Business Accounting and Tax Information Feed

The Tax Season Is Upon Us - 2 Rules for Audit Survival

Penny-dollarI've been working to reconcile my 2016 taxes whenever a few minutes of sharp mental acuity arise.  Numbers are not my thing, but I like to have some financial awareness of the past year figured out before going too far into the new year. This year my records worked out to the penny! 

For sure, more expenses always seem to tally up than I anticipated.  Yet, the beginning of the year is when you need to know whether you made money in the last year so that you can be ready to pay income taxes while there is some money in the bank.  

I've been audited by the IRS twice in my career.  They red flag home-based businesses some times to check on abuse or sloppy records.  Fortunately, good record keeping and a few other tips allowed me to survive both times without any "extras" due.

So here are my top two super simple rules for artists and makers to keep their business accounting on the up and up -- separate your business accounts and keep receipts.  The rest of this post will explain what I mean, followed by a list of posts about accounting and my experience with the I.R.S., all written from my personal experience as an artist, not an accountant. 

 

SEPARATE-ACCOUTNS
RULE 1. Separate Accounts 

The first thing the I.R.S. will ask is if you co-mingle any personal and business money.  They do not allow any personal expenses to be written off as business expenses.  Therefore you should maintain separate credit cards for your business and personal expenses. You should also have separate bank accounts for business and personal money.  If you co-mingle personal and business accounts, the I.R.S. is going to dive much deeper into your records looking for inconsistencies in your records.

RECEIPTS-FOR-EVERY-EXPENSE
RULE 2. Receipts for every expense
The I.R.S. wants proof, not memories, of your itemized records.
 No fudge factors work here.  The I.R.S. will ask you to account for specific expenses in each category to the penny, and ask for specific receipts....such as "show me your advertising expenses for August 2016."  This is their quick way to look for sloppy records. If you don't have receipts for your records, the I.R.S. will dive deeper into your records looking for more inconsistencies in your records.

Track each expense in the appropriate expense category. You MUST have a receipt for every single expense. Period. Then take your receipts and itemize each expense in the appropriate category for your records.   For example, printing business cards would go in advertising, while shop supplies has it's own expense category. It turns out that the I.R.S. has "formulas" for the total of each category in each business. 

Track your revenue exactly.  I use a separate Excel page for each revenue stream so that the totals are a lot easier to figure out. (In the past I used different columns for various revenue streams. Sure, in theory that should work, but finding an inconsistency in my numbers took hours and hours.) Now a separate page for each revenue stream seems so much easier.

I know that the I.R.S. has many more rules.... but the overarching advice is that you must "Act like a business."

Besides the usual overarching goal of making money, I try to keep my record keeping simple and straight forward.  I track my business activities on a CASH basis to record "cash out" expenses and "cash in" revenue.  I don't buy an accounting program, but use my own Excel document which I can improve and modify each year. I am not going to spend money on some "powerful" accounting program when the real work is writing in every expense and revenue item.

I know that the 2 rules above seem so obvious....but I hear stories about people making up numbers for their business, or they approximate their expenses and revenue.  These won't get you through an IRS audit.  I was scared to death when I was first audited.  Fortunately I had separate accounts and all the receipts.  The headache of regular record keeping is minor compared to having an IRS agent sift through more and more accounts due to inconsistencies.

Previous posts about accounting for artists and makers:

I Covered My Expenses” and Other Forms of Delusion & Denial 

Time, Effort, Knowledge, Recognition, Appreciation

Hobby or Business? Criteria for the I.R.S.

She Sells Wholesale. She Sells Retail. Is She Selling Wholesale at Retail?

Avoid the Red Flag of IRS Form 1099

TAX TIME, Tick Tock, The Tax Clock is Ticking

Video Workshops from the I.R.S. - Am I a Business or a Hobby? - OR - Make Your Business More Business-like!

I.R.S. sign

Morning Heartburn with the I.R.S.

Surviving an I.R.S. audit - Avoid Problems and Penalties - A Final Word.

Surviving an I.R.S. audit - Withdrawing Inventory Items for Personal Use? Very scary!

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?

Surviving an I.R.S. audit - Cost of Goods SOLD and Jail House Orange - A Fashion Accessory Nightmare

Surviving an I.R.S. audit - What Is Included in the Cost of Finished Good besides your best guess?

Surviving the I.R.S. - Cost of Goods Sold, Are you ready? Watch my head explode!

Surviving an I.R.S. audit - No change!

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

 

 

 

 

  


Your Money Talks But Are You Listening?

Calculator-ASK Harriete-I-covered-EXPENSES
Passion does not equal profit.
 If expecting to make money, we need to separate our love for creative making from the down to earth reality of selling. 

The caution is to not let our creative passions cloud the realities of marketing, selling, generating profits, and avoiding loss.  

I will always encourage makers to make the best work possible. No holds barred. BE PASSIONATE. Work hard. Spend countless hours doing what you love.  But when it comes to making money and selling for a profit, that is when business principles apply.

Read the post I wrote for Artsy Shark: “I Covered My Expenses” and Other Forms of Delusion & Denial and see if "I covered my expenses" really means I lost more money faster than ever before and four days of my time.
Calculator-ASK Harriete-opportunity-cost
Have you asked yourself what is the "opportunity cost" when spending weeks making low cost sell-able, bread & butter items to prepare for a show?  What if you had spent that time making your most inspiring, most creative work without thinking about who might be shopping at a show and what their budget might be?  

Calculator-ASK Harriete-booth-showWhat about scheduling fewer art/craft festivals? This interview with Carrol Swayze is makes a lot of sense when you read "How a Hard Look at Business Changed an Artist’s Life."

Calculator-EXPENSES-ASK-Harriete-5buttonsAfter adding up all the true costs on your calculator for profit and loss, you might be saving yourself money doing fewer shows.

