Business Entities And Taxes: A Musician’s Basic Guide
As a band or artist, it can often be smart to establish yourself as a loan-out company or some similar form of corporate entity, as doing so can both shield you from liability and allow for numerous tax write-offs.
Guest Post by Justin M. Jacobson, Esq. on the TuneCore Blog
[Editors Note: This guide is written by Justin M. Jacobson, Esq., a New York City-based entertainment and media lawyer, (therefore this article does pertain to New York State law). Read his last equally helpful piece on the TuneCore Blog about songwriter split sheets!]
As an individual embarks on their chosen journey, a career in music and in the music business, it is essential for them to have a basic understanding of the complexities and formalities associated with operating a legitimate business. You should treat your “musical career” as a full-time occupation in order to prosper and succeed on this journey.
As Jay Z said “I’m not a businessman, I’m a business, man” and he literally meant it. In fact, in order to better protect their personal assets, (i.e. Shawn Carter’s personal assets – cars, houses, stocks, bonds, securities, bank accounts, etc.), Jay Z and many other musical acts typically create a business entity, such as a corporation or limited liability company (LLC). These limited liability entities shield the owners from personal liability for any claims arising from any contracts or other arrangements entered into on behalf of the individual through its corporate or LLC entity.
Generally, these individual’s business entities are called a “loan-out company” (i.e., Jay Z, Inc., a corporate entity that has rights to the performer). These loan-out companies typically enter into a contract with a third-party as part of a loan-out agreement. Ultimately, the corporate entity, not the members of it, is liable for any debts or contractual obligations of the entity and creditors generally cannot recover against each individual’s personal assets. This protects a person’s assets from judgments or outstanding debts.
For example, this is beneficial if you are a member of a four-person musical group and during your live performance, a member spills a drink on the club’s soundboard and destroys it. If the live performance agreement at the venue is solely entered into with the band’s loan-out company (which it should be), the loan-out company will be the only party contractually responsible for the damaged property and each member will not be personally liable for the damage. The venue’s only recourse is to go after the corporate entity (which may not have assets) and, not each individual band member, for payment to fix or replace the broken equipment.
While shielding an individual from personal liability is one of the most important advantages of creating a corporate entity, there are also several other important benefits for an artist’s career. One is that having a separate corporate entity permits the musician to open a corporate bank account in an assumed name. This also facilitates easier tracking of your expenses and permits the deduction, or “writing off”, of relevant properly documented business expenses.
In order to determine a corporate entity’s eligibility for these deductions and not have the Internal Revenue Services (I.R.S.) categorize your musical career as “a hobby” (which disallows the deducting of your losses), the entity must substantiate that they are actually carrying on the business activity (music career) for profit or to attempt a profit. Since most artists do not typically make a profit and end up incurring losses for great spans of time, they may be permitted to deduct these documented losses on their tax returns.
The following is a non-exhaustive list of factors that the I.R.S. may consider in determining whether or not you are a “for-profit” business and thus eligible for appropriate tax deductions. These include:
- whether you carry on the activity in a business-like manner,
- an examination of the time and effort you put into the activity indicating an intent to make it profitable,
- whether you depend on income from the activity for your sole livelihood,
- whether your losses are due to circumstances beyond your control,
- whether you changed any of your methods of operation in an attempt to improve profitability,
- whether you were successful in making a profit in similar activities in the past,
- whether the business activity actually makes a profit in some years and the amount of profit that it makes.
There also seems to be a three out of five year guideline, i.e., a profit in two out of five years helps justify that the entertainment venture is not a hobby.
An accountant or tax professional should be consulted for a more in-depth analysis of potential tax deductions; however, some typical ones for a musician include:
- promotional materials (e.g., CDs, stickers, flyers),
- consumable supplies (picks, strings, drum sticks, etc),
- website and graphic design, professional expenses (i.e., attorney, accountant, business manager),
- copyrights and trademarks,
- travel and meal expenses (hotel, airfare, on-site travel, fuel costs),
- rental costs (equipment, car, sound),
- any related depreciation of assets (guitars, amps, recording equipment).
It is also important to organize and document these expense records in case the tax authorities are interested in a more detailed examination of them. Keeping copies of receipts and utilizing a separate credit/debit card solely for entertainment related expenses makes it easier to target the deposits and credits to the corporate account.
Another benefit is that a corporate entity typically is governed by a written contract (an operating agreement for an LLC or a shareholder agreement for a Corporation) that outlines how the entity will operate. This includes an outline of the split of any profits and losses among owners.
Also, it specifies how any management decisions shall be addressed and how additional owners and members can be added (or removed) to an entity. These companies also provide easy management over any artist owned intellectual property (i.e. sound recordings, audio-visual works, photographs, logos) for licensing and distribution purposes as well as any tangible property (e.g., studio recording equipment, instruments, mixers).
Without these outlined procedures, it may be very difficult to make certain career decisions, especially when more than one individual may be involved in these important career choices.
While these business entities provide numerous benefits to its owners, there are potential ways a third-party can “pierce the corporate veil.” That is an attempt to attach an individual’s personal assets and disregard an existing corporate entity’s protection of its owners. Thus, it is essential that the company follows any and all statutory procedures and guidelines, which are different in each state.
It is vital that the entity is utilized for a proper purpose and not just merely as a shield from personal liability. Some of these corporate formalities include the preparation of annual corporate minutes to ensure the corporation is a real functioning entity. Also, careful use of business bank accounts as well as their separation from personal accounts are crucial formalities to follow.
Some labels may even require the creation of a corporate entity to permit accounting and payment by utilizing the entity’s Tax-ID/EIN number as opposed to paying an individual personally. An E.I.N. is an employer identification number and is analogous to the company’s social security number.
A final note, every individual must file its own personal federal as well as, possibly, state tax returns for the state they live in; however, an entertainer may have to deal with separate personal state tax issues in several states that they earn income from. Again, please consult an accountant or tax representative regarding the appropriate filings.
This article is not intended as legal advice, as an attorney and/or an accountant specializing in the field should be consulted.