Category: Tax

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Tax

Taxation of Unemployment Benefits for Musicians

Taxation of Unemployment Benefits for Musicians
Taxation of Unemployment Benefits for Musicians

On March 11, the President signed the American Rescue Plan Act (ARPA), which changed the taxation of unemployment benefits. Many musicians received unemployment benefits in 2020 due to Coronavirus shutdowns. Unemployment benefits have always taxable income, however, ARPA will allow you to exclude up to $10,200 of benefits from your 2020 income.

Musicians can qualify for this $10,200 exclusion as long as your modified adjusted gross income is below $150,000. The $150,000 earnings limit does not include amounts received as unemployment benefits. For married couples, each spouse qualifies for a $10,200 exclusion, if both received unemployment benefits. Benefits over $10,200 are still taxable income.

This change came well into tax season and many musicians had already filed their tax returns. The IRS says you do not need to file an amended return. The IRS will automatically issue a refund. Not sure if your tax return is correct? Check Schedule 1, line 7 and line 8. Line 7 should list your unemployment benefits received. On correct returns, line 8 should show “UCE” for Unemployment Compensation Exclusion and have a negative number, in parenthesis.

Should You Amend?

While the IRS will send you a refund if your return did not include the ARPA’s Unemployment Compensation Exclusion, you may want to start over. Why? If you reduce your taxable income by $10,200 or $20,400 (joint), you may discover that you are now eligible for additional tax credits, such as the Earned Income Tax Credit or the Saver’s Tax Credit. The IRS will recalculate these, if you already had them on your return. However, they will not determine your eligibility. So, if you did file your taxes before ARPA, you may want to check if you might now be eligible for any additional tax savings.

While the majority of taxpayers should not need to amend, there will be many musicians who could leave money on the table if they do not recalculate their return. If you recalculate and all the changes stem from Schedule 1, line 8, then you do not need to amend. If you have additional tax savings, or new tax credits apply due to the lower income levels, you may want to amend.

This has been quite a messy tax season for tax preparers, with changes happening in the middle of March. Do you pay state income tax? States are considering if they should match the Federal change on the taxation of Unemployment. Arkansas, for example, decided to exclude Unemployment from State Income Tax for 2020 and 2021. Some states are still in the process of changing their 2020 tax forms! Maryland is so slow to revise their instructions, they had push their state deadline to July 15.

Read more: Kiplinger’s State by State Guide to Taxation of Unemployment Benefits

2020 Tax Deadlines

If you have not filed your return, you have until May 18 this year. Residents of Texas, Oklahoma, and Louisiana have until June 15 due to the Federal Disaster Declaration from the winter storms. However, please note that if you file quarterly estimated tax payments for 2021, the deadline remains April 15 for the first quarter.

The ARPA exclusion of Unemployment Benefits only applied to 2020. At this point, there are no plans for the Federal exclusion to be carried forward to 2021. So, I would anticipate that any unemployment benefits in 2021 will be taxable. Taxes can certainly be a headache for musicians, but we can help. In our financial planning process, we address the major areas of your financial life, including Tax Strategies, Retirement Planning, Cash Flow and Budgeting, Risk Management, and Investing. We are accepting new clients and would be happy to discuss our services and how they may work for you. Here are 10 Questions to Ask a Financial Advisor and my answers, if you’d like to learn more.

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Tax

Deducting Concert Clothes

Deducting Concert Clothes
Deducting Concert Clothes

Can professional musicians deduct the purchase of required concert clothes? Yes, but you need to meet the IRS requirements for “uniforms” for the expense to be allowable. The IRS has a two-part test for deducting concert clothes.

  1. You are required to wear the clothes as a condition of your job.
  2. The clothes are not suitable for everyday wear.

The IRS states that “Musicians and entertainers can deduct the cost of theatrical clothing and accessories that aren’t suitable for everyday wear.” Clearly, tails and tuxedos are not everyday wear. But other concert clothes for men and women, such as black pants or shoes, might be considered everyday clothing. The IRS cautions that it is not enough that you do not wear your work clothes away from work. The requirement is that the clothes are “not suitable for taking the place of your everyday clothing.”

For details, see Miscellaneous Expenses, IRS Publication 529.