Harriete

 

RELATED POSTS:

Over Supply, Reduced Demand = Downward Price Pressure

The Economic Stakes of the White Tent - Reduced Demand

The Economic Stakes of the White Tent - Over Supply

 

 


Time, Effort, Knowledge, Recognition, Appreciation

Alarm-clock-red-time-FOR-taxesTax time is upon us which is always the time we evaluate the financial success for the previous year. But with this economy, trying to make and sell art or craft with a profit is challenging.

The I.R.S. applies multiple criteria for evaluating whether your art or craft is a "hobby" or a "business."  Without any doubt, an artist or maker has to take the accounting side of the "art business" seriously. The I.R.S. expects detailed records that reflect a business-like approach, but there is sometimes a kind of gray area.

The gray area in their evaluation criteria is characterized more by words than numbers.  The words "time, effort, knowledge, recognition and appreciation" may be the difference between defining your art or craft as a "business" or a "hobby" in the eyes of the I.R.S.

Lets look at the words:

Do you regularly invest time? Do you work regularly and frequently? A half day per week activity, e.g. Sunday afternoon, does not appear to qualify as a business-like approach.

Is it evident that you apply substantial effort? The amount of effort involved should be VERY CLEAR evidence whether the artist/maker intends to make a profit or just enjoy an occasional activity.

Do you have the knowledge from experience or education? Your education and training can be further evidence that you have the knowledge to be a professional in your field. Education certificates or degrees, professional acknowledgments, and experience needed to perform the art activity at an advanced level may differentiate it from a hobby.

Harriete Estel Berman standing in front of her  artwork on display at the Minneapolis Institute of Artshe MaIs your work recognized as professional? The I.R.S. could not define my art business as a "hobby" (even when my business lost money) because my professional profile fit most of the criteria. Establishing yourself as a recognized expert in the field is the definition of a professional.

The word "appreciation" is critical here. It is evident that my art work "appreciates" or increases in value. This is further evidence of an expectation to make a future profit in the appreciation of assets (my artwork).

So make sure that you "act" like a business in every way with detailed accounting, separate bank account, and perfect record keeping. In addition, keep detailed records with documentation of your professional efforts to make money and gain exposure. 


Art and Craft March Toward April Taxes


DollargrASK Harriete has written many posts about business accounting, taxes and compliance with the I.R.S. standards on several occasions.

In honor of this time of year when you may be
preparing for the April 15 tax deadline here are links to posts on the topic:

She Sells Wholesale. She Sells Retail. Is She Selling Wholesale at Retail?

Avoid the Red Flag of IRS Form 1099

TAX TIME, Tick Tock, The Tax Clock is Ticking

Video Workshops from the I.R.S. - Am I a Business or a Hobby? - OR - Make Your Business More Business-like!

I.R.S. sign

Morning Heartburn with the I.R.S.

Surviving an I.R.S. audit - Avoid Problems and Penalties - A Final Word.

Surviving an I.R.S. audit - Withdrawing Inventory Items for Personal Use? Very scary!

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?

Surviving an I.R.S. audit - Cost of Goods SOLD and Jail House Orange - A Fashion Accessory Nightmare

Surviving an I.R.S. audit - What Is Included in the Cost of Finished Good besides your best guess?

Surviving the I.R.S. - Cost of Goods Sold, Are you ready? Watch my head explode!

Surviving an I.R.S. audit - No change!

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


Avoid the Red Flag of IRS Form 1099

RedflagIn struggling through my taxes (along with everyone else this time of year), the number crunching reminded me of the 1099 "red flag" that probably triggered my tax audit in 2010.  Don't let this happen to you!
I.R.S.sign368
In past years, I just included my 1099 revenue within my "revenue totals."

IrsBELOWsignhbNear the end of my audit in 2010, which I survived thanks to appropriately accurate records and having every receipt requested by the auditor, the auditor revealed her hand. After an hour and half of  "inquiries", the I.R.S. iron lady finally asks, "Where is this specific 1099 revenue reported?"  She knew the exact amount of money and person who sent the 1099.

Thank goodness the 1099 was included in my reported revenue, I could show her in my records in about 2 minutes. However, this 1099 wasn't broken out separately on the tax return. Because I didn't list the 1099 revenue as a separate line item, the I.R.S. thought I was hiding income.

Back to last night....

This year all 1099 income is going on the 1099 line in the tax return.

But then, don't forget to subtract that 1099 income reported on a 1099 line from your Schedule C total revenue. You don't want to count it twice.

Harriete

Information on business accounting and taxes for artists and makers from ASK Harreite  can be found with this link or in the left column under Business Information and Tax Accounting


TAX TIME, Tick Tock, The Tax Clock is Ticking

BentClocks06 Time to get your business taxes ready.
For artists and makers, running your business in a manner compliant with I.R.S. rules
can make a BIG DIFFERENCE between being declared a "business" instead of a "hobby". This has potentially major financial consequences.

Consuming Conversation stack of teacups by Harriete Estel Berman The IRS defines a "hobby" as "an activity not engaged in for profit" and consequently deductions for expenses are limited. On the other hand, a "business" is allowed to deduct the operating expenses from the business revenue to determine net taxable income.  Read more about this issue: "Business or Hobby? Answer Has Implications for Deductions."

The I.R.S. web site offers videos to help small businesses in convenient, digestible segments. I recommend watching this videos.

Grab your tea or coffee cup!!  The  video series is called Small Business/Self-Employed Virtual Small Business Tax Workshop.

IRSvirtualWorkshop

IRSvirtual10lessons There are 10 Lessons.  I suggest that you listen to all that apply to you. 
If you hover your mouse pointer over the Lesson, it gives you the full name of the lesson and the subjects covered.

The Introduction and Lessons 1 - 4 are fundamental information.  I especially recommend that you listen to at least these four.  You can pause, replay, or skip around.  Start with the Introduction (it is really short.)

Everyone should listen to: Lesson 4. What you need to know when you run your business out of your home.

