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April 2017

Creative artists, creative accounting -- the reality or the fiction of a "serious" business

RedflagThere is a myth out there that artists and craftspeople keep poor records for their businesses. I am not sure if it is true. The only thing that I know for a fact is that the I.R.S. will not look kindly at "creative accounting" and sloppy records. Creative artists and creative accounting don't mix.  Neither do personal and business bank accounts. During two audits, the first thing that the I.R.S. "dragon lady" asked me both times is "do you mix personal and professional money."  This is an I.R.S. red flag.

My experience has shown that as long as you properly organize and manage your accounts and can substantiate all expenses and income . . . the I.R.S. will accept your records and give up looking for more problems. That is exactly what you want.  So be prepared and start now by improving your accounting practices.

As a real life story, the questions below come from Lora Hart* regarding her art business accounting.

"How do you handle the financial aspects of teaching? Do you deposit all monies collected into a business account?

Answer:
If your teaching and art/craft business are integrated roles, each enhancing the reputation for the other,
then all income and expenses can be attributed to your business and should flow into one business account.

Deposit the income for teaching and workshops into the business account. 

Deduct expenses for teaching and your art/craft business from the same account. 

Keep your business account separate from any personal accounts.  Use your business account exclusively for all business-related income and expenses.

Jeans-money-two-pocketsIt may sound like a simplistic example, but it is as fundamental as having two pockets -- whereby all your business income and expenses go in and out of your left pocket, while all your personal income and expenses go in and out of your right pocket.  Ultimately it is all your money -- you just need to organize the transactions accordingly.

"Do you deposit money from sales of goods and sales of materials/supplies into the business account and workshop fees directly into your personal account?" 

Answer:
The key concept is to clearly identify whether a transaction (income or expense) is business-related or personal -- and then use the correct account accordingly.  It is really that simple.

Do not use your personal account for any business or teaching activities. Deposit workshop fees directly into your business account.  It is most convenient to use a separate credit card for all business and teaching expenses and pay for the monthly invoice from your business account. 

 

"I teach way more than I sell, and this is my only income.  I started out putting all workshop fees into my personal account, but then sometimes had to advance money to the business account to buy supplies for students. I'd like to really figure out the best way to handle it all this year."

Answer:

Deposit-slip-exampleAs mentioned before, if teaching is related to your business, then the teaching income and workshop fees should be deposited into your business account.  
And only business expenses related to teaching or workshop supplies should be paid for from the business account.  Just keep all business-related transactions flowing through the business account.

Bank-my-business copyThe owner of the business account (i.e. You) can transfer money into or out of the business account from or into your personal account as needed.  It is like paying yourself.   Just keep personal expenses flowing separately and exclusively through your personal accounts.
Bank-personal copyI actually keep my business checking and business savings at a separate bank from my personal checking and personal savings. It is less likely to mix them up.     

The I.R.S. has pages of recommendations for sole proprietorships that are very informative.

 

 

Is there a specific percentage that one would give themselves and percentage that stays with the business? I assume that I shouldn't just take money from the business account because I need a car tune up and don't have that in my personal budget (Have never done this - just an example)." 

Answer:
It is not necessary to split funds by some algorithm.
 It is very important to clearly identify whether a transaction is business-related or personal -- and only use the appropriate account for that particular transaction.  But you can transfer funds between your business account and your personal account as needed.  

 

"Should I figure out an hourly wage and just pay myself that? Is all of my teaching income - personal income or should some go to the business?"

Answer:
There is no absolute answer to this question, but there are plenty of precedents to consider teaching income as related to your art business and that you should deposit your teaching income into your business account. When necessary, you can transfer funds from your business account to your personal account.  I'd recommend keeping enough money in your business account to cover business expenses during an expensive month (as I can't stand the anxiety of worrying if I have enough money to cover my next automatic credit card bill).

Start by keeping track of your business-related transactions.  Track your teaching income and workshop income as business-related revenue on one page.  On a separate page, track your teaching expenses and workshop expenses.  I keep separate pages for these items because it is easier to get totals and look for mistakes.

 

"Do I write myself a check to cover personal expenses?" 

Answer:
No, at least not directly.  
I hope that it is very clear that you should never, never use your business account to cover personal expenses. You can transfer funds from the business account into your personal account and then use your personal account to cover personal expenses.

The recognition and clear separation of what is business related and what is personal are essential to survive an IRS audit and require a certain mindset to diligently keep organized.