1099 versus W-2 Deductions

1099 Musicians (independent contractors) can deduct required concert clothes on Schedule C as a business expense. W-2 employee used to be able to deduct concert clothes as an unreimbursed employee expense on Schedule A. Unfortunately, the concert clothing deduction for W-2 Musicians was eliminated in 2017 by the Tax Cuts and Jobs Act. 

If you have both W-2 and 1099 gigs, you may be able to allocate your concert clothes purchases towards the requirements of your 1099 employers. Be able to provide documentation of your deduction, including:

  • receipts describing the clothes purchased
  • documents from your employer listing the required dress code
  • state both that you do not wear the clothes at any time other than concerts AND that the clothing is not suitable for everyday use. I would suggest using the exact wording “not suitable”. While the IRS does not define “not suitable” in their instructions, that is the requirement.

Deducting Concert Clothes is a common tax deduction for professional musicians. Unfortunately, it’s easy to have that deduction tossed out by the IRS if you don’t follow their guidelines precisely!

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Tax

The Musician’s Guide to Mileage, Part 1

mileage deduction for musicians
mileage deduction for musicians

The mileage deduction for musicians is one of our best tax breaks and biggest headaches! When can you deduct your driving expenses as a musician?

Between travelling to rehearsals, concerts, or lessons, you probably spend a fair amount of time in your car. It is a legitimate, and often significant, business expense for the professional musician. In Part 1 of this guide, we will look at when you can and cannot deduct mileage and your driving expenses. In Part 2, we will compare using the IRS standard mileage rate versus your actual costs.

It’s easiest to begin with what is not a deductible travel expense: you can never deduct “commuting”. The IRS defines commuting as driving between your home and primary workplace. For example, if you work at a University, then your drive to your office or studio would not be deductible.

W-2 Employee Musicians

Musicians who are W-2 employees used to be able to deduct mileage under “unreimbursed employee expenses”. This was on your itemized deductions on Schedule A of your tax return. This was eliminated by the Tax Cuts and Jobs Act (TCJA) in 2017. If you still do itemized deductions today, you might be able to deduct mileage for charity work or medical care. But for work, it’s no longer a deduction for W-2 employees.

Also eliminated: job search expenses (i.e. auditions) and moving expenses for a new job. Ugh.

Self-Employed Musicians

Musicians who are self-employed (1099, Independent Contractor) can deducting driving as a business expense on Schedule C. For most musicians, you will have some work which is W-2 and some which is 1099, so your mileage for each of these jobs needs to be tracked separately.

Here are types of mileage which you can deduct:

  1. Travel to rehearsals, gigs, or teaching. If your home is your primary office as a self-employed musician, than any drive from the “office” is deductible as a business expense.
  2. Driving to the airport for business travel.
  3. Trips for errands or supplies, repairs, meals and entertainment, and customer visits are also deductible.

The key to successfully deducting these expenses is to have contemporaneous documentation. Record the dates, locations, and miles traveled. The most common reason expenses are disallowed by IRS auditors is lack of supporting evidence. Keep a detailed mileage log, keep contracts showing dates of gigs, and be organized.

Track Your Miles

There are a number of apps to track your mileage, such as MileIQ, QuickBooks Self-Employed, Everlance, and others. These use your phone’s GPS to track your distances automatically, and then you can later categorize each trip as business or personal. This is very helpful if you, like me, often forget to write down your mileage! Just remember that you may be required to produce this documentation up to seven years in the future. Make sure you have saved your information in a hard copy or other permanent location. If audited by the IRS, they may send you an “Information Document Request” or IDR, requiring you to show evidence of all your specific trips. No evidence and they can throw out your deduction.

I know it is a pain to keep track of all this mileage, but it’s likely that your regular trips can add up to thousands of miles per year. For 2020, the IRS standard mileage rate is $0.575 per mile, so for every 1000 miles you drive, you can deduct $575 from your income. If you are in the 25% tax bracket, that will lower your tax bill by $144. If you are in a higher tax bracket, your savings will be even greater.

Also, you can deduct any tolls or parking costs on top of the standard mileage rate. Keep those receipts!

Next up: Part 2, where we compare the Standard Mileage Rate and Actual Cost methods for taking the mileage deduction for musicians.

This information is for educational purposes only and should not be construed as individual financial advice. Please talk to your CPA or tax preparer regarding your personal situation.