BELOW are summaries of the first four lessons: 

Lesson 1.  What you need to know about Federal Taxes and your new business
  EIN (Employee Identification Number)
  Record Keeping
  Bookkeeping and Accounting
  Forms of a Business Organization
  Paid Tax Preparer

Lesson 2. How to set up and run your Business so paying taxes isn't a hassle.
  Net Profit and Loss
  Deductions
  Depreciation
  Disability Access Credit
  Self-Employment Tax and Estimated Tax

Lesson.3 How to file and pay your taxes using a computer.
  Describe IRS e-file
  Benefits of e-file
  Electronic Payment Options

Lesson 4.What you need to know when you run your business out of your home.
  
Determine Deduction Eligibility
  
Types of Expenses
  
Deduction Limits  

In my limited experience, there are a couple of issues that have been of particular interest by the I.R.S.:

Withdrawing inventory items for personal use

Accurate and detailed documentation of travel expenses

A receipt for every business expense

Detailed records for Cost of Goods Sold

Records for Finished Goods

Your detailed business records are absolutely essential.

This is my head exploding when I do my taxes.
  Ask Harriete
Watch my head explode.


Surviving an I.R.S. audit - Avoid Problems and Penalties - A Final Word.

After surviving two I.R.S. audits -- and as this series concludes, I'd like to highlight several hints to help you prevent and survive (if necessary) an I.R.S. audit in your future.

RedflagKeep careful records and be prepared to justify every expense.  Especially in this tough economy, there may be more artists and makers losing money.  Losing money is not a problem in and of itself, but in my opinion, this seems to be an I.R.S. red flag for an audit.

Start RIGHT NOW improving your records. No time like the present. Keep every receipt and record it.

If you are called in for an audit, spend a lot of time preparing by reviewing your records and understanding your accounting practices. 

You need to demonstrate confidence to the I.R.S. that you have every peice of paper they want and that you know exactly where it is in your files. (My husband actually made us "role play" for over an hour.)

Everything in your "office" or "studio" needs to be for business. The I.R.S. has very clear rules about deducting the expenses associated with a home "office" or "studio." Watch Lesson 4 recommend in the previous post. To summarize these rules, if you use the same space for your family or private life, don't take deductions for that space. It is another I.R.S. red flag.

There are actually online videos provided by the I.R.S. called 'Your Guide to an I.R.S. Audit."
IRSaudit
Save the address to this site as your insurance. There is no such thing as being too prepared if you want to avoid problems and penalties with the I.R.S. There are 10 lessons, I hope you never need them.
IrsAUDIT2The information and advice on ASK Harriete is provided for your assistance and should not be considered legal advice. Use your best judgement and consider using professional tax advice as necessary.

Harriete


Video Workshops from the I.R.S. - Am I a Business or a Hobby? - OR - Make Your Business More Business-like!

For artists and makers, running your business in a manner compliant with I.R.S. rules can make a BIG DIFFERENCE between being declared a "business" or a "hobby" and potentialy major financial consequences.  The IRS defines "hobby" as "an activity not engaged in for profit" and deductions for expenses are limited.   On the other hand, a "business" is allowed to deduct the operating expenses from their business revenue to determine net taxable income.  Read more about this issue: "Business or Hobby? Answer Has Implications for Deductions."

In the course of preparing for my recent audit and writing these articles about "Surviving the I.R.S." I found a great set of videos on the I.R.S. web site that I  recommend if you want to learn more in convenient, digestible segments.

Grab your tea or coffee cup!!  The video series is called Small Business/Self-Employed Virtual Small Business Tax Workshop.

IRSvirtualWorkshop

IRSvirtual10lessons There are 10 Lessons.  I suggest that you listen to all that apply to you. 
If you hover your mouse pointer over the Lesson it gives you the full name of the lesson and the subjects covered.

The Introduction and Lessons 1 - 4 are fundamental information.  I especially recommend that you listen to at least these four.  You can pause, replay, or skip around.  Start with the Introduction (it is really short.)

Everyone should listen to: Lesson 4. What you need to know when you run your business out of your home.

Harriete

BELOW are summaries of the first four lessons: 

Lesson 1.  What you need to know about Federal Taxes and your new business
  EIN (Employee Identification Number)
  Record Keeping
  Bookkeeping and Accounting
  Forms of a Business Organization
  Paid Tax Preparer

Lesson 2. How to set up and run your Business so paying taxes isn't a hassle.
  Net Profit and Loss
  Deductions
  Depreciation
  Disability Access Credit
  Self-Employment Tax and Estimated Tax

Lesson.3 How to file and pay your taxes uing a computer.
  Describe IRS e-file
  Benefits of e-file
  Electronic Payment Options

Lesson 4.What you need to know when you run your business out of your home.
  
Determine Deduction Eligibility
  
Types of Expenses
  
Deduction Limits  

Sit back, listen up, and
                         take your legal deductions.

LifeGood72

Good to the Last Drop Flower Brooch  by Harriete Estel Berman
Retail Price $450


Surviving an I.R.S. audit - Withdrawing Inventory Items for Personal Use? Very scary!

I.R.S.sign368

I have been audited twice by the I.R.S. during the past 5 years. During both of these audits the I.R.S. agent asked how many "inventory items did I withhdraw for personal use?"  This is a potential trap, so avoid this practice if you can!

TrapA letter from the I.R.S. Information Document required:
"Documentation and computation of the cost of inventory items withdrawn for personal use. Include gifts to family members and friends, items for personal consumption, etc. A logbook, written record, or any documentation you have that shows what you used for business and what was given as gifts to family, friends or personal consumption. We need to see how you separated what was used for business and what was used for personal consumption."

FireThis could lead to an eternal trial by fire!!!  The best answer is that you do NOT give away or trade your work from business inventory.

Just to clarify here, I am not talking about taking an item from your inventory to display in your studio or wearing a pair of earrings to an opening for promotion.  These are two examples of a legitimate way to promote your work. You still own the item and you are actively offering them for sale. What should be a concern is the common practice of "trading work with other artists."

