Registering my Business for Income Tax Purposes
1. At what stage in my art business’ growth do you advise registering my business with the State, setting up business bookkeeping, and getting an EIN for my business versus using my Social Security Number for taxes?
1. See the extremely useful SBDC – “Make It Official” on demand 2-hour workshop hosted by attorney Brian Boyes and tax accountant Paul Matonis. In a nut-shell, we advise:
a. As soon as you are serious about starting a business properly, register it with the CO Secretary of State.
b. Start keeping track of your business start-up expenses. These are useful for income tax deductions.
c. Next step is to obtain an Employer Identification Number (EIN) from the IRS website. There is no charge to obtain an EIN. I like to call it a business identification number because instead of using your social security number to identify your business you use this IRS provided EIN.
2. Is there any tax benefit for an artist to register as an LLC versus a sole proprietor? Do you recommend – for reasons such as legal, privacy, risk benefit, etc. – for an artist to register as an LLC versus a sole proprietor?
2. There is no tax benefit to an artist for registering as an LLC. But this designation affords liability protection for your non-art-business assets and is recommended. For a whopping $50, when you register with the CO Secretary of State, you can create a single member Limited Liability Company (or if two or more people, then a multiple member Limited Liability Company).
3. Must I register with both the IRS and the State of Colorado?
3. There is no requirement to register a sole proprietorship with the IRS or the State.
4. Are there other registrations I need?
4. You will need Sales Tax Licenses, see below. Also, the City of Fort Collins requires a license for running a business from your home.
Income Tax Returns –Must I File One?
1. Is there a minimum level of revenue, or net revenue after expenses, which triggers a requirement to file with the IRS for Income Taxes?
1. Income is defined as Revenue received from your business minus deductible Expenses. If this is a positive number, you are required to file an income tax return.
2. Do you recommend I always use Form 1040 Schedule C for my business tax filing?
2. The most economical form to report your business activity is a Form 1040 Schedule C (an attachment to your individual or joint 1040 tax return).
3. If my expenses almost always exceed my sales revenues, must I file Income Taxes?
3. If your business has a loss (expense exceeds income for the year) you will want to file a Schedule C. This loss will offset (lower) other sources of income like from a daytime job for yourself or your spouse if married filing joint tax return.
4. What are some reasons you might recommend I show revenue on my tax returns?
4. If you want to obtain a loan or buy a house these companies want to see reportable income. Most will want to see an income tax return for multiple years. Not only is it against the law not to report income but no or little reportable income can cause you trouble when you need to borrow money today or in the future.
5. If a buyer sends me a 1099 form for his/her purchase amount, what should I do?
5. A form 1099 is used by business for whom you perform services in excess of $600. Not for selling a product, like a painting. But painting a mural in their office, for example, might be considered a service. A 1099 is like a W-2 but it has no taxes withheld, it just reports the amount the business paid you. They send you a copy and they also send the IRS a copy. The IRS will be looking for you to list the company who issued the 1099 on your income tax return and report this income in the exact same amount as is shown on the 1099.
6. Should I be sending out any 1099 forms related to my business?
6. If you pay another business to do services for your business in excess of $600 in a year, then you should issue that business owner a 1099. This might include your website manager or the company you lease your studio from.
7. What guidance can you give me regarding when I should hire a tax expert like yourself to do my returns versus doing them myself with Turbo Tax or such?
7. Turbo tax and other on-line tax programs do a good job. They use a question and answer format. If you can correctly answer the questions then it will be accurate. If you do not understand the questions then you can make a lot of costly mistakes. If you are not good at paperwork and hate to balance a check book then have someone else at least help you. The instructions assume you have some background knowledge in income taxes so it is not always very helpful. If you hire a professional you can be confident that they know the latest tax laws as opposed to friends who may think they do.
Estimated Quarterly Income Tax Returns – State and Federal
1. When is it advisable to start paying Quarterly Estimated Income Taxes for my art business?
1. Start making Quarterly payments when your business starts making enough money that you can cut back on your day job (like go part-time or actually quit your day job). Or when your income starts to exceed your expenses on a regular basis. If you don’t pay quarterly taxes, and your tax at the end of the year exceeds $1000, the IRS will charge you a penalty.
2. How do I calculate Estimated Quarterly Income Tax
2. Your first quarterly tax return is due on April 15th and covers January, February and March. Estimate the amount of Revenue you made, less your estimated expenses, and pay tax based on the federal and state tax guidelines. Businesses with fairly steady income streams can calculate this quarterly estimate once a year and use it for all four quarters if nothing substantially changes.