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Tax

Tax Parity Act Would Help W-2 Musicians

In 2018, the Tax Cuts and Jobs Act (TCJA) eliminated Unreimbursed Employee Expenses as a tax deduction. For musicians who are W-2 employees, this meant we lost the ability to deduct expenses, often significant, like our instruments and equipment, concert clothes, repairs, a home office, travel for work, study, or auditions, and even Union dues.

There is a new bi-partisan Bill in the House of Representatives which would restore some of these deductions for Performing Artists, including musicians. First, this would not change the new TCJA definitions of what is an itemized deduction. Rather, the bill expands an old tax benefit from 1986 and would allow musicians (who are employees) to take an above-the-line deduction for employee related expenses.

The original 1986 version is called the Qualified Performing Artist (QPA) tax deduction and you probably never used it because you had to make less than $16,000 to be eligible. The 2019 Bill is called The Performing Artist Tax Parity Act (PATPA) and amends the old law by increasing the eligible income thresholds to $100,000 (single, with a phaseout to $120,000), and $200,000 (married filing jointly, with a phaseout to $240,000). These income limits would be indexed for inflation. If you make below those amounts you would be eligible for the deduction.

Back in May, I was asked to comment on a draft version of this Bill, before it was made public. I am glad to see that the Bill has been officially introduced as H.R. 3121 (text here).

Important considerations:

1. The definition of Qualified Performing Artist requires that the individual have at least two W-2 employers. If someone only works for one employer, say the Fort Worth Symphony, then they wouldn’t qualify. But if they worked for the Symphony and had another W-2 job as a performing artist, then they could take the deduction. If their second job was teaching accounting, then no. 

If this is passed, it might become very valuable for a musician to play a show or church gig as a W-2 just so they could have a second job to qualify for this deduction! As long as you make at least $200 from an employer, it counts as a second employer and you become eligible for the QPA deduction that year.

2. QPAs can only take this deduction if their expenses exceed 10% of their gross W-2 income as a performing artist. (Expenses incurred for 1099 work would still be subtracted on Schedule C.) It’s a high threshold, but it would help those musicians with significant expenses. It would also encourage stuffing expenses into one year rather than spreading them out over a number of years.

3. The expenses are deducted on IRS form 2106 under “qualified performing artist”. Here are the instructions for 2018: https://www.irs.gov/pub/irs-pdf/i2106.pdf

The PATPA deduction would allow W-2 musicians to reclaim many of the lost itemized deductions under the TCJA, including vehicle mileage, unreimbursed travel expenses, study, home office, and equipment, including musical instruments. This does not require itemizing your deductions – musicians could take the standard deduction and still take the QPA.

4. Some musicians would not be eligible for the QPA deduction if their income is above the limits. Prior to 2018, those musicians were probably able to use those expenses as itemized deductions; they won’t be helped by the new Bill. For musicians in expensive cities like NY or LA, they might make too much for this deduction, even though they also have a very high cost of living.

It’s too early to make plans as we don’t know if this Bill will become law. This Bill has bi-partisan support, introduced by Reps. Judy Chu (D-CA) and Vern Buchanan (R-FL), so we will see if it makes it. I hope it does. Presently it is under consideration in the House Ways and Means Committee. I will keep you posted as new information becomes available.

Until then, if you have any financial planning questions or would like to discuss our financial planning services, please feel free to email me anytime.

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Tax

Taxes Going Up? Here’s What Musicians Can Do

My clients are completing their 2018 tax returns and it is a mixed bag. Many musicians who used to itemize their deductions, especially married couples, are now taking the standard deduction for the first time in decades. Some are seeing their taxes go down while others, myself included, are paying thousands more for 2018 than we did for 2017.

Generally, if you had a significant amount of itemized deductions, many of those deductions were reduced or eliminated under the Tax Cuts and Jobs Act. This should be no surprise to my readers, because I’ve been warning you about this since November 2017 when the law was just being proposed in Congress. For musicians who are W-2 employees, the loss of Miscellaneous Itemized Deductions meant losing the ability to deduct your instruments, supplies, mileage, home office, union dues, concert clothes, and other expenses.

