A Simple Method For A Complex Task
The aim of this article is to help all of you little procrastinating tax evaders get your shit together into a nice and neat little package for the IRS. I'll show you step-by-step how I handle my recording studio taxes every single year, and I'll explain why evading taxes is a great way to set yourself up for failure.
Note: I created a PDF to go along with this article…fill out the form below to download “11 Not-So-Obvious Tax Write-Offs For Your Home Studio“.
11 Not-So-Obvious Tax Write-Offs For Your Home Studio
Sign up now to download the guide.
I only spend a total of about four and a half hours per year on everything pertaining to taxes. The total cost from my CPA (certified public accountant) is roughly $500 per year (or about 0.4% of my total income last year).
While it's not a “perfect” system, this is essentially an 80/20 article for recording studio taxes. My goal each year is to pay the least amount of money on taxes while keeping it legal and spending the least possible amount of time and effort on tax-related bullshit.
I keep it as simple as I possibly can because that is all my little brain is capable of.
To clarify, this article is geared toward those of you who earn more than $5000-$10,000 per year at your home studio. Otherwise, this method probably won't make sense for you.
If you earn less than $5000-$10,000/yr, then be sure to download my free eBook called “Keys To A Six Figure Home Studio.” This will help you transition from hobbyist to pro home studio.
Disclaimer: I'm not a CPA, a lawyer, or any sort of tax expert. Take the following advice with a grain of salt, and always consult a professional before attempting anything I mention in this article. I'd hate to get you into trouble with the IRS due to my own ignorance of specific tax laws in your own state or country.
Life Is Hard
Income taxes suck ass.
Taxes have always sucked ass, and they always will suck ass. Unfortunately, taxes are impossible to (legally) avoid if you're a freelancer, and the repercussions for evading taxes far outweigh any benefits you could ever gain from cheating.
If necessary, the IRS will absolutely ruin your life.
They can fine you, garnish your wages, remove money from your bank accounts, sell your car, sell your home, or even throw you in prison (when fraud is involved).
The IRS is the most unforgiving pimp you'll ever encounter, and they want their motherfucking money NO MATTER WHAT.
Even so, there are dozens of home studios I personally know who don't claim any income from their freelance work. Some don't think they don't make enough to bother claiming the income on their taxes, and most just have no idea where to even start.
Taxes can be a complex subject, to say the least. The amount of tax forms that exist is enough to make any young professional want to avoid taxes like an STD. Unfortunately, auditors don't care about your lack of knowledge with taxes, so ignorance is not an excuse that could save you in the event of an audit.
Help me save you from a “rough” 5 years of prison…
“When Should I Start Paying Taxes?”
AS SOON AS YOU MAKE YOUR FIRST DOLLAR.
ALWAYS PAY YOUR TAXES, AND ALWAYS MAKE SURE THE GOVERNMENT GETS THEIR CUT.
BE A GOOD SHEEP.
THE IRS IS THE BEST AND THEY DESERVE YOUR MONEY.
GOD BLESS THE I.R.S., AND GOD BLESS WHAT THE IRS DOES FOR US.
ALL HAIL THE IRS.
Haha ok kidding. Now for a real answer:
Know the Laws
As a freelancer, you are legally required to file a tax return once you exceed $400 in gross income. This is the minimum amount of income where self-employment tax kicks in (don't confuse this with the $600 threshold where 1099-misc forms need to be sent out to contractors).
New guys just making “a few bucks” on the side try to skirt around this by receiving all payments in cash. I (somewhat) see the point of their dubious ways, only because getting recording studio taxes sorted out can seem like a daunting task.
If you're getting paid in cash, and literally stuffing it into your mattress instead of your bank account, then you'll probably get away with it.
There are some cons to skipping out on paying income tax, which I'll cover later, but the “mattress money” method will only get you so far.
For the record, I'm not suggesting people do this. I am, however, realistic about how the world works. I'm simply stating that I know it happens, and I know it's seemingly easy to get away with.
Why You Should Stay Legit With Taxes
I'm going to state the obvious first, and just say that it's your legal obligation. You don't have to like it, but you have to do it.