Recently I read an online art/craft busines newsletter discussing how much fun it is to trade work!  Trading work is NOT a business like behavior. Sorry if I sound like a fuss budget, but there are many facets of behaving "like a business." If you want to deduct your legitimate art or craft business expenses (whether you make money or not), you need to be able to prove that you are "acting like a business."

The whole point is that the I.R.S. wants to determine if you fit their definition of a "hobby" or a "business."  If you want the I.R.S. to perceive your entrepreneurial efforts as a business, then you must show them that you act like a business.  A business needs to account for every item in their inventory.

The I.R.S. has rules regarding giving your work away or trading from business inventory. It is called "barter." If you want more information on barter, see the information below my signature (copied directly from the I.R.S. web site).

On the other hand, if you are happy being deemed a "hobby" by the IRS, then no inventory management is required. You may give away or trade your work as an informal exchange anytime on a noncommercial basis.

What disturbs me is to see public discussion about bartering work on an art business web site, at craft shows, or other requests to trade work with so little awareness of the consequences.  If you feel you must give gifts or barter, you could make such work on your own personal time not using your business inventory or materials or employees. That is what gifts are for.

Harriete

BUBBLEbarter Topic 420 - Bartering Income (from the I.R.S. web site)
Bartering occurs when you exchange goods or services without exchanging money. An example of bartering is a plumber doing repair GhostSCARY.GR
work for a dentist in exchange for dental services. The fair market value of goods and services received in exchange for goods or services you provide must be included in income in the year received.

Generally, you report this income on Form 1040, Schedule C (PDF), Profit or Loss from Business. If you failed to report this income, correct your return by filing a Form 1040X. Refer to Topic 308 for Amended Return information.

  The Internet has provided a medium for new growth in the bartering exchange industry. This growth prompts the following reminder: Barter exchanges are required to file Form 1099-B for all transactions unless certain exceptions are met. Refer to Barter Exchanges for additional information on this subject. If you are in a business or trade, you may be able to deduct certain costs you incurred to perform the work that was bartered. If you exchanged property or services through a barter exchange, you should receive a Form 1099-B (PDF), Proceeds From Broker and Barter Exchange Transactions. The IRS also will receive the same information.

Please refer to the I.R.S. Bartering page for more information on bartering income and bartering exchanges.

Direct Barter Transactions (from the I.R.S. web site.)
If you engage in the direct barter of products or services with an individual or a business you will generally not receive a Form 1099-B, but the transaction must be accounted for in your books and records just the same. Think of a barter transaction as just another sales transaction of your business goods or services you must include in your income at the time received. Accurate accounting and record keeping can help you manage barter transactions.

For example, if a doctor agrees to give an accountant a personal medical exam in exchange for personal tax return preparation, the fair market value of the medical exam is taxable to the accountant, and the fair market value of the tax return preparation is taxable to the doctor.

For simplicity sake, let’s assume the fair market value of both services is equal to say, $200. Note that all pieces of the transaction should be clearly marked as a bartering transaction in the books and records of both the doctor and the accountant. With the fair market value of both services being equal, both the doctor and the accountant must include $200 in their income as a result of the bartering transaction.

 

 


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

Hands hiding face keeps secrets. My personal insight after two audits is that the I.R.S. does not reveal their hand . . .ever! You are asked to bring tons of documentation, but really you don't know why.  They then ask lots of questions, all presuming you are guilty until you prove otherwise.

After surviving my I.R.S. audit (with "no changes") I think they wanted documentation about my travel expenses to see if I mixed my business travel with leisure travel. They did not debate the amount but seemed to want to be sure that my deductions for Travel, Meals and Entertainment expenses were for BUSINESS ONLY.  Fortunately (or unfortunately), I never seem to have time to add any leisure to my business trips.

Harriete Estel Berman with tons of receipts. I had receipts for all my Travel, Meals and Entertainment business expenses and adequate documentation. My trips were all 100% business. Thank goodness. It immediately curtailed this line of interrogation.

What concerns me is that so many artists or makers do mix business travel with leisure. They go to conferences or exhibition openings and then add on a few days of traveling around the area for leisure/vacation/entertainment.

There a two ways you can look at this.
- Think like an artist/maker, or
- Think like the I.R.S.

Sex in the City Brooch is jewelry from recycled materials by Harriete Estel Berman. Thinking like an artist, maybe you don't care about deducting the travel as a business expense or think .... "Wow, the Conference is in a city you have always wanted to visit!" Your spending money to get to the city, why not stay for extra days. You already have to spend the money on the travel and hotel. Maybe you want to take advantage of the fact that you are already there. Have fun!

WARNING: Be very careful about deducting your business travel expenses. The I.R.S. looks very carefully at combined business and leisure travel, especially when you aren't making very much money from your business.

I.R.S. THINK LIKE THE I.R.S. To be deductible for tax purposes, expenses incurred for travel, meals, and entertainment must be ordinary and necessary expenses incurred while carrying on your trade or business. Generally, you also must show that entertainment expenses (including meals) are directly related to, or associated with, the conduct of your trade or business. For more information on travel, meals, and entertainment, including deductibility, see Publication 463.

Count weekends, holidays, and other necessary standby days as business days if they fall between business days. But if they follow your business meetings or activity and you remain at your business destination for non-business or personal reasons, do not count them as business days.

Make Sure that Your Trip is Primarily for Business
You can deduct all of your travel expenses if your trip was entirely business related. If your trip was primarily for business and, while at your business destination, you extended your stay for a vacation, made a personal side trip, or had other personal activities, you can deduct your business-related travel expenses. These expenses include the travel costs of getting to and from your business destination and any business-related expenses at your business destination.

Example.
You work in Atlanta and take a business trip to New Orleans. On your way home, you stop in Mobile to visit your parents. You spend $2,012 for the 9 days you are away from home for travel, meals, lodging, and other travel expenses. If you had not stopped in Mobile, you would have been gone only 6 days, and your total cost would have been $1,712. You can deduct $1,712 for your trip, including the cost of round-trip transportation to and from New Orleans.

