When you work as a solo musician, or in a band, and you’re trying to make money, you’re essentially working as a freelancer. So, is that freelance work (your music) a business or a hobby in the eyes of the IRS? Either way, your income is still supposed to be reported to the IRS, but having your music classified as a freelance business rather than a hobby can have tax benefit, like greater deductions for equipment and travel expenses.
It can be in your best interest to consider yourself a freelancer, and deduct your expenses. However, if you keep reporting a business loss year after year, the IRS may decide to step in and classify your music as a hobby, which means you’ll be able to deduct far less, and may have to pay back-taxes for money you previously deducted. Although this isn’t “official,” it’s commonly understood that the IRS expects you to make a profit during 3 out of every 5 years. But, if you’re not, don’t worry! Other factors come into play too. If they try to classify your music as a hobby, you’ll have to defend your business classification. That doesn’t have to be difficult. According to the IRS, here are some things that are considered:
1. You carry on your freelance work in a business-like manner. (In other words, you’re not getting drunk at your shows, you honor your commitments, you keep track of your finances, and you sign and keep performance contracts.)
2. The time and effort you put into your freelance work indicate you intend to make it profitable. (If you’re spending significant time writing new material, recording, and performing regularly, you may be able to prove that you’re making a sincere effort to be profitable.)
3. You depend on income from your freelance work for your livelihood. (This won’t apply to the majority of independent musicians, but some are earning enough to at least equal income from a part-time job. If the money’s essential to you, or if your music is your full-time work, just keep track of the finances to be able to prove it.)
4. Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of freelance work). (Few independent musicians are profitable early on, so your music could reasonably be considered a business with a normally slow start-up phase.)
5. You change your methods of operation in an attempt to improve profitability. (This means if you see something’s causing you to lose money, you change it. That could mean cutting back on free or low-paying gigs in favor of fewer but higher paying ones. It could also mean that you switch from renting studio time, to buying your own equipment, or vice versa. Instead of sticking to local venues, maybe you’d start touring. The possibilities are pretty much endless.)
6. You, or your advisors, have the knowledge needed to carry on your freelance work (music in your case) as a successful business. (If you’re hiring a manager, publicist, or someone else with specific expertise in an effort to become successful, you’ll satisfy this requirement.)
7. You were successful in making a profit in similar freelance work in the past. (That means that maybe you were in a profitable band in the past, so you know the work involved.)
8. Your freelance work makes a profit in some years and the amount of profit it makes. (If your music has ever made a profit, it’s in your favor. They’ll also look at how much profit you made in the past, if any.)
9. You can expect to make a future profit from the appreciation of the assets used in your freelance work. (Maybe you invested in recording equipment and you can rent that out to other artists.)
No single factor listed above will guarantee that your music will be deemed a business instead of a hobby, and you don’t need to satisfy every one of them. Instead, the circumstances surrounding your freelance work are considered collectively. Here are a few things you can do to be sure that you can make a case for your music being a business, if you ever have to:
- Write a detailed business plan for your band, and update it regularly. Be sure to include financial information and projections stating when you expect your music to turn a profit, or how you intend to solve problems from the past that led to losses.
- Keep an organized office space for your admin and financial records, and a separate practice space, completely separate from your typical home life. You can even keep a photograph of your office space available, just in case your business intentions are ever questioned.
- Keep excellent records! Have receipts, invoices, and all of your books available the moment someone questions your business intentions as a musician.
- Continue your education. By taking classes, or other forms of continued training, you’re demonstrating that you’re trying to maintain your expertise and stay competitive in your field of freelance work. Take an online music course, take some basic business courses, invest in music law and music business books. Prove you’re trying to learn and develop as a business person.
- Advertise! If you can prove that you’ve actively been marketing and advertising your music, you’ll stand a better chance of proving that your music is really a business and not a hobby. Buy some cheap online ad space to push your new album. Up your promotion efforts in any way, keep records of everything you do, and keep records of your results.
The basic idea is to gather and maintain enough evidence that you’re making a good faith effort to earn profits over time with your music. If you take the necessary steps early on, if your business status ever does get challenged, you’ll be prepared. Start reaping the benefits of classifying your music as freelance work, and do it smartly by following the steps I’ve outlined here for you.