3. What is self-employment tax and how do I calculate it.
3. Self-employment taxes are for Social Security and Medicare. As a self-employed artist, you must pay employee and employer portions of these fees based on the income you made. These amounts are calculated based on your estimated income and are included in quarterly payments. The total S.E.T rate is 15.3%, currently.
4. Please share any tips you have – such as putting the dates for Income tax payments (and sales tax payments) into your calendar/phone.
4. Wherever you record important calendar dates to remember, such as your spouse’s birthday, also record the Quarterly Estimate Tax Return due dates there.
1. What expenses can I legally deduct against my business revenue?
1. Any cost that you incur in running your business can be a deduction in one shape or another. Any time you reach into your wallet or purse, ask yourself this question. Is this for my business?
a. Yes – then keep the receipt as a business exp.
b. Maybe – then create a second category as “might be a business deduction”, keep the receipt.
c. No – then it is personal but keep the receipt in case you have to return it.
The most common examples of fully deductible business expenses are: advertising, business cards and brochures, studio expenses, specific art and office supplies and materials, continuing education seminars, workshops, studio rent and office furniture and equipment.
Then we have dual-purpose expenses (part personal, part business) like cell phone use, internet, computer use, business use of the automobile and home office.
a. Cell phone. Use a good faith estimate of how much you are using the phone for business and personal. Let’s say you use it 35% for business. Then you can deduction 35% of your portion of the cell phone bill every month you use it for business.
b. Same with the internet. The business use percentage can be the same. Remember most of us use these for personal use too so be real about the business use.
c. The computer. This may be even tricker. If you use it a lot and need a more powerful than average computer, then have two computers and use the more powerful one strictly for business. It will be a 100% business tax deduction. Again, we all use computers so if you only have one computer then you may be able to deduct a business precent of the use.
2. How do I deduct my expenses for a Home Studio properly?
2. To deduct costs for a home studio, it has to be an exclusive-use area of the home. It does not have to be a separate room or physically separated from the rest of the area. Say you use ¼ of the basement. Then ¼ of the square footage of the basement would be the home studio area and say the basement is 1,000 square feet and the main living area is also 1,000 square feet. Then your percentage would be 1/8 of 2,000 square feet. Then if you own the home, you can take 1/8th of the mortgage interest, property taxes, insurance, utilities, HOA fees, repair cost, etc. We can also depreciate 1/8 of the cost of the house over a 39 year period. If you are renting then you can take 1/8th of the rent, insurance, utilities, HOA fees, repair cost, etc.
3. What kinds of deductions can be made related to business use of my personal vehicle, i.e. mileage, maintenance, repairs, sale?
3. Most of us use our automobile for both business and personal purposes. The IRS allows deduction per mile for business use of the personal automobile. In 2023 it is 65.5 cent per mile. You must keep track of business miles, usually with a log of some kind. Examples of acceptable business miles include going to see a customer, picking up supplies, going to workshops, making bank deposits etc. Use a mileage app or use google maps to calculate the miles from home to your destination then double it for the return trip home.
4. Do I need to keep the paper receipts?
4. Credit card statements and canceled checks are not sufficient on their own to back up the business expense. You need a detail list of the actual items and the business purpose. If you cannot tell from the receipt what exactly you purchased, then write it on the receipt or on a note pad itemizing the items and if it is not obvious then write an explanation of its business purpose. Then keep it with your records.
5. Can I deduct expenses for both a Home Studio and a leased studio space?
5. Yes, you can deduct costs for a home studio and for a rented studio space, but certain guidelines have to be met. There must be a valid business reason why you need to use the home studio in addition to the rental. If you work in the rented space but have no room for business-related paperwork and record-keeping, then you can take a home office deduction. If you are creating, building or need special facilities for the work you do and you need additional space at a different location then again you can have a home studio and deduct rented space. There has to be a specific reason why you need two spaces not just because you want two spaces.
6. When can I write-off travel expenses – I like to take trips which enhance my art business?
6. There needs to be a business purpose for the trip and it needs to be reasonable. A trip to Hawaii to draw, paint, take pictures, write about culture, etc. might not qualify as a business expense unless you spend a considerable amount of time doing the business activity and it fits into your actual art business model. I am not saying it is not deductible, but it needs to be important to the business income activity to not be a red flag. Travel expenses to appear as a vendor at an art fair, however, would likely be deductible.
