contribution will reduce your personal taxes, unlike a SEP, which is considered an employer sponsored plan. The SEP reduces the amount of your QBI deduction, but the Traditional IRA does not. However, there are two issues with the Traditional IRA:

  • The contribution limit is only $5,500 for 2018 ($6,500 over age 50). With a SEP, you could contribute as much as $55,000, ten times more than a Traditional IRA.
  • If you or your spouse are covered by any employer retirement plan, your eligibility to deduct a Traditional IRA contribution depends on being under income limits.  (Details here.)

If you are single and are not covered by any employer plan (or married and neither spouse is eligible for a company plan), then there are no income restrictions on a Traditional IRA. And if you were planning on contributing less than $5,500 to your SEP, just skip the SEP altogether and fund a Traditional IRA so you can receive the full QBI deduction.

If you are eligible for both a Traditional IRA and a SEP, I would always fund the IRA first to the maximum, and only then make a contribution to the SEP.

2. Roth 401(k). A Traditional 401(k) or Profit Sharing Plan, like a SEP, can also land you in the penalty box for the QBI as a self-employed person. However, if you set up an Individual 401(k) plan that allows for Roth 401(k) contributions, then you will receive the full QBI deduction, even if you put $18,500 into your Roth 401(k). 

Of course, you won’t get a tax deduction for the Roth contributions you make, but that account will grow tax-free going forward, which is a lot better than a taxable account. It’s a great option if you anticipate being in the same or similar tax bracket in retirement as you have today. The only problem is that unlike a Traditional IRA, you cannot establish a 401(k) today for the previous year (2018). 

But you can establish one for this year, and if you’d like to do so, I can help you with this. 

3. Spouse’s 401(k)/IRA. If you are self employed, but your spouse has a regular W-2 job, have your spouse increase their 401(k) contributions through their employer. That won’t ding your QBI Deduction and will reduce your joint taxable income dollar for dollar. If your spouse is eligible for a Traditional IRA – including a Spousal IRA if they do not have any earned income – that would also be preferable to having the self-employed spouse fund a SEP-IRA.

I do not want to suggest anything to discourage musicians from saving for retirement! But when one type of retirement account will reduce other tax deductions, I want to make sure that all my clients are informed to make the best choices for their situation. Feel free to email or call me if you’d like more information.

This article does not offer or imply individual tax advice; please consult your tax professional for information regarding your personal situation. 

7 Missed IRA Opportunities for Musicians

The Individual Retirement Account (IRA) is the cornerstone of retirement planning, yet so many musicians miss opportunities to fund an IRA because they don’t realize they are eligible. With the great tax benefits of IRAs, you might want to consider funding yours every year that you can. Here are seven situations where many musicians don’t realize they could fund an IRA.

1. Spousal IRA. Even if a spouse does not have any earned income, they are eligible to make a Traditional or Roth IRA contribution based on the household income. Generally, if one spouse is eligible for a Roth IRA, so is the non-working spouse. In some cases, the non-working spouse may be eligible for a Traditional IRA contribution even when their spouse is ineligible because they are covered by an employer plan and their income is too high.  This is great if one spouse is a stay-at-home parent or in school.

2. No employer sponsored retirement plan. If you are single and your employer does not offer a retirement plan (or if you are married and neither of you are covered by an employer plan), then there are NO income limits on a Traditional IRA. If you are a self-employed musician, and looking to get started with saving for retirement, start with a Traditional or Roth IRA.

(Note that this eligibility is determined by your employer offering you a plan and your being eligible, and not your participation. If the plan is offered, but you choose not to participate, then you are considered covered by an employer plan, which is number 2:)

3. Covered by a employer plan. Here’s where things get tricky. Anyone with earned income can make a Traditional IRA contribution, but there are rules about who can deduct their contribution. A tax-deductible contribution to your Traditional IRA is greatly preferred over a non-deductible contribution. If you cannot do the deductible contribution, but you can do a Roth IRA (number 4), never do a non-deductible contribution. Always choose the Roth over non-deductible. The income limits listed below do not mean you cannot do a Traditional IRA, only that you cannot deduct the contributions.

If you are covered by an employer plan, including a 401(k), 403(b), SIMPLE IRA, pension, etc., you are still eligible for a Traditional IRA if your Modified Adjusted Gross Income (MAGI) is below these levels for 2018:

  • Single: $63,000
  • Married filing jointly: $101,000 if you are covered by an employer plan
  • Married filing jointly: $189,000 if your spouse is covered at work but you are not (this second one is missed very frequently!)

Your Modified Adjusted Gross Income cannot be precisely determined until you are doing your taxes. Sometimes, there are musicians who assume they are not eligible based on their gross income, but would be eligible if they look at their MAGI.

4. Roth IRA. The Roth IRA has different income limits than the Traditional IRA, and these limits apply regardless of whether you are covered by an employer retirement plan or not. (2018 figures below.) If you don’t need a tax deduction for this year and are eligible for both the Traditional and Roth, I’d go for the Roth. 

  • Single: $120,000
  • Married filing jointly: $189,000

5. Back-door Roth IRA. If you make too much to contribute to a Roth IRA, and you do not have any Traditional IRAs, you might be able to do a “Back-Door Roth IRA”, which is a two step process of funding a non-deductible Traditional IRA and then doing a Roth Conversion. We’ve written about the Back Door Roth several times, including here.

