Once you’ve decided to officially become a professional musician, you are faced with a problem that every working American has to face – you need to file a tax return.
This fact alone is enough to dissuade some very talented musicians from starting their own companies. The idea of being self-employed – keeping track of all the compliance forms, doing the bookkeeping, paying tax – leaves a lot of people paralyzed, to the point where they just give up and go back to their day job, afraid to make any real money from their art.
This breaks my damn heart. So it’s my mission to demystify the tax process for you and give you confidence to work hard, earn money, and file that tax return on time.
Is it a hobby or a business?
To start, I want to address a common question in the tax world – what if I’m just a hobby musician?
That’s totally cool. The world needs hobby musicians – it’s one of the most satisfying hobbies in the world. But if you did make money from it – it would be taxable.
That’s right – hobby income is taxable.
The big difference between pros and hobbyists lies in the way the IRS treats expenses and losses. If you are a hobbyist, you are legally obligated to pay tax on your profit but you cannot claim a loss if you lose money.
The IRS kind of expects hobbyists to lose money. You aren’t operating with an intent to have a profit and you’re spending money from your day job on supplies and materials. So whatever money you spend on your hobby can reduce your taxable hobby income down to zero but you can’t put a negative number in there.
With that said, if you are running a business – you intend to make a profit, you depend on the income for your livelihood, and your losses are due to startup expenses or circumstances beyond your control – then, you can take a loss.
Taking a loss means you’re reducing your overall taxable income by the amount you spent on your business. Say you work a day job as a barista and you earned $15,000 from that job. Meanwhile you are in the startup phase of your music career and you earned another $15,000 from gigs and merch sales, but you spent a total of $17,000 throughout the year. That means your music business lost $2,000 and you’d report it on your tax return as -2000. It would change your barista income from $15,000 to $13,000, decreasing the amount of tax due overall.
As I’m sure you can imagine, the IRS wants this loss to be accurate. If you’re regularly decreasing your tax due by taking a business loss, they’re going to ask you if your losses are legitimate. They’re going to question whether you’re actually running a business that has the intention of being profitable, or if you have an expensive hobby and you’re using it to dodge taxes.
All this is to say – if you start a music business, you need to know from the get-go that you’re doing so with the intention of being profitable within 3 to 5 years. And profitability means you will owe tax – both income tax, and self-employment tax (also known as Social Security and Medicare).
Understanding the Different Types of Taxes for Musicians
My favorite boss had a saying that I still use almost every day – “good in real life, bad in taxes.” What he meant was – profitability is great. If you’re running a profitable business, you’re winning. You’re succeeding. You’re putting food on the table.
But you gotta pay Uncle Sam.
In the US we have a complicated tax system, so I’m going to keep it simple by discussing the four types of tax that most self-employed musicians will pay every year.
1. Federal Income tax
This is a tax due on the net amount of your income. We have a bracket system, so in 2021 the first $9,950 you earn is taxed at 10%. Then everything from $9,951 to $40,525 is taxed at 12%. $40,526 to $86,375 is taxed at 22%, and so on. This number is called your “taxable income” and it’s calculated AFTER expenses and deductions. So if you earned $45,000 but you had $20,000 in expenses, you don’t have to worry about paying 22% – you’ll subtract the expenses and deductions first.
2. Self-Employment (SE) tax (FICA)
Made up of Social Security and Medicare, The Federal Insurance Contributions Act (FICA) is a social benefit program for retirees, the disabled, and children. FICA tax is a total of 15.3% of your income. If you’re an employee, you pay half of this, and your employer pays the other half as a benefit to you. Then, they get to deduct that amount as a business expense called payroll tax. But if you’re self-employed, you’re responsible for the entire 15.3%. You do get to deduct half of it from your income tax, but first you have to pony up the full 15.3% and earmark it for FICA. Self-Employment Tax is due on the net amount of your self-employed activities combined – so if you have a profitable business, you need to know that you’re going to owe 15.3% of that income to SE tax/FICA.
Worth noting that if you have a “pass through company” in the form of an S Corp you don’t have to pay this 15.3% in taxes on your profits if you don’t take it as personal income. Instead, you hire yourself as an employee, write yourself payroll checks, and FICA gets paid just like any other employer/employee relationship. This is the big reason artists create S Corp’s instead of LLCs for their business. S-Corps have specific rules, so consult a trusted advisor before starting one, but they can save you a ton of money, if you’re profitable.
3. Capital Gains tax:
Royalties are often considered a capital gain,which is an income stream with different tax rules than regular income. Songs are technically assets – pieces of intellectual property – and whether or not you claim this money as capital gains or as ordinary income depends on whether or not you are the songwriter or publisher. If you’re a professional musician (not a hobbiest), then your royalties are subject to regular income tax and SE tax. But, for example, you invested in a publishing catalog like through Royalty Exchange or Sound Royalties where you aren’t the publisher, you’re not the songwriter, and you don’t really have anything do with it other than you want to make money when the songs make money, then this could also be considered a capital gain.