7. What kinds of in-kind and art donations are tax-deductible?
7. When you donate a work of art, you can deduct as a charitable contribution ONLY hard expenses such as materials used, mileage for delivery, shipping, and any associated business meeting costs (coffee you purchase for the charity director, for example). You CANNOT deduct your labor in making the art. You also cannot deduct the market value of the work. If someone buys a piece from you and then donates it to charity, however, they can deduct the full purchase price as a charitable contribution on their tax return.
8. What expense deductions are red flags?
8. Expense that are red flags to the IRS are things that can be used for business use and also provide an element of personal enjoyment. The expenses need to be reasonable, ordinary, and necessary. So, this will depend on the type of art business you have. For these red flag expenses, you need to let your conscience be your guide, and if you use a professional tax preparer like myself, you need to convince me of the legitimate business purpose.
a. Travel Expense, see previous comments above.
b. Excessive business use of the automobile. Driving around and going to other locations just to get creative ideas might not be legitimate enough for a business deduction. But going to an art fair where you are trying to make sales would probably be deductible. See previous notes about business use of personal automobiles.
c. Meals are a third example. Currently we get to deduct 50% of the cost of the meal (alcoholic drinks included) plus tip. Along with the mileage to and from the location. But there needs to be a clear business purpose. It does not have to be a successful business meeting but the potential for business needs to be realistic. Also meeting with business associates or even your significant other once in a while for a meal to talk about business is acceptable within reason. Doing this once a week, however, is probably not acceptable.
1. Can I deduct net losses from my business against my other income (or my spouse’s)?
1. Yes. If you can demonstrate your art business is serious, a net loss can be shown on your Schedule C and it will reduce your overall taxable income.
2. Are there limits to deducting business losses?
2. Two types of limits to claiming losses:
A. You can’t deduct more losses in one year than the adjusted taxable income from which you are subtracting it. If you have $50,000 in taxable income from a job and your art business has a $60,000 loss, you can only deduct $50,000 in this tax year and carry-over the remaining $10K to the next year. See more on this below.
B. In general, the IRS wants to see a business showing profits 3 out of 5 years in order not to question whether it’s really just a hobby. There are sometimes good reasons why serious businesses do not meet this target, pandemics, for example. And those situations will usually not be a problem but may call for some explanation. You might need to demonstrate that you’ve been seriously running an art business during these years of losses – by appearing at art fairs, for example.
3. How does loss carryover work?
3. In the example in 2.A, above, the loss carry-over amount of $10,000 can be subtracted from the following year’s adjusted taxable income (as long as that figure is at least $10K, of course) before income tax is calculated. However, if you are also subject to paying self-employment taxes (SET = SS and Medicare) as a business, the basis for calculating the amount of SET in the second year will NOT be reduced by the carryover amount. If possible, it is better in that case to claim some expenses from Year 1 on your Year 2 return, and only show expenses in Year 1 up to the amount of the Revenue shown (so you aren’t showing a “loss”, just a zero-profit year). The expenses you move into Year 2 will then reduce your Year 2 taxable income AND the S.E.T. in Year 2 will be based on this reduced taxable income figure.
1. What records of expenses must I keep? What additional records SHOULD I keep?
1. Keep copies of invoices and receipts, write clearly what the expense items are, so it will be understandable. Keep these till the end of the year and then organize them so you can fill out your tax returns. Keep on-line payment records, like credit card reports. Records can be scans, not necessarily original paper receipts.
2. Do I need to keep physical records of all payments I receive, i.e. photocopies of checks, printed receipts?
2. It’s important to open a separate checking account JUST for the business. Always deposit all revenue from the business into this account first. If you need to transfer some of it to your personal account for expenses, make that a separate step. Log every sale in a book or spreadsheet.
3. How long must I keep records for?
3. Keep records from the business for 7 years, in case the IRS audits you.
4. Is there a record keeping system you would recommend I use.
4. Excel spreadsheets are good, if you know how to use them. A written ledger is fine. Keep each tax year’s receipts together in a file or a box. If you divide these into categories, make the categories useful to you, so you can calculate where your biggest expenses are. That way you can manage your financial condition better.
1. Must I pay Sales Tax for every sale I make? Is there a minimum annual revenue figure which triggers this requirement?
1. You must collect sales tax on all sales of taxable products which you make if the jurisdiction where the goods are RECEIVED BY THE BUYER is a location which requires it.
2. In what jurisdictions must I obtain a Sales Tax License for my business?
2. You are supposed to obtain a Sales Tax License in any jurisdiction where you sell. In Colorado, as a minimum, you should obtain a State Sales Tax License from the CO Department of Revenue and any Home Rule City, such as Fort Collins and Loveland, in which you will make sales. Get more information on State Sales Tax Licenses here.