6. Self-Employed. If you have any self-employment income, or receive a 1099 as an “independent contractor”, you may be eligible for a SEP-IRA on that specific income. This is on top of any 401(k) or other IRAs that you fund. It is possible, for example, that you could put $18,500 into a 403(b) at a University job, contribute $5,500 into a Roth IRA, and still contribute to a SEP-IRA for self-employed gigs.

There are no income limits to a SEP contribution, but it is difficult to know how much you can contribute until you do your tax return. The basic formula is that you can contribute up to 20% of your net income, after you subtract your business expenses and one-half of the self-employment tax. The maximum contribution to a SEP is $55,000 for , and with such high limits, the SEP is essential for any musician who is looking to save more than the $5,500 limit to a Traditional or Roth IRA. 

Learn more about the SEP-IRA.

7. Tax Extension. For the Traditional and Roth IRA, you have to make your contribution by April 15 of the following year. If you do a tax extension, that’s fine, but the IRA contributions are still due by April 15. However, the SEP IRA is the only IRA where you can make a contribution all the way until October 15, when you file an extension. 

Bonus #8: If you are over age 70 1/2, you generally cannot make Traditional IRA contributions any longer. However, if you continue to have earned income, you may still fund a Roth IRA after this age.

A few notes: For 2018, contribution limits for Roth and Traditional IRAs are $5,500 or $6,500 if over age 50. For 2019, this has been increased to $6,000 and $7,000. You become eligible for the catch-up contribution in the year you turn 50, so even if your birthday is December 31, you are considered 50 for the whole year. Most of these income limits have a phase-out, and I’ve listed the lowest level, so if your income is slightly above the limit, you may be eligible for a reduced contribution. 

Retirement Planning is our focus, so we welcome your IRA questions! Most musicians are going to be responsible for funding their own retirement plans and we want to see you succeed. Be sure you don’t miss an opportunity to fund an IRA each and every year that you are eligible. 

Your Goals for 2019

Welcome to 2019! A new year brings a fresh chance to accomplish your goals. No one becomes a musician for the paycheck, but at the end of the day, musicians have the same financial goals as most people: to become a home owner, pay off your student loans, get married, raise a family, plan for your retirement, or support your favorite charity. We can help you achieve these goals or others. The purpose of our financial planning is not to own a bunch of stocks and bonds or get a nice tax break, it is about finding an effective, efficient, and logical way to help you accomplish your life’s goals.

We love when someone has a concrete, specific objective. When you truly embrace an important goal, there is ample reason to find the discipline for whatever steps are needed to achieve your objectives. That’s why you spent all those years honing your skills as a musician.

I can tell you all about the benefits of a Roth IRA or a 529 College Savings Plan, but if that doesn’t fit into your needs, all my words are worthless. The “why” has to be there first, before we can get excited about “how” we are going to do it. If you have goals that you want to accomplish in 2019 – or 2020 or 2029 – I’d like to invite you to join us and become a client of Good Life Wealth Management today. We serve smart investors who value personalized advice centered on their goals.

I’d welcome the opportunity to share our approach and allow you to consider whether it would be a good fit for you and your family. 

  • Our process focuses on planning first – we want to fully understand your goals and needs before we make any kind of recommendation. You would think this would be universal, but believe me, most of the financial industry has a product that they want to sell you before they have even met you. (Read our 13 Guiding Beliefs.)
  • We have no investment minimums. Younger musicians have financial goals and complex, competing objectives (hello, student loans!) even if they haven’t started investing or only have a small balance in an IRA. We think helping young professionals build a strong financial foundation is important work. This is our Wealth Builder Program.
  • I’ve been a financial planner for 15 years and hold the Certified Financial Planner and Chartered Financial Analyst designations. Professional expertise and deep investment experience should be a given if you’re seeking financial advice. (More about Scott‘s background as a financial planner and musician.)
  • Having your own plan means that you have taken an objective measure of where you are today, that we have created specific goals and objectives, and that we identify and implement steps to achieve those goals. While this is often savings and investment based, we’re going to evaluate your whole financial picture, from taxes and employee benefits to estate planning and life insurance. Bringing in a professional delivers accountability to a plan and protects you from what you don’t know you don’t know. (Financial Planning Services)
  • We are a Fiduciary, legally required to place client interests ahead of our own. Our fees are easy to understand and transparent. We aim to eliminate conflicts of interest wherever possible and if not possible, reduce and disclose. I invest in our Growth 70/30 model right along with our clients; if I thought there was a better way to invest, we would do that instead. (Skin in the Game)

Successful musicians seek out the help and expertise of others. They surround themselves with knowledgeable professionals, not to abdicate responsibility, but to improve their understanding through asking the right questions. I became a financial planner to help others achieve their goals, and I love my job. For me, it is endlessly interesting and personally rewarding, especially when I get to work with a fellow musician.

You could make a New Year’s resolution about your finances, but I genuinely believe you are more like to have a good outcome if you hire the right advisor who understands a musician’s career and can help guide your journey. If you want 2019 to be the year when you turned your dreams into goals and a plan, then let’s talk about how we can work together.

Musicians and the QBI Deduction

This year, there is a new 20% tax deduction for self-employed individuals and pass through entities, commonly called the QBI (Qualified Business Income) deduction, officially IRC Section 199A. While most musicians who file schedule C will be eligible for this deduction, high earners – those making over $157,500 single or $315,000 married – will see this deduction phased out to zero, because they are considered a Specified Service Trade or Business (SSTB).