Here's an overused quote from Benjamin Franklin that continues to stand the test of time:
Nothing is certain except death and taxes.”
(I promised myself I wouldn't use this quote on this article, yet here we are)
Don't assume that your home studio will be a “side gig” for the rest of your life. Have some damn ambition in life, and set bigger goals for yourself.
Just because you pulled in less than $1000 this year doesn't mean you can't make 30x that next year. Just put in the work and don't be a complete sack of shit.
When the day finally comes where you can quit your job to record bands full time, it's important that you already have your tax BS together.
If you've created bad habits with your taxes since day one, it's going to be extremely difficult to make yourself give up the money once you're successful.
If, on the other hand, you've been paying taxes since day one, then it should be much easier to give up the money once it becomes a significant amount.
If you were to show the 2009 version of myself a tax bill from 2015, I'd probably shit myself. Fortunately, I've been honest and consistent with my taxes since day one, and I've only experienced a mild increase in taxes owed each year.
This is the best way to do it, as you become numb to the pain of tax season over time.
Home or Business Loans
Do you ever want to buy your own home, or build a semi-pro recording studio in your basement? Most people lack the capital to pay in cash (although that is the best way to fund most things).
This means that eventually, you'll need a home or business loan of a significant amount (especially for a home loan).
Banks use your taxable (or net) income to determine how much money they're willing to loan you. If you've been hiding income from the IRS, then it's going to be extremely hard to get a home loan (if not impossible).
To make things even more complicated, you have to verify the source of the money you use for your down payment on the home. This means the more money you hide, then more you're screwed. You won't be able to use any of this hidden “mattress money” for your home purchase.
You can see how bad this can get once your home studio is a significant source of your total income.
Peace of Mind
Audits happen. Here is a nice breakdown that shows your chances of getting audited in 2011 (courtesy of nolo.com).
Adjusted Gross Income Audit Rate
|No adjusted gross income
There are several things to note about this chart. Not filing your tax return will quadruple your chances of getting audited, and showing less than $25k of income is another great way to increase your chances of getting audited.
While these percentages sound quite low, keep in mind that there are a lot of things to can dramatically increase your chances of getting audited. The IRS uses extremely complex algorithms to automatically determine who gets audited, so here are some things that can put you on their radar.
1. Writing off a large percentage of your income: This is actually something I did in 2014. Since all of my write-offs were legit, I didn't have anything to worry about. Even so, I'm sure it still increased my chances of getting audited.
2. Writing off items that aren't related to your business: An example of this would be writing off a trip to Spain if you were a plumber in the USA (or something like that).
3. Not reporting income from your 1099-MISC forms: These are what you'll be getting from labels once you start recording signed bands. You should technically be getting these from anyone who pays you over $600, although I've never gotten one from an unsigned band.
There are plenty of other red flags that can get you audited, but I honestly don't know them all, nor would I have the time to write about them. The important thing is that you want to be 100% honest on your recording studio taxes so you have nothing to worry about if you ever get audited.
How I Handle My Taxes
Now it's time to get into the step by step part of this article. I've simplified this as much as I can, and this keeps me sane every year when tax season arrives.
1. Buy A Small Tax File Folder
This doesn't have to be sexy or expensive. Keep it simple. All you need is something to keep everything organized. When you give this to your CPA each year, he'll be happy you didn't resort to a shoebox full of loose receipts.
2. Label The Tabs
I typically label the tabs from front to back as follows:
1. Bills: This is where you'll store any bills related to your home studio (gas, water, electricity, insurance, etc.).
2. Invoices: This is where I store invoices from contract labor or repairmen that are used for my studio.
3. Receipts: Self-explanatory. One thing to note – I keep full page receipts (8.5″ x 11″ paper) separate from the small thin receipts you'd typically get from somewhere like guitar center. This is just to keep things nice and neat.
4. Tax BS: I keep anything tax related in this tab. This could be 1099-MISC forms from labels, state income tax papers (which my state does not have, thank God), and any random tax papers that you don't understand (just ask your CPA about it). Yes, I really do label this tab “Tax BS”.
