Avoiding self employment tax

[Nick2012]

I totally hear you Shane. Like I said... BIG hypothetical. I have no unrealistic expectations here. But I'll have a 7 year window (age 55 to 62) in which I will be writing, recording and submitting (instrumentals) like wildfire, insha'Allah. I have 26 SS credits and I must not earn 14 before that 7 years is up. If revenue happens to start rolling in at the end of year 4 and continues through years 5, 6 and 7 (at just under $5K a year), I'll be in dangerous territory. A possible scenario? Time will tell I guess.

Maybe I'll just list Mazz and Debra as my co-writers for a while to cut my take to 33%

[anne]

Royalties are paid on a schedule E, which is unearned income - no SE tax on that.

[Nick2012]

When you are paid royalties, you should receive a 1099-MISC showing the earnings. How you report those earnings when you file your taxes is ultimately up to you. The two choices are Sched C or Sched E. Earnings on Sched C are subject to SE tax. Earnings on Sched E are not.

According to the Schedule E instruction book, you can only report royalty income which was "not derived in the ordinary course of a trade or business".

Specifically in the LINE 4 instructions it states, "If you are in business as a self-employed writer, inventor, artists, etc., report your royalty income on Sched C."

And by IRS definitions, most songwriters are self-employed business persons.

[coachdebra]

I totally hear you Shane. Like I said... BIG hypothetical. I have no unrealistic expectations here. But I'll have a 7 year window (age 55 to 62) in which I will be writing, recording and submitting (instrumentals) like wildfire, insha'Allah. I have 26 SS credits and I must not earn 14 before that 7 years is up. If revenue happens to start rolling in at the end of year 4 and continues through years 5, 6 and 7 (at just under $5K a year), I'll be in dangerous territory. A possible scenario? Time will tell I guess.

Maybe I'll just list Mazz and Debra as my co-writers for a while to cut my take to 33%

Cool, sitting back waiting for my checks to roll in

[guitarhacker]

A lot of folks here are advising you that you do not need to pay the SS/MC tax ...self employment tax.... I think this is poor advice.

Whether this tax is owed depends on if the income is EARNED....as in work. That is determined by several things.... one of which is did YOU write the song? If you did, it's considered WORK by you and you owe self employed tax on it. If you inherit the copyright and the money you make is not money you WORKED for, then no, tax is not due for SS/MC.

Before you do anything ..... I would suggest highly that you contact a CPA who specializes in taxes for working musicians and songwriters. The guy down the corner might be able to do business taxes, but if you don't get it right, and the IRS audits you, and three years from now they find that you filed incorrectly and they determine that you do owe the SS/MC tax.... add up the original amount owed, the interest, and the penalties for not paying it on time, and the price of the music CPA's advice will seem like chump change.

Go see a professional CPA....

look here and read this.... it says basically what I just pointed out. http://www.bradheck.com/songwriter-tax.htm Read the first section.

[Nick2012]

Yeah, it's interesting to see all the different opinions in this thread.

The way I see it, the only simple way a songwriter can legally avoid paying SE tax on his/her royalties is if the net income can be reduced to $400 or less by legitimate business deductions. There are more complex ways, which involve corporations, LLC, limited partner status, etc., but I'm nowhere near that level yet.

Songwriters who just blindly report all their song royalties on Sched E may be making a filing error. When I read, "If you are in business as a self-employed writer, inventor, artists, etc., report your royalty income on Sched C." in the schedule E instructions, it's pretty clear to me what that means.

[pboss]

While I read most of this but probably not all details, forgive me if you already covered this, but depending upon your current age, etc, it seems not out of the question that the residuals from your royalties ultimately might exceed that 12 percent potential retirement reduction. From what I'm seeing, there is a curve to the income generated - a long slow curve that can end up increasing, maybe not exponentially, but the curve might become more 'steep' in time, if you keep succeeding with placements.

I'm suggesting that if you are having success now, and plan to continue this music 'hobby' then it might be nice to sit back and not have to worry too much about earning too many credits, because it very well may be that in the end, your current income, and also the passive income generated after age 62, might balance things out or surpass the retirement penalty. It sounds like a careful numbers game, though, and I respect your need to be careful about calculating correctly.

* You could always just change the copyrights to include splits, whereby your other 'writer' is your child / wife - and they can get the income credits along the way. They might be deserving of such co-writer status just for bringing you coffee in the studio, right ? - the money will still be in the family and you can divide the cash as you see fit.