See: New 20% Pass-Through Tax Deduction

Professions that are considered an SSTB include health, law, accounting, athletics, performing arts, and any company whose principal asset is the skill or reputation of one or more of its employees. That’s pretty broad.

Some musicians may have income that is from an SSTB and other income which is not. For example, consider a musician who has a business managing tours and logistics. If she performs a concert, clearly she is working in an SSTB as a performing artist. If she is making a profit from organizing and promoting a concert tour, that might be considered a different industry.

This possibility of splitting up income into different streams has occupied many accountants this year, to enable high-earning business owners to qualify for the QBI deduction for their non-SSTB income. Since this is a brand new deduction for 2018, this is uncharted territory for taxpayers and financial professionals.

In August, the IRS posted new rules which will greatly limit your ability to carve off income away from an SSTB. Here are some of the details:

  • If an entity has revenue of under $25 million, and received 10% or more of its revenue from an SSTB, then the entire entity is considered an SSTB. If their revenue is over $25 million, the threshold is 5%
  • An endorsement by a performing artist, or the use of your name, likeness, signature, trademark, voice, etc., shall not be considered a separate profession. If you are in an SSTB, an endorsement will also be considered part of the SSTB.
  • 80/50 rule. If a company shares 50% or more ownership with an SSTB, and receives at least 80% of its revenue from that SSTB, it will be considered part of the SSTB. So, if our musician only organizes tours for herself, then that business will be considered part of her SSTB. If the Tour business has at least 21% in revenue from other bands, then it could be considered a separate entity and qualify for the QBI deduction.

Business owners in the top tax bracket of 37% for 2018 (making over $500,000 single or $600,000 married), might be considering forming a C-corporation if they are running into issues with the SSTB. While a C-Corp is not eligible for the QBI deduction, the federal income tax rate for a C-Corp has been lowered to a flat 21% this year.

Of course, the challenge with a C-Corp is the potential for double taxation: the company pays 21% tax on its earnings, and then the dividend paid to the owner may be taxed again from 15% to 23.8% (including the 3.8% Medicare surtax on Net Investment Income.)

Still, there may be some benefits to a C-corp versus a pass-through entity, including the ability to retain profits, being able to deduct state and local taxes without the $10,000 cap, or the ability to deduct charitable donations without itemizing.

If you have questions about the QBI Deduction, the Specified Service Business definition, or other self-employment tax issues for musicians, we can help you understand the new rules. We want to help you keep as much of your money as possible, so let’s talk about how we might be able to help you.

Starting a Profitable Music Studio

Many professional musicians find teaching to be personally fulfilling and an important part of their annual income. Sharing your love of music with someone else is incredibly rewarding and a way of giving back for the great teachers who inspired us to follow our own path.

Teaching the content is easy, but I think many of us struggle with the business, marketing, and organizational aspects of being a self-employed private lesson teacher. That’s why I reached out to Andrea Miller, founder of MusicStudioStartup.com, for advice. I’ve learned from reading her posts and think many musicians would benefit from subscribing to her newsletter, whether you are starting a studio for the first time or have been teaching for decades. Here’s our conversation:

Finance For Musicians (FFM): I’ve really enjoyed reading your posts on starting and running a music studio. You’ve got a unique story, please tell us about your background as a musician, piano teacher, and in business. How did this all come together?

Andrea Miller (AM): My interest in entrepreneurship developed long before my interest in music! I was always starting businesses as a kid. I started piano lessons when I was seven and started teaching in high school. That’s also about the time I decided the first business I would start after college would be a music school.

I paid my way through a double-major in Entrepreneurship and Piano Performance by teaching and running a house-painting business. My senior year was an especially busy one. When I wasn’t practicing for my senior recital, I was wrestling with my music school business plan, trying to find a way to make it work without having to go into major debt.

There was always a tension in college between the music and business worlds. The two finally collided when I had to reschedule my senior recital at the last minute because I was invited to compete in a national business plan competition the same weekend.

I launched my music school a few months after graduation and hired my first teacher that same year. Soon we had over 100 students and five teachers in our thriving community. Four years into growing the music school, a move to the East Coast led me to pass the music school off to a new owner and revise my entrepreneurial path.

I opened a home studio in my new town and began consulting for startups and business owners in a variety of industries. In 2016, I decided to bring my entrepreneurial focus back to the music world full-time. Today, I coach ambitious music teachers who want to accomplish big things in their careers!

FFM: Musicians are certainly taught how to be great performers and teachers, but most schools aren’t preparing their students for the business side of music, such as having your own private studio. What do you find are the biggest initial challenges facing someone who wants to start a studio? 

AM: Unfortunately, I think many fantastic teachers start off on an unsustainable path by under-pricing their services. They don’t have a clear picture of their long-term financial goals and responsibilities or are afraid to charge what they need to to make it work.

FFM: A lot of musicians resent the idea that we have to market and “sell” ourselves. As artists, it seems maybe a bit degrading, or at the very least, it’s uncomfortable. How can musicians open themselves up to think more like an entrepreneur and embrace marketing? For creative people, why does this seem so difficult?

AM: I encourage musicians to think about why they’re uncomfortable with marketing.

Afraid of coming across as “salesy?” Look for a promotional style that fits your personality. Timid about putting yourself out there? Make mini goals each week to practice and grow in this area. (It’s kind of like learning a new instrument!)

FFM: If someone is new to a town, what would you suggest for them to get established as quickly as possible? If you are trying to pay your bills, you can’t exactly wait three years to get your studio up and running. 