BentClocks06 What Does the IRS Consider a Business Day?
Any of these qualify as a business day:
   - a day on which you travel getting to and from your business destination
   - a day when you spend at least 4 hours on business related activities
   - a day when you have a pre-scheduled appointment

The first two are relatively simple to understand. Just be sure you have documentation to back up your travel, such as ticket stubs. On days when you are spending at least 4 hours on business activities, your activity log serves as documentation. (This is where your travel log or diary will help document your trip.)

On days when you have a pre-scheduled appointment, you have to be able to prove that you actually attended the appointment. How do you prove it? If you met someone for a meal and picked up the tab, the receipt from the meal serves as proof. Otherwise, you'll need to print out emails from before and after the trip to the person or people you met. The email from before your trips proves that the meeting was pre-scheduled. The email sent after the meeting (for instance, thanking them for meeting you) proves that you were at the meeting.

Use your travel diary to help you with this record keeping.

Business Meals You can deduct the cost of meals if it is necessary for you to stop for substantial sleep or rest to properly perform your duties while traveling away from home on business. Half the cost of all your meals during actual business days can be deducted. This is true whether you met another person for a meal and picked up the tab, or you ate alone.  The I.R.S. has lots of rules about business meals including a standard meal allowance. Read more about this on their web site.

Harriete Estel Berman on a personal family trip in Mexico City with family.Was Your Trip Primarily for Personal Reasons
If your trip was primarily for personal reasons, such as a vacation, the entire cost of the trip is a nondeductible personal expense. However, you can deduct any expenses you have while at your destination that are directly related to your business.

P.S. The rules for traveling outside the United States are different. If you want to know how to account for your business travel outside of the U.S. read the I.R.S. web site.

It really irks me that big companies routinely take their executives on fancy trips for days of golfing with a couple of meetings thrown in and then deduct the entire amount as a business expense while artists can never do this. But for most of us, complaining about another industries indulgent business expenses isn't going to sway your own personal auditor at the I.R.S.

So keep your business expenses legitimate and above board. Avoid combining business with leisure travel, unless you don't plan on taking the business deduction.

Harriete

Much of the information in this post (with the exception of my opinion) came directly from the I.R.S. web site. Read the I.R.S. web site for more information.

Sex in the City Flower Brooch by Harriete Estel Berman is constructed from post consumer recycled tin cans.

SEX in the City Flower Brooch by Harriete Estel Berman
Post consumer, recycled tin cans,
© 2010. Retail Price $625


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

To prepare for my I.R.S. audit, I was required to bring A LOT of INFORMATION and DOCUMENTS. It filled an 11" x 12" accordion folder, all of the 12 slots were full. We were running out of room!  AccordianFOLDER

Frankly, it was hard to tell if the DEMANDING, "business like language" on the I.R.S. letters was a standard request or if I was in BIG TROUBLE!

Nightmare_victim_lg

I was petrified and had recurring nightmares about how I wasn't allowed to be an artist because I didn't follow the rules of the I.R.S.  The irony in the daylight never escaped me. I didn't become an artist because I was good at paperwork.

One of the many pages from the I.R.S. said:

 

Travel, Meals and Entertainment
Verification of the number of nights away from home overnight for business purposes. Include receipt or credit card statements for meals and actual lodging. 

A log or diary for travel costs incurred while away from home on business.  This information should include transportation tickets, receipts, and canceled check. Note: Canceled checks written to MasterCard, VISA, American Express, Discover, etc. are not sufficient to establish a business expense, even if they are business cards. You must keep the actual receipts or the monthly credit card statements showing each expense in detail.  (There was more, but I think you catch the drift.)

So, do you have a receipt for every expense on your business trips?

Do you keep a log or diary of your trips?

credit-card-receipts While I had a receipt for all my expenses, I didn't keep a log or diary for every trip in 2008, and there were quite a few business trips that year. Thank goodness, I have a great memory for small details which we wrote into the accounting records.

During the I.R.S. appointment, the topic of my business travel expenses was part of the "interview". Dressed to the nines in my business battle fatigues with intimidation proof vest (my best black suit with Harriete Estel Berman jewelry. of course), I was in hyper mode.  There was not doubt that we were prepared with itemized receipts for every expense. In addition, the expenses were color coded and highlighted on the credit cards statements. This level of preparation and organization for the audit was deemed "adequate" by the auditor, but it took hours and hours to get ready.

From now on I am keeping a travel diary.Notebook I'm thinking a small notebook, with a pocket for my receipts will be more effective and a lot easier when I get home to write all the expenses into my CASH OUT Excell spread sheet.

This low tech solution is just the point. I believe that every artist should be able to deduct their legitimate business expenses without getting into trouble with the I.R.S. but you need to BE PREPARED with the required level of documentation.   

The next post will cover the key question from the I.R.S.about business travel? This is what I think they wanted to know all along....."Did I combine my business travel with leisure travel?"

Harriete

RELATED ARTICLES: 

Hobby or Business? Criteria for the I.R.S.

Nightmare_lg

Close-up view of The Nightmare by Henry Fuseli
Oil on canvas, 1210 x 1473 x 89 mm; Exhibited 1782
Lent by the Detroit Institute of Arts, Founders Society Purchase with funds from Mr and Mrs Bert L. Smokler and Mrs Lawrence A. Fleischman


Surviving an I.R.S. audit - Cost of Goods SOLD and Jail House Orange - A Fashion Accessory Nightmare

Jailhouse ORANGE outift If the I.R.S. asks you to bring your Cost of Goods Sold from two years ago. Are you ready?  An I.R.S. audit causes lots of anxiety. They earn their reputation. My vivid imagination, normally a fantastic creative asset, revved into the red zone as I imagined myself in jail house orange - a fashion accessory nightmare.  