What also came as a surprise to many musicians was that their employers significantly reduced their tax withholding from their paycheck. Payroll software has several weaknesses – it doesn’t know what deductions you may have or what other income you or your spouse earns. The software just sees a lower marginal tax rate and automatically withholds less. If your employer under-withheld, you can ask HR to reduce your exemptions to zero and if you are married, you can also ask them to withhold at the higher single rate. If your spouse earns a similar amount as you, withholding at the single rate is likely more accurate.

How can you lower your tax bill for 2019? First, try to increase your 403(b) or 401(k) contributions, if you are eligible for a retirement plan through your employer. So many people are only contributing the amount that their company will match, often four to six percent. Others are contributing 10%, which is slightly better. But your goal should be to max out both your and your spouse’s 403(b) or 401(k) if you can. For 2019, that has been increased to $19,000, or if you are age 50 or over, $25,000. Build wealth, fund your retirement, become financially independent sooner, all while reducing your current tax bill. That’s why we try to max out our accounts every year.

I suggested other ways to reduce your taxes last February, to give everyone a head start on their 2018 taxes. See: Reduce Your Taxes Without Itemizing.

If you have both 1099 and W-2 Income and are wondering if you can just shift all your expenses to your Schedule C, the answer is no. If you have expenses and equipment which is used both for your 1099 and W-2 work, please read: What Should Free-lancers Do with Both W-2 and 1099 Income and Expenses.

For musicians who are W-2 employees, many of you who used to take a home office deduction found that this was eliminated in 2018, to your great frustration. So today, I’d like to give an update on two ways to get a deduction for your other major expense, your car.

First, if you are a self-employed musician, including a 1099 independent contractor, you might consider having a dedicated vehicle for your music business, especially if your work requires frequently driving to places other than your “primary office”. You have a choice of taking the IRS standard mileage rate (58 cents per mile for 2019) OR you can use your actual costs, including gas, repairs/maintenance, depreciation, insurance, etc. Since the standard rate is so much easier to calculate, most people use the standard rate. But, you are allowed to calculate both and use whichever is higher.

If you are self-employed and your car is getting old, instead of getting a new car and using it for both personal and business miles, consider getting an SUV, Van, or Truck for your business and keeping your old car for personal use. If you have a business vehicle with a GVWR over 6000 pounds, and use it 100% for business, you may be able to deduct the full purchase price upfront as a Section 179 deduction. This saves you from having to depreciate the vehicle over time. Then, you should deduct all of your actual costs going forward. Under the new tax law, you can now use the section 179 deduction for used vehicles, in addition to new vehicles. Read more: Bonus Depreciation for Self-Employed Musicians.

If you aren’t self-employed but are in the market for a new vehicle, I wanted to give you an update on the $7,500 tax credit for electric and plug-in hybrid vehicles. A tax credit is not a deduction to your income, but a dollar for dollar reduction of your taxes owed. This credit can reduce your taxes to zero, but is non-refundable if your tax bill was less than $7,500 before the credit.

The full $7,500 tax credit is available on the first 200,000 qualifying vehicles each manufacturer sells. The first two companies to exceed 200,000 vehicles are Tesla and General Motors. If you were hoping to get the full tax credit, I’d look at other companies. Depending on the size of the vehicle battery, some vehicles have a credit of less than $7,500. For complete details of eligible new models, see the IRS Website: Electric Drive Motor Vehicle Credit.

For GM, the credit drops from $7,500 to $3,750 on April 1, then to $1,875 on October 1, and then to zero on April 1, 2020. Tesla hit the 200,000 vehicle mark one quarter earlier. The tax credit for a Tesla purchase is $3,750 right now, falling to $1,875 on July 1, 2019, and then to zero on January 1, 2020.

The Tax Credit is only available on a brand new vehicle, however, used prices for electric vehicles usually reflect the $7,500 credit. So, if you wanted a Chevy Bolt or Volt, or a Tesla, you might want to look at used models now that the tax credit has been phased down.

My goal is to help you keep more of your money so you can invest and grow your wealth. Although the new tax law simplified returns for many musicians, it did not cut taxes for everyone across the board. If you’re wondering if you’ve missed some ways to save on taxes for the year ahead, send me an email and we can discuss what we do for our clients to help. 

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Retirement Planning Tax

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. 

Categories
Tax

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.

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Tax

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.

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Tax

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.

Categories
Tax

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.