AM: Set up a website and get involved in your neighborhood. Actively participate in community events and introduce yourself to the local play group organizers and school music teachers.

FFM: As teachers get more students, the administrative tasks outside of lesson time can become quite time consuming, with scheduling, billing, and communicating with parents. I know some teachers get really burned out on this part of being a self-employed teacher. Any suggestions for this, maybe tools or apps that help a teacher save time and be better organized?

AM: I love a good system! Use an automated system for billing so you never have to worry about not getting paid on time because you forgot to send the invoices.

Write canned email responses for new student inquiries so you can respond quickly and don’t waste time writing the same email over and over.

Establish routines for important tasks that you have to do manually (every Saturday morning I spend about 15 minutes processing receipts and doing my bookkeeping).

Schedule time to zoom out from the day-to-day tasks and establish long-term goals (Ex. If the admin side really isn’t your forte, what would it take to hire an assistant or outsource one particularly arduous task?).

FFM: You’ve got a lot of great resources on your website and you also coach people to start, grow, and better manage their studio. Tell me about what you do for your clients and who would benefit the most from your services. What sorts of concerns can you help teachers address and solve?

AM: We cover a lot of topics in coaching, but ultimately I help teachers build financially-viable studios faster. Most teachers don’t realize that running an unsustainable studio when they’re young can have huge long-term costs.

Right now, if a 25 year old teacher decides to max out his Roth IRA this year only, his $5,500 investment will be worth about $82,000 when he retires. If he waits until he’s 30, he loses five years of potential investing and his $5,500 investment is only worth about $59,000 when he retires. If he waits until 35 the value of that $5,500 investment drops to $42,000.

The ramifications of building a sustainable studio early on are huge!

FFM: There’s no substitute for getting an early start on saving, so thank you for pointing out how important that is! What qualities do you think are most important to be a successful lesson teacher?

AM: From a teaching perspective, you have to actually care about the students. If you don’t care about them, they won’t care about what you have to say.

From a business perspective, I think focus is one of the most important qualities. There will always be more things to do than you have time for and you have to be able to look past the distractions to work on the important things.

FFM: Suggested book or resource for studio teachers?

AM: The Power of Habit by Charles Duhigg

FFM: I think most teachers have had teachers who inspired them. Would you like to give a shout out to any people who made a big impact on your life?

AM: I’ve had three teachers who each inspired me in different ways. My first teacher taught me how to motivate and inspire students. My second teacher taught me how to foster a love of music in my students. My third teacher taught me how to coach students to reach a higher level of musical mastery. I’m thankful for all of their influences!

FFM: Thanks for your insights! Where can readers connect with you?

AM: Thank you, it’s been a pleasure. My site is MusicStudioStartup.com. I’m on Instagram @musicstudiostartup, Facebook: https://www.facebook.com/musicstudiostartup, and (soon) on the podcast!

Estimated Tax Payments For Musicians

The IRS requires that tax payers make timely tax payments, which for many self-employed musicians, including 1099s, means having to make quarterly estimated tax payments throughout the year. Otherwise, you could be subject to penalties for the underpayment of taxes, even if you pay the whole sum in April. The rules for underpayment apply to all taxpayers, but if you are a W-2 employee, you could just adjust your payroll withholding and not need to make quarterly payments.

If your tax liability is more than $1,000 for the year, the IRS will consider you to have underpaid if the taxes withheld during the year are less than the smaller of:

1. 90% of your total taxes dues (including self-employment taxes, capital gains, etc.), OR
2. 100% of the previous year’s taxes paid.

However, for musicians with an adjusted gross income over $150,000 (or $75,000 if married filing separately), the threshold for #2 is 110% of the previous year’s taxes. Additionally, the IRS considers this on a quarterly basis: 22.5% per quarter for #1, and 25% per quarter for #2, or 27.5% if your income exceeds $150,000.

Many self-employed musicians will find it sufficient to make four equal payments throughout the year. If that’s the case, your deadlines are generally April 15, June 15, September 15, and January 15. However, if your income varies substantially from quarter to quarter, or if your actual income ends up being lower than the previous year, you may want to adjust your quarterly estimated payments to reflect those changes.

You can estimate your quarterly tax payments using IRS form 1040-ES. Of course, your CPA or tax software should automatically be letting you know if you need to make estimated tax payments for the following year. You can mail in a check each quarter, or you may find it more convenient to make the payment electronically, via IRS.gov/payments.  For full information on quarterly estimated payments, see IRS Publication 505 Tax Withholding and Estimated Tax.

Estimated payments will fulfill the requirement of 100% of last years payment, or 90% of this year’s payment if that figure is lower. However, estimated payments are not designed to cover 100% of the current tax bill, so if your income is significantly higher this year, you could potentially owe a lot of taxes in April even after making quarterly estimated payments.

If you’re a self-employed musician, you don’t need to be a tax expert, but you do need to understand some basics and to make sure you are getting good advice. When you aren’t being paid as a W-2 employee, it is up to you to make sure you are setting money aside and making those tax payments throughout the year, so that next April you aren’t facing penalties on top of having a large, unexpected tax bill.

20% Pass Through Deduction for Musicians

You’ve probably heard about the new 20% tax deduction for “Pass Through” entities under the  Tax Cuts and Jobs Act (TCJA), and have wondered if musicians qualify. For those who are self-employed (1099, not W-2) here are five frequently asked questions:

1. Do I have to form a corporation in order to qualify for this benefit?
No. The good news is that you simply need to have Schedule C income, whether you are a sole proprietor (including 1099 independent contractor), or an LLC, Partnership, or S-Corporation.

