How do I start a side job as a musician and avoid audit?

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financial.freedom
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Joined: Fri Oct 03, 2014 1:18 am

How do I start a side job as a musician and avoid audit?

Post by financial.freedom » Sun Jun 26, 2016 12:13 pm

My hobby as a musician is becoming more serious. In part, it is because I have more money to buy the instruments I enjoy. Also, I am at a phase in my life that I'm getting closer to financial independence (maybe less than 10 years away depending upon several factors). In an ideal world, I'd like to crossover from my current high-stress professional job to becoming a musician who mostly records at home and puts out an album every couple of years, selling content online.

I was thinking the first step is to set up a website and start uploading my music to websites that will pay me for each time my songs are played (Spotify, iTunes, etc.). On YouTube, I can put videos of myself performing some of the songs. I could start a blog and write about my journey and goal of changing from a high-stress professional job to a stay-at-home father and musician. I could have other spin-offs, such as selling background music for shows, video games, etc. Maybe none of this is realistic and I'm just having a mid-life crisis. I could blog about that too.

1. Because this is going to start slowly as a side job, how do I set things up to avoid getting audited? There will probably be mostly losses the first 2-3 years and I'm concerned that could get flagged.

2. Can this money be used to fund a solo-401k?

3. Any advice from BHs who converted a hobby to a side-job and then eventually another career?

Thank you in advance!

DSInvestor
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Re: How do I start a side job as a musician and avoid audit?

Post by DSInvestor » Sun Jun 26, 2016 12:27 pm

Declare your side income using schedules C/SE on your tax return assuming you're not going to incorporate. The income reported this way can be used to contribute to Solo 401k. Keep in mind that the Employee salary deferral contribution limit of 18K (24K if age 50+)for solo 401k is shared across all 401k/403b/TSP plans. If you max out 401k at your main job, you'd have no room to make employee salary deferral contributions to your solo 401k. However you can still make employer profit share contributions to your solo 401k. If your side business does well, say net business profit of 260K, you'd be able to max out your solo 401k for 53K.

The 53K limit for solo 401k is separate from other 401k/TSP. There is a wrinkle with 403b which I believe is treated as being owned by the plan participant which results in the 403b and solo 401k sharing the 53K limit.

In the early stage of your side business, your side income may be low relative to your expenses (purchases of instruments and equipment). These expenses are reduced from your revenue to reduce your sole proprietor net business income . You need to have a positive net business income in order to contribute to solo 401k as sole proprietor.
Last edited by DSInvestor on Sun Jun 26, 2016 12:34 pm, edited 1 time in total.
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Atgard
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Re: How do I start a side job as a musician and avoid audit?

Post by Atgard » Sun Jun 26, 2016 12:29 pm

If you have losses for too long (don't recall the exact rule, you can Google it), your "business" will be considered a "hobby" by the IRS and you will run into trouble trying to deduct losses.

If you make a profit, you can use some of those profits to fund a Solo 401k, assuming you set up an LLC and do the proper accounting and such.

Personally, I waited until my side businesses (I wrote novels & sold a few) turned an annual profit before I tried to deduct losses on something with no income. Although that is a conservative way to do it, and I didn't have many expenses before making at least some profit (I didn't have to buy expensive instruments, for example). My recommendation if you're serious is to keep the accounting clean, create an LLC, have a business bank account & business credit card to keep income & expenses separate and easy to track, etc.

financial.freedom
Posts: 367
Joined: Fri Oct 03, 2014 1:18 am

Re: How do I start a side job as a musician and avoid audit?

Post by financial.freedom » Sun Jun 26, 2016 1:11 pm

DSInvestor wrote:Declare your side income using schedules C/SE on your tax return assuming you're not going to incorporate. The income reported this way can be used to contribute to Solo 401k. Keep in mind that the Employee salary deferral contribution limit of 18K (24K if age 50+)for solo 401k is shared across all 401k/403b/TSP plans. If you max out 401k at your main job, you'd have no room to make employee salary deferral contributions to your solo 401k. However you can still make employer profit share contributions to your solo 401k. If your side business does well, say net business profit of 260K, you'd be able to max out your solo 401k for 53K.

The 53K limit for solo 401k is separate from other 401k/TSP. There is a wrinkle with 403b which I believe is treated as being owned by the plan participant which results in the 403b and solo 401k sharing the 53K limit.