5. Personal (optional): This is a tab that I tell my accountant to ignore. I just keep my own personal paperwork in there, like car insurance, car registration, or anything else I want to keep a record of.
6. Misc: This is just anything left over that I think my accountant might need.
3. Determine Your Legitimate Tax Writeoffs
This is something you should always talk to your CPA about, but here are my typical tax write-offs:
Bills: Rent, electric, gas, water, cable, internet, and insurance. The main thing to note about writing bills is that you can only write off a percentage if you live and work in the same building. This percentage is based off the total square footage of your home compared to the number of square feet you use for your studio (Note that there is a maximum square footage you can use for business in your home, so this is why it's important to talk to your CPA).
Invoices: If a plumber comes to fix a toilet in my studio, that is a tax write off. If you outsource drum editing to another engineer, that cost is a tax writeoff. If you hire someone to build a custom console desk for your studio, that is a tax write off. This should all be common sense, and all invoices should be stored in your “invoice” tab of your tax folder.
Receipts: This is anything that could be considered a business expense. I'll just brainstorm a list of things, but this is far from a complete list of items you could write off (note that these are all for items being used exclusively for your studio): Toilet paper, paper towels, disposable dishes and cutlery, studio hardware, studio software, items for your studio lounge (tv, surround sound, video games, gaming systems, stereos, etc.), any and all music gear, guitar strings, bass strings, blankets, pillows, bunk beds (if you lodge bands). Meals can also be a partial write off, as long as the meal was business related. Just be sure to write down who you met with, and the purpose of the meeting on the back of the receipt, just to make your CPA's life easier.
Uncommon Writeoffs: If you pay money for anything considered a “networking event,” you can write that off. This includes concerts (if you actually network), meetup events (with other people in the music industry), or parties you host (if the guests are part of the music industry). Certain membership fees can also be written off, such as a membership to your local Entrepreneur Center.
Don't forget to download the companion PDF: Enter your nam and email below to download “11 Not-So-Obvious Tax Write-Offs For Your Home Studio”.
11 Not-So-Obvious Tax Write-Offs For Your Home Studio
Sign up now to download the guide.
Side note: If you lodge bands at your home/studio, talk to your accountant about writing off the cost of their lodging. For example, you could possibly “charge” a certain dollar amount per night, and then “comp” the band or label for that cost (comparable to a hotel). This would make those comped nights a tax write off. I've never done this, but it's absolutely worth talking to your CPA about. Especially with the prevalence of Airbnb and other home-sharing sites, there is now a clear “nightly value” for the space the band is occupying.
Tax write-offs are a double-edged sword when it comes to securing a home loan in the future. While tax write-offs may mean you pay less in taxes, this also means you make less money “on paper.”
Lenders look at your net income to determine how much they'll loan you for a home, so the less money you make “on paper”, the less you can afford for a home purchase (in the lender's eyes).
4. Stay Consistent With Your Paperwork
This part will be easy once you start forming routines. I'm extremely lazy about this, but I'm still effective in my laziness because I batch everything.
My system is fairly simple. As soon as I make a business purchase or pay an invoice, I print the receipt out (and leave it on the printer).
I also check my mail once or twice per week and place my bills into a pile.
Once per week I pay those bills, then write the date that I paid on the top of the bill, just so I know that I've paid the bill on time (nothing's worse than forgetting to pay a bill).
At the end of each week, I file away the pile of paid bills, as well as the stack of invoices/receipts sitting on my printer.
It's not a perfect system, and it's definitely not pretty, but it's consistent and effective.
5. Get Your Shit Together At The End Of The Year
This is where you need to make sure you've accounted for all of your income and expenses. I sometimes wait until the end of the year to print out receipts of things that I know I'm paying every single month.
This includes Dropbox ($9.99/mo.), Soundcloud ($4.99/mo.), Spotify ($9.99/mo), my CRM (~$700/yr), server costs for my websites (~$150/mo.), domain renewals (~$100/yr), PayPal and Stripe fees (~$2500/yr), Xbox Live ($59/yr and only if it's for your studio's lounge) and I'm sure there are a ton of other things that I'm forgetting.