2. How does it work?
If you report your music earnings on Schedule C, your Qualified Business Income (QBI) may be eligible for this deduction of 20%, meaning that only 80% of your net income will be taxable. Only business income – and not investment income – will qualify for the deduction. Although we call this a deduction, please note that you do not have to “itemize”, the QBI deduction is a new type of below the line deduction to your taxable income. The deduction starts in the 2018 tax year; 2017 is under the old rules.

There are some restrictions on the deduction. For example, your deduction is limited to 20% of QBI or 20% of your household’s taxable ordinary income (i.e. after standard/itemized deductions and excluding capital gains), whichever is less. If 100% of your taxable income was considered QBI, your deduction might be for less than 20% of QBI. If you are owner of a S-corp, you will be expected to pay yourself an appropriate salary, and that income will not be eligible for the QBI. If you have guaranteed draws as an LLC, that income would also be excluded from the QBI deduction.

3. What is the Service business restriction?
In order to prevent a lot of doctors, lawyers, and other high earners from quitting as employees and coming back as contractors to claim the deduction, Congress excluded from this deduction “Specified Service Businesses”, which includes not only health, law, accounting, financial services, athletics, and consulting, but also performing arts. High earning self-employed people in one of these professions will not be eligible for the 20% deduction.

4. Who is considered a high earner under the Specified Service restrictions?
If you are a performing artist and your taxable income is below $157,500 single or $315,000 married, you are eligible for the full 20% deduction. The QBI deduction will then phaseout for income above these levels over the next $50,000 single or $100,000 married. Musicians making above $207,500 single or $415,000 married are excluded completely from the 20% QBI deduction. Please note that these amounts refer to your total household income, not the amount of QBI income.

5. Should I try to change my W-2 job into a 1099 job?
First of all, that may be impossible. Each employer is charged with correctly determining your status as an employee or independent contractor. These are not simply interchangeable categories. The IRS has a list of characteristics for being an employee versus an independent contractor. Primarily, if an employer is able to dictate how you do your work, then you are an employee. It would not be appropriate for an orchestra, university, or contractor, to list one worker as a W-2 and someone else doing the similar work as a 1099.

Second, as a W-2 employee, you have many benefits. Your employer pays half of your Social Security and Medicare payroll tax (half is 7.65%). You might think that 20% is more than 7.65%, but remember that a 20% deduction in taxable income in the 24% tax bracket only saves you 4.8% in tax. That’s less than the value of having your employer pay their 7.65% of the payroll tax.

Employees may be eligible for other benefits including health insurance, vacation, state unemployment benefits, workers comp for injuries, and most importantly, the right to unionize. The Lancaster Symphony spent eight years in court, unsuccessfully trying to assert that musicians were not employees, to prevent them from unionizing. You would have a lot to lose by not being an employee, so I am not recommending anyone try to change their employment status.

Still, I expect many of you have Schedule C income from teaching private lessons, playing weddings, or other one-time gigs. If you do have self-employment income, you should benefit from the new tax law as long as you are under the income levels listed above. If you do other related work in music – publishing, repairing instruments, making accessories, etc. – that income might not be considered a Specified Service, so be sure to talk with your tax advisor about your individual situation. We will continue to study this area looking for ways to help musicians like you take advantage of every benefit you can legally obtain.

Musicians, Reduce Your Taxes Without Itemizing

If you used to itemize your tax deductions, chances are you will not be able to do so in 2018 under the new Tax Cuts and Jobs Act (TCJA). While it sounds good that the standard deduction has been increased to $12,000 single and $24,000 married, many musicians are lamenting that they no longer can deduct many expenses from their taxes. (See Tax Bill Passes, Strategies for Musicians.)

As a reminder, these changes impact W-2 employees. Musicians who are self-employed or “1099” can continue to deduct business expenses on Schedule C, as well as take the standard deduction. However, for any taxpayer who used to itemize on Schedule A, we’ve lost the following deductions in 2018:

  • Miscellaneous Itemized Deductions, including all unreimbursed employee expenses, tax preparation fees, moving expenses for work, and investment management fees. W-2 musicians have lost the ability to deduct instruments, equipment and supplies, concert clothes, mileage, home office expenses, union dues, etc.
  • Interest payments on a Home Equity Loan
  • Property Tax and other state and local taxes are now capped at $10,000 towards your itemized deductions.

For a married couple, even if you have the full $10,000 in property tax expenses, you will need another $14,000 in mortgage interest and/or charitable donations before you reach the $24,000 standard deduction amount. If you do have $25,000 in deductible expenses, you would effectively be getting only $1,000 more in deductions than someone who spent zero. And that $24,000 hurdle makes it a lot less attractive to try to maximize your itemized deductions any more.

Under the new law, people are no longer going to be able to say “it’s a great tax deduction” when buying an expensive home. When you take the standard deduction, you’re not getting any tax benefit from being a homeowner or having a mortgage.

So if you’ve lost your itemized tax deductions for 2018, can you you do anything to reduce your taxes? Thankfully, the answer is yes. I’m going to share with you 9 “above the line deductions” and Tax Credits you can use to lower your tax bill going forward.

Above The Line Deductions reduce your taxable income without having to itemize on Schedule A. All of these savings can be taken in addition to the standard deduction.

