Artistic Businesses and Taxes
Artistic types - writers, crafters, artists, designers, others - who sell their products for business income can take deductions on their expenses if they follow certain procedures and act like a real business.
Let's say you are a writer who is working on a novel. You have expenses - your computer, the place where you write, writing tools, maybe a website. If you act like a real business, you can deduct those expenses on your income tax return, to reduce your income legitimately. But there are some things you need to do in order to increase your chances of being considered legitimate by the IRS.
An Example of an Artistic Business
A 2012 Tax Court case provides an example of the importance of working on the business part of your business. In this case, a man had taken a leave of absence from his company to travel and take photos for a travel book. He accumulated $19,000 in business expenses during this time but had no income.
He wrote about 150 pages of a book but didn't complete the book. He created a business plan and kept good records, but the Tax Court found that was not enough. What he didn't do was to show that he was "regularly and actively involved" in the business of writing. The Court denied his tax deductions.
Some comments made by the Tax Court show their thinking in this matter:
Not a Hobby. The Tax Court said that the writer's "planned travel book could just as easily be an isolated venture for the personal satisfaction of taking a worldwide trip and seeing his travel adventures in print as it could be a product of a trade or business."
What the IRS looks for is proof that the work isn't just a hobby. Expenses for a hobby aren't deductible because they aren't for business purposes.
Proving the Expenses. The Tax Court also noted that, even if the taxpayer were in a "real" business to do writing, his expenses still would not be allowed because they did not meet the requirements to prove those expenses by including the "time, place, business purpose, and business relationship" of the expenses.
The Court said that not all expenses during a business trip are necessarily business related and that business purpose must be proven for each expense.
The Bottom Line - Why It's Important to Keep Good Records
Keeping good records allows you to prove your business expenses, so you can deduct them on your business tax return and lower your tax bill.
Three Steps to Business Purpose
Here are the steps involved in getting your artistic business considered as a legitimate business by the IRS, and not a hobby, so you can deduct expenses on your business tax return.
Step 1: Regular and Active Work
Set a schedule. You must be able to show that you are working on your artistic business as a business. For example, if you are a painter, you should be able to prove you are painting on a regular basis. Set up a schedule and put it in writing. You could put it in your online calendar or on a printed calendar. Keep notes on what you worked on each day.
You don't have to work every day or even every week, but you should be able to show that over the course of a year, you worked regularly and that you produced something each time you worked.
Set aside a space at home where you work exclusively on your artistic activity. This will establish that you have a clear business purpose and that you are using the area regularly for this purpose.
Make sure your space is used regularly and exclusively for business purposes. That means you aren't doing anything personal in that space. Read more about how to set up a home business space, for tax purposes.
Step 2: Start a Business
Set up your artistic activity as a business, by creating business finance, marketing, and planning systems:
Get a separate business checking account and credit card and don't use your personal bank account or credit card for business expenses. It's easier to keep track of expenses if you have a separate account, and it shows taxing authorities that you consider your activity a business.
Show your marketing efforts. Show you have a way to get money from your artistic business. If you aren't trying to sell what you make, it looks like you are just doing it as a hobby. Maybe you want to sell on Etsy or other online stores or through your own website, using PayPal for payments to your business.
Create a business plan that details how you will make money from this artistic activity, including marketing and promotion activities.
Show you are keeping track of finances, by having a budget and regular financial statements.
All of these activities show that you intend to have a business, rather than just a personal hobby. You will be set up as a sole proprietorship by default, which means you will be filing your business taxes on a Schedule C, as part of your personal tax return.
Consider Creating a Formal Business Type
Another way to prove that your artistic work is a business is to form an LLC or corporation. The fact that you have a formal business type doesn't guarantee that the IRS will see this business as "real," but it does help make you look more professional.
Step 3: Keep Track of Business Expenses
Save expense receipts. Mark on each one (a) the business purpose, (b) who you were with, (c) the location. Read more about keeping good records on business expenses.
Keep business travel receipts. Make sure you record mileage and other expenses as you go, not at the end of the year. Read more about deducting business travel expenses.
In general, you can't deduct the expense unless you record it at the time it occurs and you provide complete information on why the expense was for business purposes.