3-16-07
Manifesting Multiple Personalities
Inchoate childhood fantasies about being an artist reshape themselves as we mature. An adult actor’s mission statement might be along the lines of, “I want to do satisfying and creative work which is sufficiently regular and well-paid that I can live comfortably on my earnings as an actor.”
A fair number of people achieve that, particularly if you consider that “satisfying,” “creative,” “well-paid” and “comfortably” are pretty subjective concepts. These successful artists derive all of their earned income from their careers, and most or all of it arrives in the same form. As a unionized actor, you are paid as an employee, or perhaps through your own corporation if you are among the really successful.
For everyone else, there is a mix: employee or independent contractor? Arts work or civilian? There are four basic combinations, though you could have more if, for instance, you had two disparate civilian occupations.
Incoming
You can be paid for work as an employee or as an independent contractor. “Independent contractor” has many euphemisms, but they all amount to the same thing: not an employee.
This is a clear, binary distinction of fact. Where people often get confused is when the question shifts from “what is?” to “what should be?” And that is often not clear in the least. The rules tend to be subjective and open to interpretation. The rules themselves vary depending on the purpose: Social Security, unemployment, pensions, unions and many others.
If you are the person being paid, you rarely need to ponder “what should be?” It’s not your decision, and if the person hiring you makes a wrong decision, it’s not your problem.
Reframing the question as, “Which is better?” at least recognizes the theoretical nature of the question, so that my smart-ass answer of “yes” is only mildly annoying. Both are income, on which you have to pay income tax. Which way you were paid does not affect the income tax rate.
Both are also earned income, which makes them subject to Social Security tax. Which way you are paid, however, does affect the tax cost to you and how it is paid. Social Security tax on wages is paid in two parts: half by the employee and half by the employer. You just do not see the employer’s portion on your paycheck stub. Independent contractors are self-employed for tax purposes. As they are both employer and employee, they have to pay both halves of the tax (which is renamed “self-employment tax”).
That double tax rate can be costly. Clearly, being paid as an employee is “better” if you would be paid at the same rate under either scenario, and if you would incur no deductible expenses to earn the income. That is, however, not often the case.
A conscientious payer, dealing with a worker who understands the tax issue, might offer a higher rate to an independent contractor to cover the tax, perhaps $11 an hour instead of $10. Then again, he might not if there are plenty of workers who would take a lower offer. (Ask an economist to explain the math underlying this supply-and-demand analysis if you ever have a desperate need to doze off in public.)
The second “if” – if you incur deductible expenses to earn the income – is much more likely to matter in any real-life situation.
Outgoing
Two types of expenses are, or can be, deductible: those incurred in earning income, and Itemized Deductions.
Itemized Deductions are, with an important exception, more a matter of social policy than business accounting. The major ones are home mortgage interest, property taxes, state and local income taxes, charitable contributions and medical expenses above 7.5 percent of your income. To be useful, Itemized Deductions have to be more than the Standard Deduction (currently $5,150 for a single person, twice that for married couples).
Business expenses are usually much broader. With some exceptions, they need only to be reasonably related to your business, and intended to be appropriate and helpful in developing and maintaining it.
For business expenses, context matters. They must relate to a trade or business of yours to be deductible. A scene study class would be deductible for an actor, but not for an elevator repairman – unless the repairman is also an actor.
The differences in your tax come not from matching expenses to a source of income (i.e., arts or day job), but rather from the match to a form of payment (i.e. employee or independent contractor).
Independent contractors, as I mentioned earlier, are self-employed for tax purposes. Their taxes are based on the profit from their business, that is, on what is left after deducting the business expenses. If the deductible expenses are high enough, the overall taxes may be less because both the normal income tax rate and the higher self-employment tax rate are applied to a lower income figure.
Employees only get limited tax benefits from having business expenses. Only the amount above 2 percent of their income is deductible. That excess is deductible only as Itemized Deductions, so they lose some or all of their value if the taxpayer’s other Itemized Deductions are not already above the Standard Deduction. And when you have an agent and a manager and travel expenses, so the expenses are way above 2 percent, the Alternative Minimum Tax serves to put an upper limit on the tax benefit.
Determining where to deduct any particular expense can be easy, if you’re one of those fulfilled people I discussed at the top, or if you are paid only one way for a particular type of work. When you have both forms of payment as an artist, some thoughtful judgment may be required. I wish I could tell you exactly how to do that, but I can’t except to say be logical, be honest with yourself, and don’t get greedy.
Free Offer
If you would like a copy of my free “Checklist of Potentially Deductible Items” for those in the arts, just write, call or e-mail my office. We’ll be pleased to 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 has also been known to produce theatre.