1. Increase your contributions to your 401(k)/403(b) or employer retirement plan. For 2018, the contribution limits are increased to $18,500 and for those over age 50, $24,500. What a great way to build your net worth and make automatic investments towards your future.

2. Many people who think they are maximizing their 401(k) contributions don’t realize they or their spouse may be eligible for other retirement contributions. If you have any 1099 or self-employment income, you may be eligible to fund a SEP-IRA in addition to a 401(k) at your W-2 job. Spouses can be eligible for their own IRA contribution, even if they do not work outside of the home.

3. Health Savings Accounts are unique as the only account type where you make a pre-tax contribution and also get a tax-free withdrawal for qualified expenses. You can contribute to an HSA if you are enrolled in an eligible High Deductible Health Plan. There are no income restrictions on an HSA. For 2018, singles can contribute $3,450 to an HSA and those with a family plan can contribute $6,900. If you are 55 and over, you can make an additional $1,000 catch-up contribution.

4. Flexible Spending Accounts (FSAs) or “cafeteria plans” can be used for expenses such as child care or medical expenses. These are often use it or lose it benefits, unlike an HSA, so plan ahead carefully. If your employer offers an FSA, participating will lower your taxable income.

5. The Student Loan Interest deduction remains an above-the-line deduction. This offers up to a $2,500 deduction for qualifying student loan interest payments, for those with an AGI below $65,000 single or $130,000 married filing jointly. This was removed from early versions of the TCJA but made it back into the final version.

Tax deductions reduce your taxable income, but Tax Credits are better because they reduce the amount of tax you owe. For example, if you are in the 24% tax bracket, a $1,000 deduction and a $240 Tax Credit would both reduce your taxes by $240.

Tax Credits should be automatically applied by your CPA or tax software. For example, if you have children, you should get the Child Tax Credit, if eligible. (Since it’s only February, there is still time to make a child for a 2018 tax credit!) If you are low income, still file a return, because you might qualify for the Earned Income Tax Credit. But there are other tax credits where you might be eligible based on your actions during the year. Here are four Tax Credits:

6. The Saver’s Tax Credit helps lower income workers fund a retirement account such as an IRA. For 2018, the Savers Tax Credit is available to singles with income below $31,500 and married couples under $63,000. The credit ranges from 10% to 50% of your retirement contribution of up to $2,000. Note for married couples, if you qualify for the credit, it would be better to put $2,000 in both of your IRAs, and receive two credits, versus putting $4,000 in one IRA and only getting one credit. If you have a child over 18, who is not a dependent and not a full-time student, maybe you can help them fund a Roth IRA and they can get this Tax Credit. Read the details in my article The Saver’s Tax Credit.

7. Originally cut out of the House bill, the $7,500 Tax Credit for the purchase of an electric or plug-in hybrid vehicle was reinstated in the final version of the TCJA signed into law. The credit is phased out after each manufacturer hits 200,000 vehicles sold, so if you were planning to add your name to the 450,000 people on the waitlist for a Tesla Model 3, forget about the Tax Credit. But there are many other cars and SUVs eligible for the credit which you can buy right now. There are no income limits on this credit, but please note that this one is not refundable. That means it can reduce your tax liability to zero, but you will not get a refund beyond zero. For example, if your total taxes owed is $5,200, you could get back $5,200, but not the full $7,500.

8. Child and Dependent Care Tax Credit. To help parents who work pay for daycare for a child under 13, you can claim a credit based on expenses of $3,000 (one child) or $6,000 (two or more children). Depending on your income, this is either a 20% or 35% credit, but there is no income cap.

9. New for 2018: The $500 Non-Child Dependent Tax Credit. If you have a dependent who does not qualify for the Child Tax Credit, such as an elderly parent or disabled adult child, you are now eligible for a $500 credit from 2018 through 2025.

Even with the loss of many itemized deductions, you may still be able to reduce your tax bill with these nine above the line deductions and Tax Credits. We want to help professional musicians find Financial Security, whether that is through long-term, diversified investment strategies, by teaching you how to save on taxes, or making sure you can afford to maintain your lifestyle in retirement. If you want an advisor who is knowledgeable about your unique financial needs as a musician, let’s talk about what our program can do for you.

Bonus Depreciation for Self-Employed Musicians

We’ve written extensively about the loss of tax deductions for W-2 musicians under the new Tax Cuts and Jobs Act (TCJA). For self-employed musicians, however, there are some changes for 2018 which may benefit you if you are an Independent Contractor (1099), Sole Proprietor, or have formed an LLC or Corporation. Specifically, Section 179 has been expanded, which enables business owners to expense certain items (take an immediate tax deduction) instead of depreciating those purchases over a longer number of years.

Section 179 has existed for many years, but Congress has continually changed the rules, setting caps on how much you can deduct. At the start of 2017, you could only take bonus depreciation of up to 50%. Under the TCJA, for 2018, bonus depreciation is increased to 100%, the cap increased from $520,000 to $1 million, and now you can also purchase used equipment and receive bonus depreciation.

As a self-employed musician, Section 179 can help you deduct:

  • Equipment for the business, such as musical instruments, sound gear, or accessories
  • Office furniture and office equipment
  • Computers and off the shelf software
  • Business vehicles with a Gross Vehicle Weight Rating (GVWR) of over 6000 pounds

You cannot use Section 179 to deduct the costs of real estate (land, buildings, or improvements), for passenger cars or vehicles under 6000 GVWR, or for property used outside of the United States.

