The question when business expenses are deductible, and how to take the deduction, generates more queries to me from PerformInk readers than any other issue. That is not surprising, because the rules are not simple for anyone.

Those rules are only the first ingredient in an ugly recipe. We next add in the complexity of a pieced-together financial existence: lots of different income sources, some as employee, some as independent contractor, and never consistent in pattern or amount from one period to the next. Spice it with rumors and myths that become less accurate each time they are passed along in a dressing room or class, and muddle with poor records.

No wonder some people throw in a few curse words for salt and leave the whole mess half-baked.

Who or what are you?

When someone engages you to do work for them, you may be an employee or you may be an independent contractor. The correct way to treat any particular worker is often unclear, and equally often ignored. For this discussion, whatever is, is: how you were treated last year when you did the work governs how you must report the income and expenses. That, in turn, has a big effect on how much tax you save by having those deductible business expenses.

When doing tax planning during the year, I find that some people are not even clear as to which way they were treated on a particular job. A simple question—"Were taxes taken out of your check?"—used to be sufficient, but that now must be refined slightly. These days, the question has to specify federal taxes (income or Social Security) because some states are now requiring income withholding on payments to certain independent contractors.

By now, you have the definitive evidence for last year's income. If you were an employee, you were sent a W-2 form. If you were an independent contractor, you were sent a 1099-MISC form, or possibly nothing if the amount paid was under $600.

When you're an employee.

If you never had any business expenses, being an employee would be clearly advantageous. You know from experience that Social Security tax is withheld from employees' paychecks. You may not know that the employer must pay an equal amount of Social Security tax as its expense. Independent contractors, however, are technically self-employed. They are both employer and employee, and therefore must pay both parts of the Social Security tax under the name "self-employment tax."

But if you never had any business expenses, you would not be in the arts. You would be working at a boring job in an office or factory. Perhaps even at the IRS.

Unfortunately, U.S. income tax laws have an implicit assumption that most employees have little or no business expenses, that the employer provides the tools, the workplace and the means of production. Employees' business expenses are deductible only if, and to the extent that, the expenses are more than two percent of the worker's income from all sources.

Beyond that lies another hurdle. That excess is deductible only as an Itemized Deduction. Those deductions otherwise are those that do not really relate to the measurement of income in any real sense, but are allowed for reasons of economic or social policy: home mortgage interest, property taxes, state and local taxes, charitable contributions and big medical expenses. All Itemized Deductions together must be more than the Standard Deduction, or having the deductions saves you nothing.

The Standard Deduction is pretty high—$4,850 for single taxpayers, $9,700 for married this year. When it was drastically raised about 20 years ago, the notion was that few people would take Itemized Deductions unless they were also paying on a home mortgage.

For actors, though, that threshold is not too hard to reach. An agent taking 10 percent of your earnings will put you well under way.

When you're self-employed.

Self-employed persons get to deduct all the expenses of their business in addition to the Standard Deduction or Itemized Deductions. No percentages, no thresholds. While they pay a Social Security tax rate that is almost double what employees pay, the business expenses are also a deduction for self-employment tax; the net result can be lower, or no, self-employment tax.

As an employee, your income from a particular endeavor cannot be less than zero (though it might seem so on a low-tier Equity contract). But self-employed people may have a profit or loss. If your self-employment income is below zero—believe me, it happens—that loss offsets your other income.

Being self-employed does have its downside. The better-paying acting work is typically union, and therefore as an employee. You have to worry about billing and collections if you are self-employed. And health insurance for the self-employed can be breathtakingly expensive, if you can find it at all.

When you're both.

Many artists have both kinds of income every year. How should you divide the expenses between the two places? Sometimes you can clearly identify the expenses with one or another source of income. One might have been a tour, so the travel expenses clearly are associated with that. Maybe your agent's commissions relate only to W-2 income. Those deductions would follow that income.

But then there is the jumbled mess of expenses in the middle: headshots, training, local transportation and so on. You might allocate it proportionately, or you might just slap it all against the self-employment income for the biggest tax benefit. Ultimately, it is a judgment call, depending on both the absolute and relative sizes of each kind of income.

Let me emphasize that the type of income does not determine whether a given expense is deductible. Nothing is deductible by an employee that would not be deductible if paid by an independent contractor. I regularly discuss specific deductions in this column, and an archive of past columns is available on-line at www.performink.com (click the Archive link on the left column).

Also Helpful, and Free

A helpful map to artists' business expenses is my "Checklist of Potentially Deductible Items." Just write, phone or e-mail me, and I'll send you one.

Are there money or tax questions you would like to see discussed in this column? Let me know, at 2835 N. Sheffield, Suite 311, Chicago, IL 60657, or call 773/525-1778 (888/525-1778 toll-free outside the Chicago area) or e-mail greg@gregmermel.com.

Greg Mermel is a certified public accountant whose clients in the arts range from individual performers to major theatre companies and suppliers. He also has been known to produce theatre.

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