Some tax preparers will put your royalties on the capital gains form of the tax return and not apply self-employment tax to them, which is a gray area of technicality. But because you’re a professional musician and you’re regularly engaged in the process of licensing them to the DSPs like Spotify and Apple Music as well as for sync placements on TV and film, you want to move them to your self-employment form and put SE tax on them. It’s more expensive for you, but it’s accurate in the event of an audit, and it helps you pay into your Social Security fund so you have some retirement benefits available later in life.
As your business grows and you build out your financial portfolio, keep your eyes peeled for passive investment opportunities, because capital gains is a tax-preferred way to make some money.
4. State and local tax
Depending on where you live, you might owe additional tax to your state or local municipality. Some states like Tennessee, Texas, and Nevada don’t have an income tax, which makes them favorable for setting up shop (there are 9 states total that have no income tax – the 3 mentioned and Alaska, Florida, New Hampshire, South Dakota, Washington and Wyoming). Meanwhile, some cities like Los Angeles, NYC, San Francisco, Denver and Detroit have city tax on top of the state. For this reason it’s important to find a local tax pro who specializes in music. Many tax pros claim to be able to do “all states” but be sure they can do your city, as well.
What Musicians Can Deduct on Their Taxes
Luckily, the tax return isn’t solely focused on compiling all your income – you get to deduct stuff, too. Aside from your ordinary business expenses, which we are going to cover in depth in a later article, you also get to deduct other taxes you pay and basic living expenses like the cost of your health insurance/health savings account contributions, student loan interest paid, educator expenses, moving expenses, retirement contributions, tuition and fees paid, and more.
The standard deduction
Everyone who files a tax return gets an automatic deduction from their income – either the standard deduction, or an itemized deduction.
The standard deduction is meant to be an umbrella deduction that removes all your “cost of living” expenses and other taxes paid from your taxable income equation. In our tax code, it’s actually illegal for us to pay income tax on taxes we paid. What that means is that – if you earn $5000, and your annual property taxes are $5000, you are allowed to subtract the property taxes from your income tax calculation, because it’s totally unfair for us to have to pay income tax on money we earned but then had to turn around and give back to the government for a different tax.
The standard and itemized deductions cover all these taxes.
Using Tax Software To Do Your Taxes
When you sit down to do your return, your software is going to ask you how much you paid in property tax, sales tax, state and local tax, and personal property tax like registering your car. Then it’s going to add them all up together, plus your medical expenses, your mortgage interest paid, and your charitable contributions, and it’s going to see which is more – all those numbers added together – itemized – or the standard deduction. You get to subtract the bigger number from your income.
The tax changes of 2018 doubled the standard deduction, and now, fewer people itemize, but if you live in a high-tax city, pay a lot in mortgage interest, have huge medical bills, or donated a lot to charity, it’s worth doing the math to see which deduction is bigger.
For 2021, the standard deduction is $12,550.
That means that if you earn $13,000, only $450 of your income is subject to income tax. BUT, this deduction comes off at the end, after you figure out your SE tax and it only applies to your income tax – so if you earned $13,000 in self-employment income, you still owe 15.3% to FICA.
Self-employment tax causes people a lot of headaches, and this is the most common scenario. As you go through the year, you know you aren’t earning all that much, and you know you get the standard deduction, so you think – I won’t owe anything, I don’t need to pay estimates, no big deal. But you don’t factor in self-employment/FICA tax, so you do your tax return and say “why the heck do I owe so much??”
If you did earn $13,000 in net income from your self-employed activities, and you claimed it on your tax return, you would actually owe almost $2,000 – $1,900 of it to Social Security/Medicare, and about $100 to income tax. Yikes.
Being aware of your FICA obligation will make your life easier as a self-employed musician. As you go through your journey, stay aware of how much profit you have.
Monthly bookkeeping is super important. If you take the time each month to figure out how much you earned, how much you spent, and your bottom line, you can pay estimates when you have a profit and avoid penalties and interest. Estimates are due every April, June, September, and January, to the IRS and the state. Bookkeeping or tax software can help you figure out how much you owe, but a good rule of thumb is that for every $1,000 of profit, you’ll owe at least $150, or more. Plan on paying 15-35% of your profit to the Federal IRS, and then some to your state as well. Don’t let yourself get overwhelmed with the big “what ifs” of owing tax – the software is here to help. This info is meant to explain why you’re being taxed what you are.
Use the right software, like Quickbooks, Freshbooks, or Mint, and use it regularly, and you’ll be able to see your profit or loss every month, pay your estimates on time, and have confidence that you’re avoiding extra penalties and fees.
The Big Takeaway
If there’s one thing I want you to learn from this article, it is this – accurate record keeping is essential to being self-employed.
Whatever accounting software you use, be sure to track everything that comes in, everything that goes out, and keep your eyes on that bottom line. If you don’t feel like using an accounting program, you can always just use a good ol fashioned spreadsheet.
Next time, we’ll discuss the Schedule C form, which is where all your self-employed income goes, and we’ll go more in depth about the different expenses you can claim and how to keep track of everything throughout the year.
No matter what, please don’t let this dissuade you from creating and releasing music. Taxes are part of life, and you’ll be paying them on whatever job you do, so you should absolutely do something that makes your heart and soul happy. There are experts to help you navigate these waters, and trust me – we want to hear your music.
Photo by Javier Ignacio Acuña Ditzel