One of the most attractive benefits of Section 179 is the ability to deduct a vehicle for your business. Under Section 179, your first year deduction on a 6000 GVWR vehicle is limited to $25,000. You would first deduct this amount. Second, you are eligible for Bonus Depreciation, which used to be 50%, but now is 100%. That means that a self-employed musician can effectively deduct 100% of any qualifying vehicle in 2018, even if it is a $95,000 Range Rover.

To be deductible, you must use the vehicle for business at least 51% of the time. If you also use the vehicle for personal use, you may only deduct the portion of your expenses attributable to the percentage of business miles. The way to maximize your Section 179 deduction, is to use the vehicle 100% of the time for your business. If the IRS sees you claim 100% business miles on your tax return, you had better have another vehicle for personal use. You might use your spouse’s vehicle, or perhaps keep your old vehicle, for personal miles.

Don’t forget that commuting between home and the office are considered personal miles, not business miles. This works best if your primary office is at home and all of your concerts, gigs, or teaching, are self-employed or 1099. If you are self-employed, then any driving to rehearsals, performances, teaching, business meetings, auditions, etc., would be business miles.

The 6000 pound GVWR requirement doesn’t mean that the vehicle literally weighs over 6000 pounds, but has a total load rating (vehicle, passengers, cargo) over this weight. If a manufacturer lists the weight of the vehicle, that is not the GVWR; the GVWR is often 1500 or more pounds higher than the vehicle weight. Make sure you are looking specifically at the official GVWR. You can generally find the GVWR printed on a sticker in the driver’s door frame to confirm.

The list of qualifying vehicles varies from year to year and from model to model, but includes most full-size trucks, vans, and SUVs. Be careful – sometimes a 4WD model is over 6000, but the 2WD version is not. On one SUV, a model with 3rd row seating was over 6000, but without the extra seats, it was under 6000. An another SUV, 2016 models were over 6000 GVWR, but the new and lighter 2017 model was not.

There are many lists on the internet of which vehicles qualify; in addition to full-size pick-up trucks and vans, most large SUVs such as a Tahoe, Suburban, Expedition, or Escalade are also above 6000 GVWR. Several mini-vans qualify (Honda Odyssey, Dodge Grand Caravan), as do some more medium size SUVs (Jeep Grand Cherokee, Toyota 4Runner, Audi Q7, BMW X5, Ford Explorer). Again, be absolutely certain your vehicle will qualify before making a purchase. One of the nice things about the new law is that now you do not need to buy a new vehicle to qualify for bonus depreciation; used vehicles are also eligible.

Please discuss this with your tax preparer. You cannot deduct more than you earned, so don’t buy a $50,000 SUV if you only show $30,000 in net profits. Similarly, you might be able to now deduct a $100,000 violin, but if you don’t have $100,000 in self-employment income, you might be better off depreciating the instrument over several years. Lastly, consider these caveats:

  • You have a choice between taking the “standard mileage rate” of 54.5 cent/mile for 2018, or using the “actual cost” method. When you take the standard rate, that already includes depreciation. If you use Section 179 to purchase a vehicle, you are going to be locked in to using “actual costs” for the life of that vehicle. You cannot take the Section 179 deduction upfront and later switch the standard mileage rate.
  • If you are using “actual costs”, you can also deduct your other operating expenses such as gasoline, oil changes, maintenance/repairs, insurance, tolls, and parking, but will need to document your costs. Keep those receipts!
  • You may still be required to keep a mileage log (“contemporaneous record” in IRS terms) to prove you are using the vehicle for more than 50% business miles. If business use falls below 50%, you may be required to pay back some of the depreciation. Let’s just say that would be expensive and a headache.
  • If you depreciate 100% of the cost of the vehicle upfront, that will reduce your cost basis to zero. When you sell the vehicle, you may be creating a taxable gain.
  • You may be able to finance a vehicle and still claim an upfront deduction under the Section 179 rules.

Under the TCJA, these expansions to Section 179 are temporary through 2022; after that time, bonus depreciation will be phased back down from 100% to 0%. So if you want to buy an SUV or truck, you have a five-year window to take advantage of this full depreciation.

This tax deduction is especially effective if you have a banner year of high income and anticipate being in a higher tax bracket, because it will let you accelerate future depreciation on a vehicle into the current year, provided the vehicle is purchased and placed into service that year. Please remember that this section 179 deduction is available only to the self-employed and not to W-2 employees.

I feel I should point out that driving a large SUV or truck may not always be the most cost effective decision. I am not suggesting everyone rush out and buy a Suburban just to get a tax deduction. But if you were thinking about buying a vehicle this year, it can certainly help to know about this tax deduction. And it might influence which vehicle you choose to buy!

I see a lot of musicians who keep good records and find out after the fact which expenses they can deduct. But I don’t see a lot of musicians who are proactively making business decisions to maximize their economic benefit. If you’re going to need a vehicle to haul your drums, or harp, amps, or even just yourself, why not choose one where you can potentially deduct the full cost of the vehicle? With the high costs of operation, insurance, and depreciation of any vehicle, I think there are a lot of musicians who would benefit from an actual cost approach, rather than tracking miles using the standard mileage rate. If your musical life involves a lot of windshield time, know your options.

Tax Bill Passes; Strategies for Musicians

Two weeks ago, we posted how musicians would lose their tax deductions under the proposed tax bill in the Senate. Let me again state that this applies to musicians who take itemized deductions on Schedule A against their W-2 income. For 1099 income or self-employment income reported on Schedule C, there will be little or no change in claiming those business expenses.

