Avoiding self employment tax

[Nick2012]

I assume no one on this forum is a professional tax advisor. I'm simply asking this question in the event any of you have feedback to provide. I will not treat your input as any kind of legal advice, and I would speak with a tax professional before making any final decisions.

Hypothetically (BIG hypothetical), let's say after 3 or 4 years of submit-forget-repeat, income starts rolling in at a rate of $5K to $20K a year. Is it OK to always report the income as "other" and just pay the income tax? It's crucial that I do not earn 40 social security credits before age 62. Therefore, I have to avoid paying self employment tax as long as possible. The intent of my musical endeavors will never be "to make a profit". I do not need the extra income. I don't want this to be a business. For IRS purposes, I want to classify music income as "hobby" income. But if it starts producing a 5-figure annual income, will I still be able to continue reporting it as "other" income and claiming it's a hobby?

Nick

[Len911]

Nick, it might be best then to incorporate it as a business, maybe an LLC or something. That would take away the self-employment or soc sec part of it. You'll pay 15% federal tax, instead of the 28% if you are in that bracket. The "double" taxation occurs when you pay yourself, if you ever do. So if you left the money in the business account for a year, you pay 15%, if you draw it out the second year and pay to yourself you would pay say 28% or whatever bracket you might be in. That is my understanding anyway. However, if you never make a certain profit after awhile it will be considered a hobby and not a business. It would be great if you made enough to pay for your gear, and use it as a tax deduction, and enough profit left where they didn't disqualify you as a business, and you only had to pay 15% federal. I would consult a cpa, because they really don't charge all that much, I used to use one, they are as cheap as an individual that knows little or nothing, and they can give you the "legal" scoop. With an individual you can "cheat" better on your taxes,lol, though you don't get adequate counseling. In other words, I use to have a cpa do my business taxes, and ask him questions and advice all the time, and he never charged me extra, maybe that was just him though. The only conclusions I ever came to was that there weren't any "loopholes", and any way you do things has benefits and drawbacks, and you just have to choose the best way according to your situation, or hope that is your future situation,lol. Unless of course you are a large corporation, then you can make your own rules through lobbying, political contributions, and hiring ex-irs officers!

[mazz]

Just have all your royalty checks automatically deposited in my bank account, I'll be happy to pay the taxes on it!!

That being said, those questions are really between you and your accountant. You might want to re-think stating publicly that you want to avoid paying taxes.

Good luck!

Mazz

[Nick2012]

You might want to re-think stating publicly that you want to avoid paying taxes.

There's nothing even remotely underhanded about what I'm asking or what I'm trying to do here. Actually, I'm downright anal when it comes to being law abiding and paying my fair share of taxes.

It's a fact that you do not pay self-employment tax on "hobby" income. That's straight from the IRS. What's not so straight or well defined by the IRS is when a hobby should be considered a business. The wording is very ambiguous and highly interpretable.

The crazy thing is I would be perfectly willing to pay the tax, I just don't want the credits. I've actually asked the social security administration if I could pay the tax but not be awarded credits. The answer was no. That, to me, is BEYOND stupid.

LEN, Thanks for that info. From what I've read, if I MUST treat this as a business, LLC is probably the better option in my case.

Nick

[mazz]

What's the motivation for not wanting the credits? I'm not sure what the credits are, obviously I don't know much about this, I've worked with the same accountant for years and have always claimed a certain amount of business deductions, whether I was a full time musician or not, and I let him take care of it. It's always worked out. I was audited once but not for music business stuff, it was my wife's career change that triggered it.

I'm interested to know why you aren't interested in paying Social Security.

[slideboardouts]

Well, if your income is all from performance royalties, then lucky you! Because performance royalties are NOT subject to the social security tax. Thats right, if you are making all of your money through performance royalties, there is no self employment tax This info is from both my personal experience filing taxes on royalty income with an accountant and from an accountant specializing in the music industry who I heard speak at the Road Rally a few years ago. But, of course, its best to check with a qualified CPA to get the info directly from an authority on the matter and not just from some punk @$$ on the internet

For most of the last 10 years I have worked multiple jobs at a time, most of which I was self employed for. Being a self employed composer earning a living from performance royalties is BY FAR the best possible situation you can be in as far as the self employment tax goes. So I wouldn't worry about it to be honest. Its a pretty sweet deal.

The catch, however, is that you can't write off expenses against those performance royalties. You can write off expenses against money you are paid from gigs, session work, upfront payments and various other things... but not the performance royalties. At least according to my accountant.

-Steve

[Nick2012]

Mazz, I'm part of a small demographic of government employees who have to watch out for something called the "Catch 62" penalty (you can Google it for more info). Basically, on my 62nd birthday, the government will check to see if I have 40 or more SS credits. If I do, my government retirement income will be IMMEDIATELY reduced 12%. Ouch!

Nick

[Nick2012]

Steve, If what you say is true, you have definitely made my day. But 95% of what I read online states otherwise. I know there is a lot of misinformation out there, but 95% is hard to ignore. One of the few sites I can find which says royalties are NOT subject to self employment tax is this one...

http://www.ehow.com/facts_6153162_royal ... x-law.html

Maybe the context of "passive income" is the key. Anyway, I'll definitely seek the advice of a professional with music industry experience.

Thanks!
Nick

[simonparker]

Nick,

You've got a lot of moving parts to your issue here - and although the IRS might not look too closely here since they've got more juicy fish to fry, it would be good if you gather a strong understanding of how to manage this via your accountant and/or tax professional.

First, I can appreciate that you don't want your benefits cut when you reach age 62 because you somehow qualfied for social security. I can also appreciate your desire to make income from your music.

Here's what you need to ask yourself - How much money are you going to make on a yearly basis? If you're making enough that you've become a sustainable business, then you could be deemed self-employed and subject to self-employment tax. If you're getting $300 in royalties a year, you could probably drop it as "other income" on your 1040 (and/or Schedule E) and walk your merrily way. If you're making $30,000 after expenses, then it's another story. While hobbies are defined in the IRS as something that does not generate income 3 out of 5 consecutive years, it's done for a purpose. So creative people can't enjoy nice write-offs against their "real" income, if they're not making much or anything from their 'hobbies". As for you, if you make income in 3 of those 5 years, I think you'd be viewed as a business and not a hobby. Anyone who is self-employed and has net earnings (income less legitimate expenses) is required to pay self-employment tax (there are exceptions, but it sounds as though it does not apply for you).

Now as for an LLC or actual corporation, this might help add some layers of protection, but it also has some issues you should consider. First, with a corporation (not an LLC) you have double taxation - the corporation pays a tax on its earnings, and any distribution made to you, the sole shareholder is taxed at your level. Regardless, with either, you need to maintain an active recordkeeping. Do you have the time or want to allocate the time to doing such? You might have to pay a fee for incorporating, as well as pay a yearly tax to the state you incorporate under. You also subject that income to scrutiny by the IRS and the respective state taxing authority - meaning a yearly tax filing. Then there's the issue of your "salary" or management fee. If your business is profitable, and you show no expense on your tax return for wages or salaries, that might create a red-flag. Why aren't you taking a salary? Are you paying people off the books, etc. The tax law has a clause for what is called a personal service corporation, and you might want to read up on how the IRS can reallocate income in certain cases from that.

So I think you need to figure out how much money you think you're going to make from your music and how it might affect your future benefits. Go pull together an idea and talk to your accountant.

[Nick2012]

Thanks Simon for that in-depth response. I definitely appreciate you taking the time. It's all good food for thought.

Nick