For example, if you are driving to a show, then car expenses (per mileage allowance as outlined by the I.R.S.) plus parking fees could be deducted as a business expense.

In other situations, car expenses (per mileage allowance) could be deducted if your teaching job is paid as an independent outside contractor, but not if you are an employee. 

Harriete 

Thank You to Lora Hart for these questions. View Lora Hart's work on her Instagram account.

RELATED POSTS on ASK Harriete: 

My morning coffee with the I.R.S. MAN - Tips to prevent or smooth your audit with the I.R.S.

Surviving an I.R.S. audit - Is Your Travel for Business or Leisure?

Surviving an I.R.S. audit - What Is an Acceptable Receipt for a Business Expense?

More posts about Business Accounting and Tax Information on ASK Harriete 

Monopoly-Run-Money-Flower-pin-back

  Monopoly-Run-Money-Flower-pinRun for the Money Flower Pin (front and back view) $475 


Multiple Revenue Streams - Are You Swimming in the Right Direction or Up a Creek with the I.R.S.?

During my I.R.S. audit (many years ago), the very straight laced agent raised the issue of aggregating all my income and expenses for my multiple activities on one Schedule C, i.e. for Harriete Estel Berman as a sole proprietor.

What are my "multiple activities"? 
Harriete Estel Berman working on silver repair In every day life this includes my silver repair business, production of artwork, writing, lectures, and exercise instructor several times a week.

Check-it-out-Home-Energy-SMCSince every one of these activities generates revenue and is dependent on one person...
me, I thought of it as all under one proprietorship, i.e. ME.    The I.R.S. agent gently rocked her head and commented that some people mix disparate activities to cover up ill-gotten gains.  She recommended using a separate Schedule C in the future to report each activity, but she did not enforce compliance retroactively since all income and expenses were itemized and reported accurately.

Harriete-ExerciseI'll bet that a lot of my readers also have multiple revenue streams. This is the life of most artists. While it may be too late for 2016 now that your taxes are already done, this is the time to rearrange your record keeping for 2017.  

What is the correct approach for multiple revenue streams?

I try to keep it simple, accounting for clearly distinguishable income and expenses that are unrelated activities.  For example, the exercise instructor income and expenses are now separate. Expenses related to exercise instruction are deducted as unreimbursed employee expenses in accordance with the I.R.S.

Since the silver repair business uses the same tools, studio, and skills as my artwork, my artwork and repair activities are still integrated for both income and expenses. Same for lectures and writing since they are so closely related to the artwork. Everything is documented line by line in my Excel revenue and expense documents. 

Legally, there have been several precedent-setting cases regarding taxes and creative accounting for creative people (including makers and artists). If you are interested, the three articles below are worth reading to highlight the principles of tax reporting for artists and makers. I find these articles fascinating.

This first link presents the tax case of Susan Crile (artist) most clearly. 
Tax Court Judge Appreciates Art More Than Your Average Revenue Agent

Another very clear explanation is provided by Case Review: Crile v. Commission of Internal Revenue. "The decision the Court reached helps artists to remain artists, even if they are not making a profit from their work." 

And a similar article in Forbes Magazine,  Susan Crile Paints A Picture Of Tax Court Victory For Artists, highlights this exceptionally interesting case in which an established artist offset her teaching income with generous deductions as an "artist."

A very important point in this example is that "the economic losses she actually sustained in her art business were substantially smaller than the tax losses reported on her Schedules C, owing to the inclusion of many personal expenses when calculating her business income." 

Crile won in her first court appearance, but may still be sued over what the IRS perceives as excessive deductions.  To avoid IRS audit, I would recommend deducting only ordinary and necessary business expenses every year with a conservative justification especially if you show a net loss year after year.  

If losses are persistent, the IRS may question whether you are conducting your business with the intent to earn a profit.


Twitter-bird-white-on-blueI've heard lots of people say (including the I.R.S.) that a "business" should earn money at least 3 out of every 5 years.  For the sake of argument, I just wonder how that holds water when companies like Twitter have not ever made a profit.  "10 years later, Twitter still isn't close to making money".   In fact, Time magazine reports that "Twitter Has Lost a Staggering Amount of Money."

So why can Twitter continue to lose money, while an artist can't? There are no easy answers to making money for artists or Twitter, but acting like a business is important. To minimize the risk of trouble with the IRS, keep your expenses conservative.

Harriete