This is a long post (if you also read the second part) but this is very important information now that you are quite possibly in danger of economic turmoil through the Republican tax bill. While it’s not fully certain at this time as to the actual effects that this bill will have upon artists working as private contractors or sole proprietors, the information contained here is extremely important even were this bill not to pass.
For years I’ve been advocating the use of the 501(c)(3) non-profit for jazz artists who are also composers and/or educators, and despite the utterly foolish, short-sighted and irresponsible trend among funders to discourage artists from using the entity, I remain fully committed to this as the best option available – now more than ever (more on that in the paragraphs below). It’s a clean, straightforward, flexible and productive vehicle for business – as so many creative artists in other disciplines have known since the entity’s inception. You’ve probably been told of all the complexities, dangers and hassles involved in operating through the entity. While there can be some truth in that (especially if you handle things in a stupid or greedy manner), they can be pretty easily avoided, and in no way do these outweigh the multitude of advantages in the enormous value this vehicle offers. A major part of that value has been the simplification of tax deductions for the artist’s personal income.
Now, in the wake of the latest variation on the economic rape and plunder by the Republican Party for the rich that is masquerading as middle-class tax relief (“yuck yuck quack quack” as the Art Ensemble always said), there is a great concern among aware musicians as to how their business deductions may be eliminated in this latest bit of right-wing chicanery.
So, let me explain how incorporation overcomes that problem – and if you are going to incorporate, why not do so with the non-profit corporate structure that also offers so many other benefits available to those who fulfill two simple criteria:
- Focusing upon cultural and/or educational activities that are designed to enhance, enlighten and benefit the public; and
- Not being a greedy scumbag (this is not an actual requirement – but it is if you want to deal with me)
(note: it’s not yet fully clear as to how this new bill may affect the entire concept of charitable deductions for all but the top 5%. Nonetheless, there will always be certain advantages to artists and educators through the use of this vehicle…and it’s also quite reasonable to expect a constant assault by the right from which the entity will afford at least some additional protection.)
The concept is simple. When the money for your activities (your gross) is paid to the corporation, virtually all of the expenses that are incurred in delivering the services and activities involved are paid out by the corporation. Whatever is paid to the artist is the actual payment for his/her services (your net). Clean, simple and totally above-board.
And this is not only relevant for the direct expenses incurred related to each particular activity, but on an holistic basis for the artists’ entire cultural and educational imperative.
Essentially, these expenses are thereby not subject to the IRS’ approval, but rather to the internal mechanism of the organization’s board of directors and/or operations management. And if those parties have problems approving these expenses – well, you are not operating the organization in the right manner (and you might be under the condition of point #2 above). Furthermore, the diminished differential between gross and net income removes a significant red flag to the IRS that is often the cause of an audit.
Obviously, that allows for more leeway and for less stick-up-the-butt formality than might be employed at the whim of some arbitrary IRS agent who may not care for your face, your calling, your color or your gender – or who may just be an asshole.
I hope that this is sufficiently clear, succinct and informative, and if it is you can stop reading here. But if what I am saying here is too abstract or abstruse, you could just succumb to taking your chances with the better qualities of Republican control (whatever you may fool yourself to imagine them to be). If that’s not acceptable (and it shouldn’t be) and further clarification is wanted, let me provide more specific information as delineated in the non-profit chapter of my book, Straight Ahead… The first is from a section called Understanding the Basic Principles; the second from one called The Artist’s Role. There is a bit of redundancy contained in them, but important points for consideration in fully understanding the concept. The first is to help you understand the philosophy of the concept; the second illustrates application through specific example.
- Fiscal flexibility
A major benefit of this fiscal flexibility is tax avoidance. Not to be confused with tax evasion, tax avoidance is simply the totally legitimate exercising of available options to avoid paying taxes that rightfully should not be due. Individuals, corporations and other profit-making entities regularly make charitable contributions primarily for tax advantages rather than the good that may result. Corporations set up sub-corporations and other formal entities; individuals incorporate themselves, make investments, restructure mortgages and so forth; all to gain tax advantages. Incredibly wealthy corporations and individuals reduce their taxability to miniscule proportions (or eliminate it altogether) by entirely legal and accepted methods. All of it legitimized by some alleged value that they provide to the economy and the public-at-large.
Whether this is simply in order to help the rich get richer or is actually in the true spirit of public service is irrelevant. The law is the law, and if it provides advantages to those who don’t live up to its intent, those same advantages are certainly due to those who do. And the artist or individual with a meaningful cultural or educational vision that can actually benefit humanity is clearly entitled to those same advantages by law.
For those who try to play both ends against the middle by approaching the non-profit only as a vehicle to hustle the IRS, it won’t work. The abuses we read about daily involving big corporations and wealthy individuals who pay little or no taxes, or perpetrate outrageous swindles upon their investors, employees or the public are able to get away with it for reasons well beyond most people’s reach. They’re protected by their wealth and the influence it exerts. Whether it’s favor from political contributions or the effect they have on their huge number of employees, people who use their services, or the stock market in general, they’re essentially beyond the law. A small NFP is not. But there are so many advantages working within the proper spirit of non-profit that those who choose to abuse it deserve to get nailed for it. And neither “the end justifies the means” nor “so and so does it, why can’t we” is proper justification in the eyes of the law.