 

Altoids earrings by Harriete Estel Berman
  Altoids Earrings © 2010
  Recycled tin cans, sterling silver wire,
  jump rings, and posts.
  Artist: Harriete Estel Berman

Double and triple checking my Cost of Goods Sold took hours of work and lots of help to get ready. Sure, I had good Inventory Records, but they were encrypted in "Harriete lingo"  (i.e. no shape to hand over to the I.R.S.).  While I could interpret what and where everything was, auditors prefer to see rows and columns in spread sheets that clearly add up to the numbers on your tax return. 

 

Recycled Two Orange Bracelet from post consumer recycled plastic by Harriete Estel Berman
   RECYCLED Two Orange Bracelet
   © 2010 Harriete Estel Berman
   Post consumer recycled plastic
   Photo Credit: emiko oye

And here is what I learned this year.  Your Finished Goods (discussed in the previous post) becomes Cost of Goods Sold (COGS) only after it is sold. Duhhhhhhhh......

Most artists just move an item from their Inventory to SOLD. Done. Calculating Inventory is magic or subject to their creative imagination.

NOW THINK LIKE THE I.R.S.:
The IRS only wants to see clear and accurate records and neat rows and columns of numbers.

The I.R.S. wants to see how you calculated your Cost of Goods Sold. 

The I.R.S. wants  to see unmistakable evidence that you are acting in a business like manner.

Cost of Goods scratches and scribbles Scribbles and arrows are NOT good enough. You need to know how much each item/artwork cost to make. Each finished piece adds to your Finished Goods Inventory. 

So, month after month, year after year, the cost of your Finished Goods for each finished piece keeps adding to your Inventory.  By keeping an ongoing Inventory Record for each artwork or piece, the rest of this accounting becomes a lot easier.

Finally, when you sell a finished piece/artwork, you know exactly how much it cost you, right? The Finished Goods number becomes the Cost of Goods Sold for that piece. You already wrote the amount down in your Inventory Record.

Repeat, the dollar amount for Finished Goods now becomes the "Cost of Goods Sold" for the piece.  You subtract the amount from Inventory and add it to the end of year total for Cost of Goods SOLD. Voila! you've calculated your Cost of Goods Sold for the year.

Cost of Goods Sold example Ideally, as the year progresses, your list of SOLD work gets longer and your inventory decreases.
Harriete

AOL yellow and orange tin can earrings by Harriete Estel Berman
AOL Earrings by Harriete Estel Berman 

Surviving an I.R.S. audit - What Is Included in the Cost of Finished Good besides your best guess?

In the previous post we focused on using your inventory record to document your cost of Finished Goods for the IRS.  So what can be included in the cost of Finished Goods and what can't?

To keep this really simple, Finished Goods = cost of materials and employee labor that go DIRECTLY into the work.

If you use jump rings, a tube of paint, a roll of canvas, pounds of clay, or sheets of metal, anything that you use DIRECTLY in your work, is included in your Finished Goods. 

Harriete Estel BErman with a gigantic pencil working on her inventory recordTo figure out how much your raw materials cost, you can look at your receipts for purchases or write it on  the materials themselves.  For example,when I buy metal, I write the total cost on the sheet of metal with a magic marker. Buy some clay? Write how much it cost per pound on the outside of the package. Canvas? Write down the price per yard.

COGSsilver
   A sheet of sterling silver. I wrote the
   price of the sterling sheet metal when
   I bought it.


Write it down when you buy your materials so you won't have to look it up later.  If the jump rings cost you $3 for 20, then they cost you 15 cents each.

There are lots of ways to track your materials. Keep it simple and use the same method all the time. Write your cost of materials in your Inventory Record for each piece.

COGSindexhours

Employee labor is also part of your finished goods. Just keep a index card on your bench or in your studio for each work in progress. Write down the employee's labor and your labor separately.The index card on the left shows my labor ("HB") and 2 employees for a work in progress.

The IRS requires that the artist's labor (as a sole proprietor) does NOT go into Finished Goods, but I keep a record anyway.  I want to know how many hours I have invested in each piece. Don't you? How else can you plan new work or figure out if you are charging a reasonable retail price?

Your Inventory Record SHOULD INCLUDE the cost of materials and employee labor in each artwork. You need this information at the end of the year.  By the end of the year, the sum of Finished Goods for all finished work adds to your inventory.   

NOW IT IS TIME TO SELL! This will be the post for next time when we change FINISHED GOODS into Cost of Goods Sold (without magic).   

Stay tuned! to ASK Harriete Learn  the standards you need to survive an I.R.S. audit.

Harriete

  Campbell Soup Multi-Can Earrings by Harriete EStel Berman
     Campbell's Soup Multi-Can Earrings
    
© 2001 Harriete Estel Berman
     What are my materials costs?
     Materials: 2 sterling silver posts,
     2 sterling silver jump rings, sterling
     silver wire, recycled tin cans.
   


PS  If you don't have Inventory Records or if you don't consider your art or craft a business, then the IRS will not allow you to deduct your expenses.

If you intend to deduct expenses, then some how, some way, you really need to track the cost of materials and employee labor in your FINISHED GOODS to meet the expectations of the I.R.S.

This information is essential every year when you file your taxes. 


 



Surviving the I.R.S. - Cost of Goods Sold, Are you ready? Watch my head explode!

My appointment with the IRS required that I bring my Cost of Goods Sold and Inventory records. I.R.S.sign368

Visualize this written on I.R.S. stationary...

Cost of Goods Sold (and I quote directly from the Information Document Request)
"Physical inventory sheets for both beginning and ending inventory for the year. Copies of the Federal Income tax returns for the year before and the year after the return being examined (copy of your inventory list, log book, invoices, or any documentation you have that records your inventory.)

Canceled checks, receipts, journal or summaries of goods purchased for resale and all other records for labor, materials and supplies, and any other cost incurred to raise or produce goods for sale."

Does that sound scary? There was more....but we will discuss this in another post... the point is:
Are your Inventory Records good enough for the I.R.S.?

IF the I.R.S. wants it, you've got to have it!