[guitarhacker]

The only way to legally avoid the (currently 14% approx, until years end then back to 16% approx) self employment tax would be to sign the copyright over to someone else. But that opens a whole different can of worms.

I don't know how "legal" that would be to the IRS if you were to sign them to an immediate family member or to form a corp or a trust to hold them. Both of those legal entities are required to pay taxes on income and it might very likely exceed the SE tax you would pay on yourself.

It is best to pay someone for advice who knows the intricacies of the law.

Then again, we can always keep pushing for http://www.fairtax.org since ALL income is tax free at the federal level. Hurry that day! It will greatly simplify the tax process for all concerned.

I run a business that is incorporated. If I allow the corp to retain profits from one year to the next, I have to pay ( I believe it's 20% corp income tax rate) taxes on the profits retained. Then, when I pay myself from that money, I owe taxes on it as personal income....fed, state, & SS/MC. So in essence, I'm taxed TWICE on the same money if I do it that way.

What I do however, is to pay 99.9% of the corp's profits out at year end as a bonus. It counts as earned income to me and it gets taxes one time. The corp makes, literally a dollar or two, and sometimes shows a small loss. That's totally legal, since all the money is accounted for and taxed in one account or the other.

One thing you can count on while we have this current tax system..... the tax man is going to get his. So just be sure that however you do it, it's legal and not walking the grey area. Getting audited and owing for past years will hurt, and might even put you into personal bankruptcy.... and remember, taxes owed are not bankrupt-able.

[simonparker]

Hi Nick -

When you get to the point that you're close to making money with your music and you feel you need advice on self-employment tax, I would recommend seeing a tax professional at that point in time. But just my thoughts (not legal advice)...

To be subject to SE tax, you must be engaged in a trade or business, and not an occassional event - but truly active in it. This is based on your fact and circumstances, so while you might actually get royalties for several years, you can, in certain (although quite limited) circumstances, not be subject to SE tax. If you want examples or case law to read up on - just PM me. To me, I'm under the impression that it's really how much you make that the IRS will look for. If you're making 2K a year and receiving a government check, I wouldn't think much about this being a business subject to SE. But if you're making 20K a year, and receiving royalties from multiple sources, have a website up and running, taking trips to music conventions, etc. that's another story. Again, talk to your tax professional when you're ready.

As for your $400 comment, this is true, but you also have the possiblity of expensing your business 'start-up' costs against the royalties you receive - so it's possible to have a ton of start up cost expenditures you might be able to offset against a ton of royalties to get you down below the $400 threshold. There are other 'techniques' you can use to your advantage as well. You can receive an advance on your royalties and purchase equipment (i.e computer, guitar, monitors, etc.) with the advance and elect a section 179 deduction. If you purchase the equipment with all the royalties you've earned, you'd fall under the $400 threshold. You can take the home-office deduction, allocate rent, depreciation, utilities, etc. as well and potentially show a loss. There's many ways to work this through, but you need to talk to your tax advisor to find something you're comfortable with - and be well aware of what an active business is versus a casual endeavor versus a hobby.

As for some of the other comments recently posted, I'd be careful with what was said. First, signing over a copyright to someone else does not necessarily get you out of SE tax. The person you sign over to can be viewed as your agent and it would be right back on you to pay SE tax. If you were to "sell" your copyright to a third party, you would have to assess the value of the copyright versus its cost. If there's a difference, you could be taxed for it. If you "gift" the copyright, you could be subject to 'gift tax'. So you're not going to have an easy time with such method.

As for the corporation and double taxation, you could avoid such hastle by using an LLC for a vehicle, that would provide you protections that corporations have, but with one layer of tax. As I think I've mentioned before, that's for you to decide when you're ready. As for his avoidance of double taxation by giving himself a "bonus" - I would be very careful. The IRS has provisions in the law that allow them to view such a bonus as excess salary and recast it as a dividend. The recast would cause the deduction to corporation to be disallowed, and tax due on a new balance (plus interest and penalties). As for holding the earnings in a corporation - there is an accumlated earnings tax provision - which I believe is 15% on your corporation's accumulated earnings. However, there can be careful steps to take to avoid being subject to such tax, and that too can be a tool to use if you decide not to go the LLC route but rather as a corporation. Regardless of an LLC or corporation, the IRS can look at your activity and determine that you'd need to pay yourself a salary and thus create a self-employment tax.

So be careful and good luck. And find that tax advisor when you're close.