In the early stage of your side business, your side income may be low relative to your expenses (purchases of instruments and equipment). These expenses are reduced from your revenue to reduce your sole proprietor net business income . You need to have a positive net business income in order to contribute to solo 401k as sole proprietor.
Thank you! Then it may be 2+ years before I generate much of a profit. I am fortunate enough to have a 401k at my job right now, so could only do employer profit share contributions.

financial.freedom
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Re: How do I start a side job as a musician and avoid audit?

Post by financial.freedom » Sun Jun 26, 2016 1:15 pm

Atgard wrote:If you have losses for too long (don't recall the exact rule, you can Google it), your "business" will be considered a "hobby" by the IRS and you will run into trouble trying to deduct losses.

If you make a profit, you can use some of those profits to fund a Solo 401k, assuming you set up an LLC and do the proper accounting and such.

Personally, I waited until my side businesses (I wrote novels & sold a few) turned an annual profit before I tried to deduct losses on something with no income. Although that is a conservative way to do it, and I didn't have many expenses before making at least some profit (I didn't have to buy expensive instruments, for example). My recommendation if you're serious is to keep the accounting clean, create an LLC, have a business bank account & business credit card to keep income & expenses separate and easy to track, etc.
Thank you for the reply!

I've already recorded music on my keyboard and guitar but recently bought a piano (about 5.5k) so that will be a major expense. It also needed some work (new strings etc.), about $3,500 additional expense. The first year I will need a website, a laptop, some advertising, and set up LLC it sounds like. That is quite a bit of expenses the first year, hopefully it doesn't set off a flag for the IRS. The following years I will be using the same equipment and mostly just composing songs and trying to sell my work. The piano may be able to depreciate each year but I'm not sure, will look into that.

I want to start right away rather than waiting for making a profit, but at the same time I don't want to get audited.

Teague
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Re: How do I start a side job as a musician and avoid audit?

Post by Teague » Sun Jun 26, 2016 2:34 pm

I looked into something similar a while back, for a different hobby bordering on a business. My take-away points:

1. If you use your business losses to offset your W-2 income, you will increase your risk of an audit. Do it for too long, and, as mentioned, your business gets deemed a hobby, and losses are only deductible up to the amount the business brings in. You will have to pay back money with interest/penalties.
2. If your business is in a field that is often a hobby, you will increase your risk of an audit. (I think the IRS guidance to its agents specifically mentioned photography, car racing, horse breeding and a few others, as well as generally "creative" activities.)
3. Given the above, it is very important to conduct your business as a business, rather than as a hobby. Secure any required permits, insurance, separate business bank account and credit card, and keep meticulous records.

That was my take on things anyway. Hopefully you can avoid having to "face the music" :wink: of an audit.
Semper Augustus

pshonore
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Re: How do I start a side job as a musician and avoid audit?

Post by pshonore » Sun Jun 26, 2016 3:10 pm

financial.freedom wrote:
DSInvestor wrote:Declare your side income using schedules C/SE on your tax return assuming you're not going to incorporate. The income reported this way can be used to contribute to Solo 401k. Keep in mind that the Employee salary deferral contribution limit of 18K (24K if age 50+)for solo 401k is shared across all 401k/403b/TSP plans. If you max out 401k at your main job, you'd have no room to make employee salary deferral contributions to your solo 401k. However you can still make employer profit share contributions to your solo 401k. If your side business does well, say net business profit of 260K, you'd be able to max out your solo 401k for 53K.

The 53K limit for solo 401k is separate from other 401k/TSP. There is a wrinkle with 403b which I believe is treated as being owned by the plan participant which results in the 403b and solo 401k sharing the 53K limit.

In the early stage of your side business, your side income may be low relative to your expenses (purchases of instruments and equipment). These expenses are reduced from your revenue to reduce your sole proprietor net business income . You need to have a positive net business income in order to contribute to solo 401k as sole proprietor.
Thank you! Then it may be 2+ years before I generate much of a profit. I am fortunate enough to have a 401k at my job right now, so could only do employer profit share contributions.
Most business equipment (like pianos and instruments) is likely depreciated over its useful life, although you can take accelerated depreciation. Start up costs (not sure if website development is in that category) are usually amortized as well. You may want to meet with a good CPA who specializes in small business startups (if one exists).

Spirit Rider
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Re: How do I start a side job as a musician and avoid audit?

Post by Spirit Rider » Sun Jun 26, 2016 3:30 pm

There are plenty of IRS guidelines about what constitutes a business vs. a hobby. Expenses up to income can be deducted in both cases. Losses may only be claimed for a business. A business must make a profit in three out of every five years. The IRS understands that many business will have startup losses. but if your first two years have losses, your next three better show a profit or you will have a high likelihood of an audit.