On that note, it would be smart to keep a list of your monthly/yearly subscription services so you can keep up with them. That way you don't forget to write off the cost for taxes, or cancel service if you've stopped using it.
6. Send Your Tax Folder To Your CPA
This is the part that makes my life around tax season so damn easy. Once I have my shit together into a clean/organized little poop-package, all I have to do is mail this tax folder off to my CPA back in Alabama.
This is usually done after January 31st since that's the deadline for sending out 1099-MISC forms. Most labels wait until last minute to send those, so I usually have to wait.
Four weeks after sending my tax folder in, I get some papers back from my CPA to look over/confirm/sign, then I'm done.
They let me know my total owed to the IRS, I pay, then I move on with my life.
7. Set Up Quarterly Estimated Tax Payments
This honestly sucks at first, since you're sending money away to the government 4-5 times per year instead of just one.
The upside is that your total amount due in April should be much less than if you were to pay for everything at one time.
The basics of quarterly estimated tax payments are this:
1. You figure out how much you think you'll earn this year (usually based off your previous years), then split that year's tax bill into 4 equal payments (which are paid each quarter).
2. These payments are due April 15th, June 15th, September 15th, and January 15th.
3. If you made less than you estimated, then you get a tax return (which has yet to happen to me).
4. If you made more than estimated, you'll owe the difference on April 15th (along with that quarter's estimated tax payment). This can easily make April an extremely expensive month, so it's important to properly save money in anticipation for this.
If you have a decent CPA, they'll print out the quarterly estimated tax forms you send in along with each payment.
If you have a great CPA, they'll put each form into pre-addressed envelopes. This means all you need to do is put a check inside the envelope, place a stamp, then put it in your mailbox 4 times per year.
Quarterly estimated tax payments will help you understand how much of your income needs to be set aside for taxes by forcing you to pony up 4 times per year. The better your understanding of this, the less painful the entire process will be for you.
My Total Tax Numbers for 2014
Even though 2015 just wrapped up, I don't have my numbers back from my CPA yet (He didn't actually get my tax folder until Feb 19th).
This means I only have my tax numbers from 2014, which I already covered in a previous post. I'll go ahead and post them here, just for easy access.
Full Production: $46,890
Mixing\Mastering Only: $69,345
Mastering Only: $3,350
Grand total: $122,370
$16,669 – Contract labor: This includes all assistant engineer costs, as well as outsourced editing work.
$15,000 – Rent: I have a live/work setup for my home studio, so 90% of my rent and bills are a tax write-off. This beats having to pay for a mortgage on top of a lease for a separate building for my studio.
$8,575 – Gear/Software purchases: This number should be way higher, but it's not. I think I have whatever the opposite of “Gear Acquisition Syndrome” is.
$6,927 – Misc: Random things like paper, office supplies, development costs for this blog's redesign, and a bunch of other random things (mostly hookers and drugs)
$6,200 – Itemized deductions: I honestly don't know exactly what this includes. This would be a question for my accountant, which is why I pay someone to handle this shit for me.
$5,306 – Utilities: This includes water, gas, electric, cable, and internet. As I mentioned above, 90% of this is a tax write-off.
$2,500 – Education: Online courses, books, and other training. The best investment you can possibly make is in yourself.
$2,197 – Health Insurance: One of the downfalls of being self-employed. No benefits, and no 401K (although I do invest in a Roth IRA). The upside is that you can write off your health insurance payments.
$2,400 – Retirement Investments: While it is technically “savings”, I still count this as an expense since it's essentially a requirement if you'reself-employedd. When I'm old, slow, soft, and shitty, I don't want to be poor as well.
$982 – Repairs/Maintenance: Shit breaks sometimes.
Grand Total: $58,156
Total Income: $122,370
Total Tax Write-Offs: $70,722: This includes some tax exemptions and other bs that I don't understand. All I know is that this number is obviously higher than my total expenses for the year, which is cool.
Total Taxable Income: $51,648
Income tax: $8,763
Self Employment tax: $9,730 (yes…you get to pay more in taxes if you're trying to run your own business).