BobbleheadTo be honest, I am permanently confused about Cost of Goods Sold and Finished Goods...I feel like one of those bobble head dolls. Yeah, I understand this for about a minute, then get confused again.  But I do know how to keep records, simple records, but records of everything. The IRS requires records and that's what you need to survive an IRS audit.

THE QUESTION IS: "How do you figure your Cost of Goods Sold?"

First you need your Inventory Record of everything you made. This has been discussed in many posts on ASK Harriete.

Use your Inventory Records to figure a value for FINISHED GOODS.
Artists and accountants live on different planets. FINISHED GOODS is accountant speak. (All accountants live on a different planet than artists.)

Finished Goods equals the cost of any materials that goes directly into your completed work plus the cost of your employee's manufacturing labor (but not your own labor).

FINISHED GOODS is the dollar cost of the work that you finish and the amount that you add to your Inventory for each finished piece. 

GET IN A GOOD HABIT.
As soon as you finish an artwork or item, add the costs to your Inventory Record.

FIGURE OUT YOUR MATERIALS COST (and employee labor). Write down every jump ring, bead or sheet of paper. Estimate (as best you can) the cost for the clay, paint or metal. It might be by the pound, by the ounce, by the inch or by the yard.

WRITE IT DOWN
Write down the cost of your materials and employee labor in your Inventory Record. This is the monetary value of Finished Goods for each piece.

AT THE END OF THE YEAR, the sum of all the Finished Goods is how much you have increased your Inventory during the year.

Finished Goods is not your retail price. Repeat this mantra.
Finished Goods is not your retail price. 
NOD YOUR HEAD, like a bobble head doll.
Finished Goods is not your retail price. It is your materials cost (plus your employee labor.)

Finished Goods DOES NOT INCLUDE your overhead labor or overhead expenses.
Finished Goods
DOES NOT INCLUDE your profit.
Finished Goods
DOES NOT INCLUDE your labor.

This is my head exploding.  Ask Harriete
Watch my head explode.

 

 


Surviving an I.R.S. audit - No change!


Last Thursday was my I.R.S. audit.  ARRGGGHHH!  We arrived at a location (which apparently is illegal to disclose). There were no signs on the building.  This felt more like a secret liaison than an appointment with my government.
  Irs3smiles

Both Terry (Secretary), Emiko (Studio Assistant), and my husband (taking the picture) came with me. They had prepared the documentation for the audit and reviewed and scrutinized all the records for the year in question. NOTE the extra LARGE red bag full of our papers. We were PREPARED! We even practiced!

Over the next couple of weeks, I am going to share how to survive (at least how I survived) an I.R.S. audit and ultimately heard the sweetest words a civil servant could utter,  "NO CHANGE!"  -- the best outcome you can expect.

I am not a tax adviser, just a "maker" like most of the readers of ASK Harriete who like to make work far better than keep business records.  But if you want to be in the "business of art or craft" (instead of a hobby), then accurate and complete records are required to show that you are "taking care of business."  The I.R.S. requires that you act like a business and your records are the evidence.

The previous post talked about titles. Titles are your first step in accurate Inventory Records. Think about it, every sofa, sweater or shoe in the store has a name. You know what else they have? An inventory number!

PAM Flower Pins from 2010 by Harriete Estel Berman
April Flower Pin © 2010
recycled tin cans, sterling silver,
Artist: Harriete Estel Berman
Inventory #
61.4L8.10/ 575

Every single item you make, whether it is one of a kind or multiple, needs an inventory number. My inventory numbers include a code that is a description, date made, and the price.  The inventory number of this pin is:  Flower pin 61.4L8.10/ 575. This means it is the 61st Flower pin, 4 layers, recorded to inventory in August 2010, and the price is $575. Each group of work has different information in the Inventory Number. I have talked about Inventory Numbers before on ASK Harriete.

AOL earrings from 2008
AOL Earrings08  © 2010
recycled tin cans, sterling silver,
Artist: Harriete Estel Berman

INVENTORY RECORDS are an absolute must to survive your I.R.S. audit. Are you ready?

Every item needs:
-
title
- inventory number  (including date made)
-
date sold
-
materials list, cost of materials and cost of labor to calculate your FG (Finished Goods) and COGS (Cost of Goods Sold).

An itemized COGS (Cost of Goods Sold) is one of the fist items the I.R.S. agent asked for on Thursday.  Are you ready for an I.R.S. audit? Do you know your Cost of Goods Sold?

We will go over COGS (Cost of Goods Sold) in the next post.

Harriete


She Sells Wholesale. She Sells Retail. Is She Selling Wholesale at Retail?

Recent correspondence with Suzanne Sippel, Retail Manager Asher Gallery at the Houston Center for Contemporary Craft, raised an important issue.  Many artists and craftspeople too often make a huge mistake. I have witnessed this phenomenon myself for years especially when I go to the smaller shows, exhibitions and online.

Suzanne Sippel said, “It’s the craft shows and fairs where I find more artists who don’t understand the business aspect of what they do. They are so excited to be selling their work that they ignore or forget the “sales” portion of the transaction. They miss the distinction between wholesale and retail, and absolutely forget overhead. I was very excited to read your column on including overhead, as I had not found a way to explain this to my “younger” artists.

As the Asher has grown we are representing more mature artists, and these issues arise less and less as a consequence. But it’s still a problem. I will find fantastic work by a new artist, but they would want to double their prices for me (wholesale/retail mix-up again).  Naturally this keeps them out of my gallery, but they are still out there. It devalues all of our businesses and their own professional growth.”

 

64 Crayola Crayons Flower pin by Harriete Estel Berman is jewelry constructed from recycled materials.
 64 Crayola Crayons Flower pin  © 2010
 Post Consumer Recycled tin cans
 Artist: Harriete Estel Berman

So what is the impact of selling your work at wholesale prices at a street fair, open studio, online, or exhibition?  If you sell work in retail venues (such as the above) and charge only wholesale prices, then you aren't covering your retail expenses.  But even more important, no gallery or store will take your work. They don't want to compete with YOU selling at your wholesale price.