One substantial advantage is that an artist can have performance fees paid directly to the NFP. A corporation will more easily gain credit and payment flexibility from hotels, travel agents and even musicians and other professionals as well, easing both the financial and emotional stress that falls on many artists in mounting a tour or even a simple run-out. Furthermore the funds received can be used as matching funds for grants that require them, and also increase the budget of the NFP, which is extremely valuable in the eyes of most funders.
Even more advantageous is that it diminishes the artist’s accountability regarding income from performing that is directly paid out in expenses. There is no advantage in being forced to justify how 90% of your income went out in expenses. Furthermore, a large disparity between gross and net income sends up a red flag to the IRS. This alone is a significant reason why so many musicians are audited. Innocent until proven guilty is not the policy in tax situations. The burden of proof is on the taxpayer when it comes to justifying expense deductions, in both their necessity and their very existence.
However, if the gross income goes into the NFP, all expenses are paid directly to the appropriate parties by the organization, and what’s left is the artist’s share. The artist’s share can be paid out in a lump sum, or can go to the general operating which may include the artist’s salary as artistic director of the organization. That salary can be augmented by other payments based upon the actual amount of money generated by the artist’s activities; or the additional share can be utilized in the further development of new opportunities for the artist/organization.
Non-salary payments can be made within any schedule acceptable to both parties, even straddling fiscal or calendar years according to the best interests of either party. Funds for developmental projects that may take a number of years (such as creating a school, establishing a record label or ongoing concert series, building a studio or performing facility, launching an orchestra, publishing educational materials, etc.) can be maintained and invested in a much more tax-favorable and easier-justified manner than doing so as an individual.
Masters and other product can be owned by the artist and licensed to the NFP; or the proceeds from the commercial exploitation can be entirely assigned to it. The same goes for compositions. It allows the artist to control cash flow and personal income in a more beneficial rhythm, while also assisting the NFP in its own activities, reputation and overall development. Of course it’s important that the dealings between the artist and NFP be carefully drawn in all of these circumstances to protect both the legality and benefits to both.
While similar advantages are available to for-profit corporations, the other advantages exclusive to non-profits enormously favor the NFP as the better vehicle for the artist/educator or dedicated professional.
- What are the direct advantages to the artist?
One of the most important advantages is the clarity and simplicity that the organization offers regarding the artist’s personal income. Earlier, in Understanding the Basic Principles, we looked at the advantages of fiscal flexibility in terms of tax avoidance. In reality, what the NFP provides the artist is more than avoiding taxes that don’t really need to be paid, but actually the avoidance of tax problems that shouldn’t even exist.
Musicians (especially jazz musicians, for many reasons that would be addressed more appropriately in sociological terms) are often under fairly intense scrutiny. Operating as sole proprietors under their own social security numbers, musicians often have a significant disparity between their gross and net income. Also, they often earn income in other countries where the various employers may not be required to report payments to the IRS. Both of these conditions can send up red flags, leading to intense scrutiny, questions and audits even in the most innocent circumstances. Operating through the NFP entirely eliminates the disparity issue, while significantly diminishing the international problem by establishing the musician as an “employee” of the organization, receiving no direct payments from international employers.
Consider an artist who travels overseas three times a year (or within the U.S. for that matter), for extended tours of three weeks or more. Let’s estimate that each tour grosses $100,000. Now let’s assume that agent/management fees, sideman salaries, travel, hotels, etc. eat up $85,000, leaving $15,000 for the leader. That means that the leader grosses $300,000 for the year, but only nets $45,000. Even if the most precise records and detailed receipts are kept regarding all related expenses, with no cash outlays so checks can be shown paying all of the costs, the IRS may still seek an explanation of the disparity.
This will also bring scrutiny into all of the musician’s other business interactions, including deductions for home office, instrument maintenance, etc. Even if all records are kept perfectly, legal and accountant fees will likely need to be paid in order to satisfy the IRS’ stringent demands for clarity. And if the record keeping is sloppy or even somewhat less than precise, payments that are entirely legitimate may be disallowed. Not only will taxes then have to be paid that aren’t really due, but also fines and penalties may be assessed. On top of all that, it can open up scrutiny on years of previous tax returns.
By handling all finances through the NFP, the $45,000 becomes the gross income. Any legitimate expenses the musician incurs personally – such as home phone, postage, instrument maintenance, supplies, etc. – comes off this amount. So let’s say it results in net income of $42,000. A gross/net disparity of 45K/42K is infinitely more desirable than one of 300K/42K to an individual.
Additionally, that disparity which is such a disadvantage to the individual artist is quite the opposite for the organization that houses his or her activities. Increasing the budget is good for fundraising activities both in terms of the organization’s size, and in providing potential matching funds. It also increases the proportion of organizational income to the amount received directly by the artist, which is also a quite positive result.
I know there is a good deal of math and legal whatnot involved here, but I hope the message comes across loud and clear. It’s always made good sense to set up a non-profit entity for your cultural and educational imperatives in general, but now it may be essential. Otherwise you can be paying income tax on money that you actually are not receiving. The 55-page chapter in Straight Ahead: A Comprehensive Guide to the Business of Jazz (Without Sacrificing Dignity or Artistic Integrity) fully explains, clarifies and de-mystifies the 501(c)(3) with 89 Q/As clearly and directly answered – all fully vetted by my longtime colleague Leonard Easter, one of the foremost attorneys in the non-profit field.
For those of you who have been considering setting up a non-profit, Now’s the Time; for those who haven’t, Now’s the Time to be giving it some serious thought. You are under assault and need to defend yourselves. This is probably the best way to do so. Consider reaching out to me about this at email@example.com
Peace & A Love Supreme
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