I Can Deduct the Making by ert554898

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									DOLLARS & SENSE

“I Can Deduct The Making                                                                                                                    and money in writing and track-
                                                                                                                                            ing songs, you’re obviously going
                                                                                                                                            to want those tunes “mixed” by


Of My CD… Right?”
                                                                                                                                            someone who knows how to cre-
                                                                                                                                            ate a soundscape of appropriate
                                                                                                                                            instrument and effect levels that
                                                                                                                                            enhance the listening experience,
by Alan M. Friedman, CPA                                                                                                                    not muddy it. After that, the en-
                                                                                                                                            tire compilation should be “mas-
                                                                                                                                            tered” to bring a uniform clarity
                     Alan Friedman is a CPA and Senior Partner with the         music stores, instrument and product manufacturers,         and volume to each song relative
                     accounting firm of Friedman, Kannenberg & Company,         recording studios, music schools and other music industry   to the entire CD as a whole. Lastly
                     located in West Hartford, Connecticut. He holds a          professionals. Alan resides in West Hartford, Connecticut
                     Bachelor and Masters degree in Professional Accounting,    with his wife and three children. In his spare time, he
                                                                                                                                            the CD master needs to be repro-
                     and has been employed by United Technologies and the       records music in his basement studio (www.alhomeboy.        duced, along with an artistically
                     international accounting firm of Ernst & Young.            com) and plays lead guitar in the all-CPA rock band “The    pleasing CD jacket. Add the cost
                     Alan and his firm have extensive experience in providing   Accounting Crows” (www.accountingcrows.com) and             of photography and graphic
                     accounting, tax and consulting services to the music       the print music industry band “Printz.” E mail Alan at      design, and you’ve undoubt-
                     industry, servicing professional musicians and bands,      money@drumheadmag.com.
                                                                                                                                            edly got thousands (if not tens
                                                                                                                                            of thousands) in CD production
Every March and April, as we prepare scores of tax returns for                                                                              costs…and that’s before you’ve
                                                                                                                                            spent the money to duplicate the
our musician clients, the question of deducting CD production                                                                               CD for public consumption.
                                                                                                                                               It’s no wonder that any musi-
costs is inevitably raised.                                                                                                                 cian doing his/her own CD would
                                                                                                                                            want to get a tax deduction for
                                                                                                                                            these production costs. Unfortu-
    Even before I did my first CD of        listening pleasure but also to help             stupid or very naïve (or arguably               nately, the IRS has some different
bad 80’s rock tunes, I wondered if          promote, achieve and sustain a                  both) for a couple of reasons.                  thoughts about allowing you a
all of my CD production expenses            successful career in music. This                   A long time ago I thought my                 “current year” deduction for
were deductible. After all, our             partly explains why musicians                   investment in recording equip-                  these costs, resulting in less tax
tax laws are built on the premise           sometimes wonder whether they                   ment would remain at the couple                 paid to Uncle Sam.
that any expense incurred in the            can get a tax break for making a                of thousand of dollars for my
production of income is generally           CD. But the variety, magnitude                  Tascam mixer and 8-track tape-                  The “Unicap”