3. Must I file a Sales Tax return in every jurisdiction in which I’m registered, even if I had no sales there?
3. If you have a current Sales Tax License in a jurisdiction, they will expect you to file a return, even if it is for zero dollars. Failure to submit a return may result in them sending you an invoice for an assumed amount, plus late penalties. Sales Tax Return frequency varies by location. The State’s rules are here. The State Sales Tax Return will also cover all county sales taxes except Denver County, which requires their own return (to the City and County of Denver) and sales taxes for non-Home-Rule cities.
4. How do I manage Sales Taxes when I ship or deliver a piece of art to a jurisdiction other than my base location?
4. You can look on the Colorado Department of Revenue’s Geographic Information System site (“GIS”) to get the Sales Tax rate based on any address in Colorado that you either ship or delivery art to. Then you can charge the correct tax. This site also includes information on the tax rules of each jurisdiction, where and when to remit the taxes, contact numbers, etc.
5. I’ve heard of a “Delivery Charge” which must be added for sales made within Fort Collins when I deliver the artwork to the client’s location. Can you explain how this works?
5. If you either ship or deliver a product to a client in Colorado, you must charge a $0.27 Retail Delivery Fee on the invoice. This must be remitted to the Colorado Dept. of Revenue.
6. Are there other Sales Tax peculiarities that I should be aware of?
6. Other important items:
A. On your State Sales Tax Return you must identify the Physical and Non-Physical Locations in which you have sales. Thus, the state will know to which counties or non-home-rule cities it must distribute your remittance.
B. For Home Rule Cities, they each have their own rules on frequency of payments and other fees. It’s best to contact these cities directly to make sure you are compliant.
C. There are third party companies in the market who will manage your Sales Taxes for you. This might be worth doing if you have large sales in many jurisdictions around the country.
7. What is a good way to manage sales taxes for sales from my website?
7. If you make sales directly from your website, it is important to ensure that you are charging the correct sales tax with the sale. If you are shipping the artwork to the buyer, you will need to include their local jurisdiction’s sales tax rate. Website POS systems may not do this automatically. There may not be an automatic way to do this at present.
8. When I am paid for a piece of art via Zelle, Venmo, PayPal, etc., is the income reported to the IRS, State of CO, or the local jurisdiction of me or the buyer? How should I manage this?
8. If you receive $600 or more in payments via PayPal or a similar platform, they will report it to the IRS on a 1099-K. It’s important for the amount on the 1099-K to match the amount you list in your tax return. Therefore, if the payment platform lists the gross amount paid and they do not first deduct their processing fees on the 1099-K, you should do the same so the income line matches the 1099. Then deduct the processing fee as a line item expense on your Schedule C.
9. Do I have to pay sales tax if I am paid in cash?
9. Sales Tax is due on all sales, whether you are paid in cash or otherwise, in any jurisdiction which requires Sales Tax.
10. Doesn’t Etsy (and similar platforms) take care of Sales Tax for any sales of my art?
10. Some art sales sites, such as Amazon, will charge and remit sales taxes for you on sales of your items. Others may or may not do so. It’s very important for you to set up your accounts carefully (Shopify allows the seller to opt out of this) and monitor this so that your on-line sales are taxed properly. Use these services’ annual reports to help complete your tax returns.
11. What if I live in Colorado but ship prints from my printer in Texas?
11. Art shipped to a client from a printer or fulfillment center in another location is no different than if you ship art from your studio to a client’s location. The Sales Tax should be charged by the seller based on the rate applicable at the location where the product is received by the buyer, typically at their home or business address.
12. What is the difference between a “Special Event Sales Tax” license and regular sales tax license.
12. Special Event Sales Tax licenses are for one-time events where you are selling outside of your normal business location. These require payment on the 20th of the month following the event. These are issued by the state. Alternately, an event organizer will sometimes obtain their own license and collect the taxes on the sellers’ behalf. Make sure you know whether or not they have done this.
13. Where can I go to get in person help with Sales Tax?
13. Other resources:
a. Northern Division of the Colorado Department of Revenue, 3030 South College, Fort Collins, CO. No appointment needed. They take only checks and cash.
b. Larimer SBDC and LBDC have a network of local CPAs who will offer free, one-hour first appointments for SBDC/LBDC clients.
c. CO Dept of Revenue on-demand video training is very good.
d. If you choose to hire a CPA to help you with your taxes, make sure you interview them first and confirm that they are fully knowledgeable about the peculiarities of Sales Taxes as they apply to artists like you.