As someone in the arts, you may well have some income reported on a W-2 form, some on a form 1099-MISC, and some not at all. Handling this mélange, and the related questions of what to do with deductions, often produces sputtering confusion and angst.

For no small number of people, this is the issue that first propels them into my office for professional tax return preparation instead of doing their own.

You and Many Others

The people paying you are probably also confused.

In the bright, shiny alternate universe occupied by the Internal Revenue Service, people who are paid for their services are clearly either employees, or they are not. Employees work for a business and are paid by the business. The others, in this world, operate their own businesses and those businesses are paid for the services. Of course, when you are a one-person business, that is sort of paying your left hand to tell your right hand what to do.

Back on this planet, we do not even have an agreed-upon term for the second situation. “Independent contractor,” “self-employed” and “freelancer” are among those used with varying degrees of imprecision. Even the IRS ducks the issue, using the term “non-employee compensation” on form 1099-MISC.

Sometimes the appropriate classification is intuitively obvious. A CTA bus driver is an employee; a Chicago cab driver is not. More often, it is not obvious. How about software developers? Maybe they work full-time for a company, on whatever projects the company presents; that sounds like an employee. Or maybe they are engaged for a certain project; that sounds like an independent contractor. But what happens when the project requires buildings full of people for years at a time, like developing the next version of Windows? Microsoft was sued a few years ago over exactly this issue.

The IRS does offer guidance in the form of a list of factors to consider, but it is pretty subjective and fuzzy. The IRS’s turf of income and Social Security taxes are not the only area where this distinction must be made. Other legal areas include unemployment compensation, workers compensation insurance, pensions, health insurance, securities and labor law. No two, of course, have the same criteria. Those Microsoft workers, for example, were found to be non-employees for income tax purposes, but employees for pension and 401k plan purposes.

Not Rewriting History

Producers and theatre companies have a genuine need to know how to classify the people they are paying. Actors and other people being paid do not. Right or wrong, you got paid the way you got paid. If the payer was wrong and gets caught, that is his problem, not yours. You will not be penalized.

Your problem is putting that income and your deductions on your tax returns in a way that does not produce nasty correspondence from the IRS and that does not cost you excess taxes.

Some people draw the logical (but inaccurate) conclusion that all arts income should be reported in one place on the forms, and all income from your civilian work in another. That may accidentally be true, if your civilian work is all as an employee, and your arts work as an independent contractor. Employee income and non-employee income, though, are never grouped together; one is reported as salaries and wages, the other as a component of the profit or loss from a business.

Placing the Expenses

Unlike income, appropriately placing your expenses involves some judgment, and perhaps creativity. This is where the “civilian” vs “artist” concept does come into play. Whether a particular expenditure is a deductible business expense depends partially on its relationship to your trade or business. For example, a class on audition technique is a deductible business expense for an actor, but not for a plumber.

Deductible expenses incurred as an employee will not result in as great a tax savings as those incurred as a self-employed person. Only the amount of employee business expenses above 2 percent of your income are deductible. That excess gets added to your other “itemized deductions,” which are principally home mortgage interest, property taxes, state and local income taxes, medical expenses above 7.5 percent of your income, and charitable contributions. And unless that total is more than the standard deduction (currently $5,000 for single persons, $10,000 for a married couple), you get no tax savings at all. Worse, if that business expense number gets too large, the alternative minimum tax starts to offset the savings in regular tax.

Business expenses incurred as a self-employed person have no such boundaries. They start reducing your taxes from the first dollar deducted. In addition to income tax, they also cut the Social Security tax on that income (called “self-employment tax”). And if, perchance, the business loses money, that loss can offset income received in other ways.

Typically, the civilian job will be as an employee, and any related expenses have to stay on the employee business expense page. But one’s artistic career often involves both types of income in the same year. There is no one “right” way to divide the expenses. Even the “best” choice depends on specific facts and circumstances. How much of each kind of income is there? Are there a lot of expenses, or a few? Is this a typical year, or an aberration? Are some of the expenses clearly associated with one kind or the other, such as scenery and costumes for a show you produced, or the meals while your were working at an out-of-town Equity theatre? And so on.

When I’m working with a client, I know those facts and circumstances and can get specific. All I can say as a general principle is to do what you can genuinely defend as reasonable, and not get greedy.

Think About This

My “Checklist of Potentially Deductible Items for Persons in the Arts” will help you figure out what you could be deducting. For a free copy, just write, call or e-mail me at my office.

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 has also been known to produce theatre.

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