Here is relevant IRS Fact Sheet FS-2007 Business or Hobby? Answer Has Implications for Deductions

Isabelle77
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Re: How do I start a side job as a musician and avoid audit?

Post by Isabelle77 » Sun Jun 26, 2016 4:39 pm

My husband has had a side job as a songwriter and voiceover artist for more than 15yrs now. He has made anywhere from 10-60k a year in side work.

I'm not going to be much help with the tax side of things, we haven a cpa handle our taxes. The depreciation, royalties, and home office stuff was just too much for me to handle. I might be able to provide some other general advice though.

We use a separate checking account for business expenses, which are minimal at this point as all we do is update computer programs occasionally, maybe a microphone. My husband doesn't have an LLC and just acts as a sole proprietor. I deposit all checks from his side business into a savings account, we don't use them for anything other than funding a SEP IRA, paying any owed taxes, or purchasing any new equipment, otherwise we just save it and invest it.

General musician advice. If you arent set up with ascap or bmi you should register your music with them, I believe it's free. They handle royalty checks but are also valuable resources, my husband is with Bmi. Consider insurance riders for your instruments, every musician has a horror story about having their van broken into, it's a business expense and expensive but if you're playing out it's worth it. If you are writing your own music you may want to look into publishing houses that may be interested in your songs, hire a lawyer to deal with them if you go this route. My husband has had several pub deals and they can be a great source of income but also stress. Finally remember that music is one of those businesses that can be really great for a year or two and then...nothing. You have to be prepared for that possibility. Unfortunately it has a high burnout too, my husband makes the bulk of his side money now through voiceover work because writing just isn't that fun anymore for him.

Wish you the best, I hope that helps with some of it!

financial.freedom
Posts: 367
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Re: How do I start a side job as a musician and avoid audit?

Post by financial.freedom » Mon Jun 27, 2016 2:11 pm

Spirit Rider wrote:There are plenty of IRS guidelines about what constitutes a business vs. a hobby. Expenses up to income can be deducted in both cases. Losses may only be claimed for a business. A business must make a profit in three out of every five years. The IRS understands that many business will have startup losses. but if your first two years have losses, your next three better show a profit or you will have a high likelihood of an audit.

Here is relevant IRS Fact Sheet FS-2007 Business or Hobby? Answer Has Implications for Deductions
So maybe I should try to see if the start-up costs/losses can be deducted the first year (rather than depreciating the instruments over time), have a small profit the next couple of years, and hopefully slowly build it over time.

financial.freedom
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Re: How do I start a side job as a musician and avoid audit?

Post by financial.freedom » Mon Jun 27, 2016 2:15 pm

Isabelle77 wrote:My husband has had a side job as a songwriter and voiceover artist for more than 15yrs now. He has made anywhere from 10-60k a year in side work.

I'm not going to be much help with the tax side of things, we haven a cpa handle our taxes. The depreciation, royalties, and home office stuff was just too much for me to handle. I might be able to provide some other general advice though.

We use a separate checking account for business expenses, which are minimal at this point as all we do is update computer programs occasionally, maybe a microphone. My husband doesn't have an LLC and just acts as a sole proprietor. I deposit all checks from his side business into a savings account, we don't use them for anything other than funding a SEP IRA, paying any owed taxes, or purchasing any new equipment, otherwise we just save it and invest it.

General musician advice. If you arent set up with ascap or bmi you should register your music with them, I believe it's free. They handle royalty checks but are also valuable resources, my husband is with Bmi. Consider insurance riders for your instruments, every musician has a horror story about having their van broken into, it's a business expense and expensive but if you're playing out it's worth it. If you are writing your own music you may want to look into publishing houses that may be interested in your songs, hire a lawyer to deal with them if you go this route. My husband has had several pub deals and they can be a great source of income but also stress. Finally remember that music is one of those businesses that can be really great for a year or two and then...nothing. You have to be prepared for that possibility. Unfortunately it has a high burnout too, my husband makes the bulk of his side money now through voiceover work because writing just isn't that fun anymore for him.

Wish you the best, I hope that helps with some of it!
Very helpful, thank you! I will ask our CPA about LLC versus Sole Proprietor. That is great your husband has been able to generate 10-60k per year of side income. I'd be happy generating 1k per month 5-10 years from now. When I look at how much online service (Spotify, iTunes, etc.) pay per stream it is very little. It might also be hard to get the songs to stand out amongst the millions of Indie songs. I might be able to generate more income selling background music for movies, commercials, video games, and teaching lessons to kids. I will look into BMI as well. Thank you again!

amazonchic
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Re: How do I start a side job as a musician and avoid audit?

