Accounting question

[bayouandme]

I own a couple of businesses none of which is music related and have had a long time CPA do all my tax stuff. This whole songwriting/recording/producing venue has simply been a hobby and an avenues for stress relief. Long story short, I produced (paid for) a 14 song CD that we sell at shows and uploaded the individual songs to TAXI for submission opportunities. On the CD I used top shelf players from both Nashville and Atlanta where we recorded the CD. Well you know the costs. How do you folks deal with the costs involved. My CPA tells me that I can only deduct the costs for producing the CD as each CD sells or digital download occur. When the CD has run its course and if I am left with excess costs then I can write the balance off. How do each of you deal with the costs of producing your demos until you reach a profitability point? Thanks,

[mer]

Hm, I did a three-year safe harbor thingie (technical word), allowing me to deduct as expense 1/2 of the cost of producing the CD the first year, then 1/4 each of the next 2 years. However I had lots of music income to take this against (from other sources, not the CD), I wonder if that is the issue - that this is a "start-up" schedule C, so perhaps you can only take the expense as you earn income. Sorry to not be of more help, I may ask my tax-expert husband for his ideas when he has a moment...--Mer

[coachdebra]

Your accountant is thinking of the CD as inventory and the expense of the creation as "Cost of Goods Sold". And therefore the expense comes out of the income as you sell your inventory.It's possible that it could be thought of as a capital investment and depreciated over 3 years. I recommend doing some research and finding an accountant who is familiar with the music or art business. There are a lot of differences between a regular small business and the business of music and it really helps to have someone familiar with that.Warm regards,Debra

[arkjack]

Most of what I deal with are artists who have multiple revenue streams from CD sales, teaching, performance, and royalties and licensing, plus other consulting or lecture fees. In that regard, we normally view the production costs involved in making a recording as "expired" rather than capitalized into a project. For a one time project single revenue stream, your accountant pretty much has the right approach to capitalize the production and manufacture costs as inventory and amortize them on a per unit cost of the units as they are sold. The cost mismatch can occur if the royalties from sync & licensing are realized faster than units are sold, since the costs of musicians and production are involved in generating that stream of revenue. Thus there is the argument to expense the production cost, and only capitalize the cost of manufacture of physical CDs as inventory. It also depends on the size of the run of the CDs. A 1000 copy press costing around $995 is hardly worth the effort to account for as inventory, particularly when you consider that sometimes more than 50% of product is a giveaway for promotional purposes in generating performance revenue. Mer referred to the IRS 'hobby - loss rules that require a profit to show in at least 2 of 5 years. So if you write off the costs as expense and show continual losses it may be a problem down the road.Hope some of that helps.ArkJack** Any U.S., STATE, OR LOCAL tax advice contained in this electronic mail communication was not intended or written to be used, nor can be used, by any recipient ofthis communication for the purpose of avoiding penalties that might be imposed pursuant to the Internal Revenue Code or U.S. Treasury Regulations,or any other state or local law or regulation.

[bayouandme]

You folks are very helpful and you said pretty much what my CPA told me. Thankfully we are getting lots of forwards, CD and digital media sales have been increasing and we have several major artists helping our project along. Now we need the whole profitability aspect to occur.Thanks,

[simonparker]

I'd agree with the above postings to a certain extent - but it really depends on a lot of factors, including how extensive and aggressive you really want to get in your business/hobby.I'm not going to put a disclaimer in this posting a la arkjack, but a few things need to be remembered here:1- are you treating this as a business or a hobby? Hobby activities do not allow for losses (Internal Revenue Code Section 165 and regulations under 1.183), except in certain situations. You should do some research to see if these situations apply to you. Regardless, if you claim this is a business, you need to show profit motive (which is a tricky concept when showing large losses year after year).2- if treating as a business, what type of entity classification are you filing under (Sole proprietorship, C corporation, subchapter S, or partnerhsip)?3 - where your product is being sold to (i.e. Canada, Australia, Georgia, Arizona, etc.)4- where your place of domicile for your business is locatedThese are things that need to be considered and should not be taken lightly if you are generating thousands of dollars of revenue (my threshold is 10K or greater).Regarding to capitalize costs and amortize over multiple years as sold (inventory approach) versus immediate deduction, again, I would suggest reading Arkjack's suggestions. Dollar value does matter. But in short, you shouldn't be surprised, if running your recording venue as a business, that the IRS can come in and disallow immediate deductions and requires a cost of goods sold approach. Furthermore, if you do not have a game plan for generating profits and show considerable losses, you might be in for a world of hurt.I would suggest you do some research on the topic matter, than just rely solely on what you hear here (including my comments), or from your CPA. A good starting point for hobby losses/business losses is "Prieto v. Commissioner" tax court case. You can google that case and get commentary from many sources, which can help define your business/hobby.Regardless, I wish you the best of luck and hope you only show substantial profits, so you need not worry about how to handle associated costs.