How to Set up Your Artistic Business to Save on Taxes
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:
- 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."
- The Tax Court also noted that, even if the taxpayer were in a legitimate writing business, his expenses still would not be allowed because they did not meet the requirements to substantiate 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.
Three Steps to Business Purpose
Just to be clear, here are the steps involved in getting your artistic business considered legitimate:
Step 1: Regular and Active Work
- Create a business plan that details how you will make money from this artistic activity, including marketing and promotion activities.
- Set up a schedule and show that you are working on a regular basis. 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 a substantial number of days on this activity.
- 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. 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:
- Get a separate business checking account and credit card and don't use your personal bank account or credit card for business expenses.
- Show you have a way to get money from your artistic business. 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 way to manage finances, including 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.
What about business type?
Another way to prove that your artistic work is a business is to form an LLC or to incorporate your business. But the act of setting up a business doesn't guarantee that your expenses will be deductible.
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.
- If you exchange your artistic work for services, keep track of these barter transactions for tax purposes.
In general, you can't deduct the expense unless you record it at the time it occurs and you provide complete information on why its business purpose.