64 Crayola Crayons Flower pin by Harriete Estel Berman
 64 Crayola Crayons Flower pin  © 2010
 (Back View)
 Post Consumer Recycled tin cans
 Artist: Harriete Estel Berman


A gallery or store can't sell your work when they know that their customers might buy something similar from you at at half the price.  It makes their retail price look like they are ripping off their customers. Of course, that isn't true, but the customer might not understand that the artist is the one making a big mistake.

 

Conversation M from the series Consuming Conversation by Harriete Estel Berman
   Consuming Conversation
   Conversation M © 2004
   Post Consumer recycled tin cans.
   Artist: Harriete Estel Berman
   Photo Credit: Philip Cohen

You heard the gallery perspective in the quote from Suzanne Sippel, but the message concerns your survival as an artist or maker. Your wholesale prices should cover your investment in fabricating the work including  hours, materials, and overhead (including overhead labor and overhead materials.)

Your retail prices should cover your retailing expenses. In the example of a street fair, you have the booth fee, travel, hotel, food, time for sitting at the booth, expenses involved in creating your booth (such as tent, cases, tables, fabric for your drape, and display expenses such as lights, fixtures, and more.) These expenses are not covered in your wholesale price. Retailing has its own set of expenses which is why there is a retail price. 

Harriete

 

RedOLDtime

Old Time Quality Flower Pin by Harriete Estel Berman is constructed from post consumer recycled tin cans. Retail Price for this pin is $380. One of a kind and hallmarked with my iron hallmark to establish the provenance. This flower will never fade.

 


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

Coming up is my "anniversary" of my I.R.S. audit. Three summers ago, I was "invited" for a morning visit with the I.R.S. What a petrifying experience!  Coffee was politely offered but my adrenaline was pumping already.  Everything turned out fine...but perhaps you may gain some insight from how I survived economically unscathed and on excellent terms with the I.R.S.

Here are 3 basic tips based on my experience that you should implement immediately (if you are not doing this already).

Consuming Conversation R a stack of teacups or coffee cups constructed by Harriete Estel Berman from recycled tin cans
 Consuming Conversation © 2001-2004
A series of 200 cups.
Recycled tin cans, brass, s.silver,
Artist: Harriete Estel Berman
View the entire series on my web site.
 

1) Keep your business banking accounts COMPLETELY SEPARATE from your personal banking. I mean completely separate! For years I had my business bank accounts at a different bank than my personal bank accounts.  I often grumbled and chafed at this extra deposit and bookkeeping effort with two different banks.

I'll never complain again. It paid off BIG when the I.R.S. MAN casually asked questions to glean if my art business funds were co-mingled with my personal funds. One of the first levels of inquiry (even before the audit) is to discover any commingling of business money with personal money. Once the I.R.S. man found out that I not only had separate business and personal accounts, but further separated them at different banks ..that topic was OVER. He saw no glimmer of possibility of catching me in a wrongful accounting of my business income or expenses with personal checking and savings or credit cards.

Uncle Bens Cup from Consuming Conversation teacups or coffee cups constructed by Harriete Estel Berman from recycled tin cans
  Consuming Conversation © 2001-2004
  Recycled tin cans, brass, s.silver,
  Artist: Harriete Estel Berman
  Photo Credit: Philip Cohen
   View the entire series on my web site.

2) Keep detailed and accurate records. The I.R.S. asked for specific categories of receipts in advance. I was required to bring this portion of documentation to the I.R.S. office that morning.  In this case they wanted to look at my Advertising Expenses for the year. While it was a tremendous amount of effort to separate my Advertising Expense receipts (month by month) from all the other receipts (it took about fourteen hours), I was prepared to show each and every receipt. 

He started out asking for the Advertising Expenses for a particular month in random order. He jumped around, March, August, October, etc. Each and every time I had every receipt (already organized by month) ready to go without hesitation or excuse.

When it was obvious that I was well organized (thanks to Emiko Oye, my studio assistant) and he could find no mistakes, he ceased this line of questioning. 

Consuming Conversation 3 teacups or coffee cups constructed by Harriete Estel Berman from recycled tin cans
  Consuming Conversation © 2001-2004
  Recycled tin cans, brass, s.silver,
  Artist: Harriete Estel Berman
  View the entire series and video.
 

3) The primary test is whether you act like a business. I was surprised to come to the realization that the I.R.S. is not interested in whether I was a professional success or a financial success. They did not care about my exhibitions or gallery representations.  They did not care about my education, publications or professional visibility. They only wanted to determine whether I performed like a business.

The I.R.S. measures business standards with definitions that have nothing to do with art or craft. While my advertising expenses must have been a red flag since they were so high for a small business (professional photography is a significant expense). The I.R.S. only wanted to see that I kept complete and accurate records like a business.

Illy COFFEEPOT. titled Coffee the Golden Ratio by Harriete Estel Berman is constructed from reycled tin cans, an art coffee pot
   Coffee Φ: The Golden Ratio © 2004
  Recycled tin cans, brass, s.silver,
  Artist: Harriete Estel Berman
  Photo Credit: Philip Cohen

My advice:
-Keep your business checking account separate.
-Never co-mingle personal and business money.
-Get a separate credit card for your business.
-Keep detailed and accurate records of every business expense.
-Act like a business. 

Do all of this before you have coffee with the I.R.S.

Harriete

Here are the 9 criteria from the I.R.S. used to figure out if you are a business (copied directly from the I.R.S. web  site.

The following factors, although not all inclusive, may help you to determine whether your activity is an activity engaged in for profit or a hobby:

  • Does the time and effort put into the activity indicate an intention to make a profit?
  • Do you depend on income from the activity?
  • If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
  • Have you changed methods of operation to improve profitability?
  • Do you have the knowledge needed to carry on the activity as a successful business?
  • Have you made a profit in similar activities in the past?
  • Does the activity make a profit in some years?
  • Do you expect to make a profit in the future from the appreciation of assets used in the activity?