Post by amazonchic » Mon Jun 27, 2016 2:56 pm

financial.freedom wrote:
Atgard wrote:If you have losses for too long (don't recall the exact rule, you can Google it), your "business" will be considered a "hobby" by the IRS and you will run into trouble trying to deduct losses.

If you make a profit, you can use some of those profits to fund a Solo 401k, assuming you set up an LLC and do the proper accounting and such.

Personally, I waited until my side businesses (I wrote novels & sold a few) turned an annual profit before I tried to deduct losses on something with no income. Although that is a conservative way to do it, and I didn't have many expenses before making at least some profit (I didn't have to buy expensive instruments, for example). My recommendation if you're serious is to keep the accounting clean, create an LLC, have a business bank account & business credit card to keep income & expenses separate and easy to track, etc.
Thank you for the reply!

I've already recorded music on my keyboard and guitar but recently bought a piano (about 5.5k) so that will be a major expense. It also needed some work (new strings etc.), about $3,500 additional expense. The first year I will need a website, a laptop, some advertising, and set up LLC it sounds like. That is quite a bit of expenses the first year, hopefully it doesn't set off a flag for the IRS. The following years I will be using the same equipment and mostly just composing songs and trying to sell my work. The piano may be able to depreciate each year but I'm not sure, will look into that.

I want to start right away rather than waiting for making a profit, but at the same time I don't want to get audited.
I don't have an answer to your original question, but I can address your question about business expenses. I have a full-time job and play piano locally. I use Weebly for my website. I feel my website is professional enough for what I am doing, although my husband, who is getting into web design, would say otherwise. Weebly is free, but I have used Music Teachers' Helper (paid). Their service was terrible in the end. I'd rather pay someone to set up and run my website.

I also purchased a new 4'10'' petite grand piano in 2001 for around $5k and depreciated it over time with my CPA. You can choose whether to depreciate expenses all at once or over time, depending on your income and what makes sense for income vs. expenses.

I've marketed myself successfully online and in the community through networking and other means. I did meet with several marketing agencies but the cost wasn't worth it for my own income (at that time). As your income increases, you may feel differently. The best marketing agency I met with did suggest I not pay anyone for marketing for what I could accomplish on my own. You could build a good following through social media to sell your CD's and videos.

financial.freedom
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Re: How do I start a side job as a musician and avoid audit?

Post by financial.freedom » Tue Jun 28, 2016 11:44 pm

Thank you for the replies!

Based on my own research and the replies above, this is my plan so far:

1. business bank account and credit card

2. sole proprietor under my name

3. Set up tax ID number

4. Website, advertising, record/sell work

miamivice
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Re: How do I start a side job as a musician and avoid audit?

Post by miamivice » Wed Jun 29, 2016 12:00 am

financial.freedom wrote:Thank you for the replies!

Based on my own research and the replies above, this is my plan so far:

1. business bank account and credit card

2. sole proprietor under my name

3. Set up tax ID number

4. Website, advertising, record/sell work
Be aware that as a sole proprietor, you personally are liable for risks that are incurred by your company. For example, say you make a recording using music that you believe you have copyright approval, but turns out you don't, and your company is sued for copyright infringement. You are personally liable for any judgment.

Another possible situation is that someone is injured at your place of work...you personally become liable for any judgment laid out by the courts. You cannot simply dissolve the firm and have the debt go away.

A LLC would provide a certain degree of asset protection and would be well worth considering.

miamivice
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Re: How do I start a side job as a musician and avoid audit?

Post by miamivice » Wed Jun 29, 2016 12:03 am

amazonchic wrote:
I also purchased a new 4'10'' petite grand piano in 2001 for around $5k and depreciated it over time with my CPA. You can choose whether to depreciate expenses all at once or over time, depending on your income and what makes sense for income vs. expenses.
I don't think you can choose whether to depreciate a capital asset immediately or over a long period of time. A CPA would know for sure but I think that capital assets must be depreciated over time.

cadreamer2015
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Re: How do I start a side job as a musician and avoid audit?

Post by cadreamer2015 » Wed Jun 29, 2016 5:46 am

I have had a side gig as a performing musician for over 20 years. I am not a CPA nor a Lawyer, but in my experience you must depreciate major equipment items. You may have a choice as to straight line vs. accelerated depreciation, but you can not write off the entire cost in the year of purchase. I have not been audited so far.

Also, it is my understanding that forming a single member LLC will not shield your personal assets from liability based on your own actions. They might protect you from liability from actions taken by your employees, should you have any. Consult with your attorney.
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