Total Taxes for 2014: $18,493
Finding A CPA To Handle Your Recording Studio Taxes
I've honestly only worked with 3 CPAs in my studio's existence, so I'm not exactly the expert with this. I'll just give you a short story about my experience, some general tips, and what to avoid.
CPA 1: Small Town Life
My first accountant was a lady from my church. She took the time to explain everything in plain English and simple terms. She was patient with me and my stupid questions, made sure I was legit with everything on my taxes, and she made the entire process as simple as possible.
Average cost from 2009-2010: ~$500 per year
CPA 2: Big City Suckage
Unfortunately, she sold her business the same year I moved my studio to Nashville, so I decided to look for a new CPA in my new city.
After a bit of research (which consisted of reading Google and Yelp reviews), I decided on CPA that specializes in small business.
They were a “fancy” looking CPA firm in a nice tall office building. The CPA met with me, spent a few minutes going over my needs, then ended up chatting about golf for nearly an hour.
Unfortunately, they required me to do more work than my previous CPA, which consisted of categorizing, organizing, and calculating the totals for all of my expenses. Not only was this more time consuming, but they also charged more than my old CPA
Total cost for that 2011: ~$800 (plus an extra 6 hours of my own personal time)
CPA 3: Out-Of-State Champs
Since my experience with “Fancy Fuck” CPA was less than stellar, I decided to go back to the CPA that my original CPA sold her business to. When she sold, she sent out a letter to all her old customers assuring her that the new owners would treat her old customers well.
I figured it couldn't be worse than the Nashville CPA, so I gave them a shot.
Thankfully, these guys are every bit as good as my old CPA, and they charge about the same as her. The only price increase coming from the fact that I now send 1099-MISC to several contractors that I use regularly (which costs me a flat amount per 1099).
Average cost from 2012-now: ~$550 per year
Small Town Wins
The lower the cost of living is where you CPA is located, the lower the cost should be for their services. This is why I encourage people to look for a qualified CPA in a smaller surrounding city if you're located in a large, expensive city.
When in doubt, look for CPAs that are “Endorsed Local Providers” for Dave Ramsey. He has strict requirements for his ELPs, and does a great job vetting each candidate in order to weed out the good from the bad.
These ELPs can be found by either filling out the form on his website, or be simply searching Google for “Dave Ramsey Endorsed Local Provider in (your city and state)”.
My CPA was not a Dave Ramsey ELP when I first started using him but became one recently (which is a good sign that he's doing something right).
The time savings alone is more than worth the ~$500 my CPA charges, but if the fee is keeping you away from finding a CPA, I'd encourage you to talk to talk to one about your specific situation. If you're just running your studio part time, you'll most likely have a much smaller CPA bill than I do.
To recap, I spend…
* 3 minutes per week filing away my stack of bills, invoices, and receipts. (2.6 hours per year)
* 1 hour at the end of the year “getting my shit together” and mailing off my tax folder (1 hour per year)
* 30 minutes per year confirming my CPA's work and signing papers (.5 hours per year)
* 30 minutes per year writing and mailing quarterly estimated payments to the IRS- made simple thanks to my CPA (.5 hours per year).
Grand Total: 4.6 hours per year spent on taxes and tax-related BS.
While my system isn't perfect, it's worked well for me over the years. Feel free to cherry-pick bits and pieces of what I've been doing, and apply it to your specific situation!
Again, consult with a CPA before trying any of the stuff you just read.
One Note: The Goal Is To Pay AS MUCH In Taxes As Possible
This seems ridiculous but stick with me…
While you should always take every single tax write-off that you can legally take, my goal every year is to pay more in taxes than the previous year.
Because that means I profited more this year than I did last year.
The goal is to be as profitable as possible…NOT to spend money on random bullshit just to have another tax write-off.
If that's what you're doing, you're essentially spending one dollar to save 33 cents.
While I obviously want to minimize my tax burden each year, I also want to maximize my profit.
So if I'm earning more each year AND maximizing my profit, then I will always pay more in taxes every single year.
Keep that in mind next time you catch yourself buying something JUST for the tax-writeoff.
The math does not work in your favor.
Want to Maximize the Profit Of Your Studio?
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This means making the most money possible while spending the least.
It's all about staying “lean”.
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