While there have been many last minute changes to the version passed in the Senate, I am sad to report that all of concerns which I have for my clients (and myself) have made it into the final version passed at 1:51 AM in Washington. The last step will be for a committee to reconcile the House and Senate bills into a final version to be signed by President Trump. They will begin work on the process on Monday.

The bill applies to your 2018 tax year, so your 2017 tax return (due April 15, 2018) is still under the old rules. Here is an overview of significant changes which will be relevant to musicians as you prepare your taxes.

  1. The Senate version keeps our current seven bracket structure, but lowers everyone’s marginal tax rate by a percent or two. The current brackets of 10, 15, 25, 28, 33, 35, and 39.6 percent will become 10, 12, 22, 24, 32, 34, and 38.5 percent. Additionally, the income levels for these brackets are increased at the high end. The income brackets will be linked to inflation, but the IRS will use chained CPI, which will likely have a lower growth rate than the current method of calculating CPI. Most significantly, the lower tax brackets have a sunset after 2025 at which time, the higher rates return. (Note that the corporate tax reduction from 35% to 20% is permanent. That will have to be a conversation for another day!)
  2. The Standard Deduction will increase from $6,350 single ($12,700 married) to $12,000 single ($24,000 married). However, the personal exemption of $4,050 is eliminated. So the net change is only from $10,400 to $12,000 single, or $20,800 to $24,000 for a married couple. Additionally, since the personal exemption applies to dependents, a family of four would actually see their standard deduction and personal exemptions drop from $28,900 to $24,000. Offsetting this is the child tax credit, which will increase from $1,000 to $2,000 in the Senate bill. The additional $1,000 increase under the Senate plan will be non-refundable, meaning it can reduce your tax liability to zero but will not be paid back.
  3. With a higher standard deduction, it will be more difficult for musicians to have enough itemized deductions to claim a tax deduction. As a reminder, itemized deductions currently include state and local income, sales, and property taxes, mortgage interest, charitable donations, and miscellaneous itemized deductions such as unreimbursed employee expenses.
  4. The Senate Bill eliminates the tax deduction for state and local income and sales taxes and caps the property tax deduction to $10,000. Starting in 2018, you will no longer be able to deduct home equity loans or interest on a second home. Another change: in order to receive the capital gains exclusion on the sale of your home, you must have had the house serve as your primary residence for 5 of the past 8 years. (An increase from 2 of the past 5 years.)
  5. Also eliminated are the Miscellaneous Itemized Deductions. This is on page 83 of the Senate Bill. This category includes unreimbursed employee expenses which are very significant to many musicians. You will no longer be able to claim the following as itemized deductions: tools and supplies, required clothing, home office expenses, mileage and travel, union dues or professional organization dues. Again, this applies to your expenses in generating W-2 income and not to 1099 income. It is essential to know how you are paid.
  6. The Senate version increased the above-the-line deduction for teacher classroom expenses from $250 to $500. This was eliminated in the House bill, to universal outrage. You do not have to itemize to take this deduction. Let’s hope this makes it into the final bill.
  7. There are many other changes to Alternative Minimum Tax, the Estate Tax, the individual mandate of the ACA, pass-through entities, and allowing 529 Plans to pay for private and religious schools for K-12. The student loan interest deduction is eliminated. We’re aware of these changes and others and are happy to discuss those on an individual basis.

While I cannot provide personal tax advice to non-clients, I can make some general recommendations you may want to consider for your own tax situation.

If you currently itemize, you may want to accelerate as many of your deductions into 2017. Before December 31, consider:

  • Paying your property taxes. Next year, you will be capped to $10,000. But even if you are below $10,000, only your itemized deductions above $24,000 will net you any additional tax savings versus the standard deduction. Will you have more than $24,000 in itemized deductions in 2018? It will be more difficult under the new rules.
  • If you have unreimbursed employee expenses, you might want to make those purchases in 2017: concert clothes, sheet music, tools and supplies, or musical instruments. Buy your plane tickets now for 2018 travel. Pay your dues and subscriptions. Remember that to count as a 2017 expense, you just have to put these on a credit card by December 31.
  • Making your charitable donations. If you are over age 70 1/2, you really have to look into doing a Qualified Charitable Donation from your IRA rather than trying to deduct a charitable donation.
  • Reviewing your sources of 1099 /  Schedule C income. If you have both W-2 and 1099 income, you will want to tie your expenses to your Schedule C business expenses instead of Schedule A itemized deductions starting in 2018. If you are primarily W-2, having some 1099 gigs may allow you to claim expenses which will otherwise be lost.

As a musician and the spouse of a musician, I have spent hundreds of hours in keeping receipts and detailed records of expenses which will no longer be tax deductible for us. It’s frustrating, and I believe our taxes will be higher in 2018 as a result. Being a musician is already a challenging way to make a living and this change will complicate things further for many of us.

Musicians want financial security and we can help you achieve those goals. If you’re ready to have a financial plan that is specific to your life and needs, please contact me and we can discuss how we work with musicians.

As an aside, I’d like to applaud Senator Bob Corker who was the sole Republican to vote against the Bill, because it will increase deficits by $1 trillion over the next decade. Corker – who is retiring and not running for re-election – was the only Senator who did not vote along party lines. The Bill passed 51-49. Interesting times, indeed.