deductible. But my right brain              and timing of CD production costs               based recorder. But somehow                     Rules Of 1986
started to cross over to my left            is usually what causes your typi-               that evolved into spending tens                    In 1986, a new tax act created
brain with questions like “What             cal musician to find themselves                 of thousands (or hundreds of                    Section 263A of the internal rev-
if I incur big recording expenses                                                           thousands of dollars if you ask                 enue code which governed the tax
but don’t have CD sales income              “Can I deduct all                               my wife) for constant equipment                 treatment of costs incurred in the
right away?” or “Can I imme-                                                                upgrades over the years. The                    production of tangible personal
diately deduct money spent on               of the expenses I                               Tascam recorder got replaced by                 property, like sound recordings.
                          ,
recording equipment?” leading                                                               ADATs, which later got replaced                 This new section of law (also
up to the big question “Can I               incur in the mak-                               by a modular digital 24-track                   referred to as the “Uniform Capi-
deduct all of the expenses I incur                                                          recorder, which was further                                       ,
                                                                                                                                            talization Rules” or “UNICAP”)
in the making of my CD and, if              ing of my CD and,                               replaced by ProTools hardware                   was enacted, in part, to prevent
so, when?” Frankly, these ques-                                                             and software, and finally (for                  taxpayers from inappropriately
tions didn’t matter much to me              if so, when?”                                   the moment) replaced by more                    mismatching income and ex-
while I was recording my CD, as                                                             software and hardware upgrades.                 penses which, in turn, create a
all I wanted to do was produce a                                                            Four-rack-space analog effects                  “current deduction” of produc-
body of musical work I was proud            confused over the deductibility                 got replaced by single rack-space               tion costs that have future value.
of. But these issues began to               of CD production and replication                digital effects, only to disappear                 Under Section 263a(b), our
matter more once I sat down to              costs – and for good reason. The                by the advent of software plug-                 internal revenue code requires
do my own tax return in light of            answers are not straightforward,                ins. My microphone collection                   the artist/songwriter to “capital-
the thousands of dollars I spent            often confusing and have been                   expanded hand-in-hand with my                   ize” (not immediately deduct) the
in CD production. Knowing how               changed over time by our friends                guitar & amp collection, coupled                costs to create, research, write,
important this issue is to most, if         at the Internal Revenue Service.                with money spent for an assort-                 prepare and record the body of
not all, musicians, I thought I’d           I’ll explain a little later in this ar-         ment of cables, accessories and                 work. The costs also include any
shed some light on this somewhat            ticle, but first let’s talk about the           studio furniture. Accordingly,                  travel, rent, equipment deprecia-
complicated topic.                          myriad of costs typically incurred              there’s a lot to be said for simply             tion and repairs, office overhead,
                                            in producing one’s CD.                          paying the hourly or daily rate for             interest and any other costs relat-
The Fine Line Between                                                                       an “up-to-date” recording studio                ing to the production of tangible
Art & Business                              Endless Love,                                   to do your tracking.                            personal property, including labor
   Most musicians have a passion            Endless Costs                                      Furthermore, while CD track-                 costs for any persons involved in
to capture a lasting memory of                 I used to think CD produc-                   ing may be the most time con-                   the production activity.
their musical artistry and cre-             tion costs would be somewhat                    suming task, it’s only one of the                  In compliance with the UNI-
ativity. That passion has fueled            minimal, once I made my “one-                   critical stages in the production of            CAP rules, the taxpayer must
an explosion of sound recordings            time” investment into recording                 a quality sound recording. After                “amortize” (ratably write-off)
made not only for the musician’s            gear. This notion made me either                your investment of time, effort                 the production costs under the

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                                                                                                    DOLLARS & SENSE
                          ”
“income forecast method. This         owner.” A “qualified employee                                               and at your shows for $10 each. At
method requires the taxpayer to       owner” is an individual who owns    “there’s a lot to be                   the end of this year you determine
estimate the future expected in-
come to be received from (in this
                                      at least 95% of the corporation’s
                                      stock or at least a 95% partner-
                                                                          said for simply                        you’ve sold 600 of the 1,000 CDs
                                                                                                                 you bought, with 400 CDs still
example) the sound recordings,
in addition to only allowing the
                                      ship interest.                      paying the hourly                                             .
                                                                                                                 sitting in “inventory” Can you de-
                                                                                                                 duct the full $2,000 you spent on
deduction for tax periods that        How Do I Make                       or daily rate for                      the CDs? No. But you can deduct
report income from the sound          This Election?                                                             $1,200 ($2 cost x 600 sold) against
recordings.                             Qualified taxpayers may auto-      an ‘up-to-date’                        the $6,000 ($10 selling price x 600
                                      matically elect to use the three-                                          sold) of CD sales income you’ve
You’ve Got To Be Joking               year safe harbor by timely filing    recording studio                       earned, netting $4,800 ($6,000
   Shortly after the IRS enacted      their federal income tax return                                            in sales - $1,200 of cost) in gross
Section 263A UNICAP rules, they       and noting the election by typing   studio”                                profit from CD sales.
started to receive numerous inqui-    or legibly printing ‘Three-Year                                               Why can’t you immediately
ries and complaints from authors,     Safe Harbor Adopted Under The       incurred the cost to create the CD     take a deduction for the $2,000
recording artists, photographers      Provisions of Notice 88-62” at      master and artwork layout, you         of CD duplication costs? The IRS
and other persons expressing          the top of Form 1040, Schedule      have the final task and cost of du-     considers your CD inventory an
concern regarding the application     C, Page 1 (for a sole proprietor-   plicating and packaging the CD         “asset” (something having future
and administrative complexities       ship or single-member LLC), or      for public consumption. Here’s         value) until it’s sold. Only upon
of these new rules… what a sur-       Form 1065, Schedule A (for part-    where things get a little tricky as    disposition can you take a deduc-
prise. In response to this concern,   nerships), or Form 1120 / 1120S,    far as taking a tax deduction for      tion for the cost of the CDs sold or
Congress granted the Treasury         Schedule A (for corporations).      these duplication costs.               disposed of. The good news is if
Department authority to “adopt                                               Let’s say you just spent $2,000     you give away 100 CDs as part of
other simplifying methods and         Deducting CD                        for a 1,000 piece run of your new      the promotion of your CD you can
assumptions, where the costs          Duplication Costs                   CD; the cost per CD is $2. You start   take an immediate $200 ($2 cost
and other burdens of compliance         Now that you’ve                                selling your CD online    x 100 CDs) deduction for those
with the Code may outweigh the                                                                                   CDs.
           .
benefits” In other words, Con-
gress was strongly suggesting                                                                                    Some Final Thoughts
the Treasury find a simpler way                                                                                      The IRS has recently announced
for taxpayers to comply with the                                                                                 some other tax benefits, includ-
spirit of the new tax law.                                                                                       ing a special deduction for certain
                                                                                                                 domestic production activities
A Kinder, Gentler IRS                                                                                            (that includes sound recordings)
   Based on these numerous com-                                                                                  as well as capital gains treatment
plaints and concerns, the IRS pro-                                                                               for the sale or exchange of musi-
vided an elective three-year “safe                                                                               cal compositions or copyrights in
harbor” for certain authors, art-                                                                                musical works. By the same token,
ists and taxpayers who were now                                                                                  there are some stringent IRS
required to comply with the new                                                                                  guidelines that determine whether
Sections 263A rules. Under the                                                                                   your musical endeavors are truly
three-year safe harbor, taxpayers                                                                                part of a “business” or are part of
could aggregate and capitalize                                                                                                  .
                                                                                                                 your “hobby” Although the IRS
all of their “qualified creative                                                                                 generally requires a “net profit”
costs” incurred during each tax                                                                                  (as opposed to recurring losses)
year, and then amortize (deduct)                                                                                 to be shown 3 of the last 5 years
50% of the aggregated costs in the                                                                               from any musical endeavor treated
year they’re incurred, 25% of the                                                                                as a business, there are other fac-
costs the following year, and the                                                                                tors the IRS considers, going both
remaining 25% in year three.                                                                                     ways, in determining the tax status
   This safe harbor election                                                                                     of those endeavors.
greatly reduces the administra-                                                                                     Just like most of us wouldn’t do
tive complexities of complying                                                                                   our own plumbing, I suggest you
with the UNICAP rules by elimi-                                                                                  consult with a CPA or other tax
nating the necessity to amortize                                                                                 advisor familiar with these some-
these costs using the subjective                                                                                 what complex rules. But just like
income forecast method, as well                                                                                  your investment in a music editing
as eliminating the need to figure                                                                                 software upgrade or CD mastering
out which costs should be capi-                                                                                  services, the benefits from using a
talized versus expensed.                                                                                         good tax preparer will most likely
   Although the safe harbor                                                                                      far outweigh the cost. So keep
generally applies to individuals                                                                                 track of your CD production cost
only, a corporation or partner-                                                                                  receipts and invoices, as they save
ship may use the three-year safe                                                                                 you money by reducing tax liabili-
harbor election if the corporation                                                                               ties and minimize headaches if or
or partnership is substantially                                                                                  when Uncle Sam comes knocking
owned by a “qualified employee                                                                                    at your studio door.

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