bennychico11 said:
like everyone said, ask an accountant.
Hey! I'm one of those! Here's some answers:
http://www.irs.gov/businesses/small/industries/content/0,,id=100767,00.html
http://www.irs.gov/pub/irs-pdf/p535.pdf
First, let's leave the hobby loss rules until the end.
I know that legally I have to pay taxes on every CD I sell (because they're a form of income at that point), but can I write off any particular expenses (credit card processing, CD manufacturing, artwork, software, etc), and to what extent?
You need to separate expenses into four categories:
- Selling & marketing expenses, general & administrative--credit card processing, web hosting, advertising, etc. No issues here--write 'em off!
- Master recording & CD duplication expenses, artwork--these need to be allocated among the CDs produced and deducted when the CDs are sold.
- Capital expenditures - gear which includes software. These assets have to be depreciated (spread over a given number of years), although you might be able to writeoff all of the cost the first year, depending on the amount you spend, how much you earn, and a few other provisos . . . depreciation on your home studio would then be considered a production cost of the CD treated as above.
- Personal expenses. No can do, but I don't see anything personal listed in this thread yet. The home office deduction might be worth a thought if you're making money (net profit, that is).
What are the tax implications if I go through a site like CDBaby?
No different really, they are just a sales channel.
Make sure, also, that you keep track of sales tax if you sell any yourself (if its through CD Baby, you don't have to worry about it, because they're the retailers). I'm not sure who you have to pay that to, but it sounds like you really need to find out.
Sales tax is a different animal. You are probably required to collect & remit sales tax for sales within your state only (or at sales in other states if your band does an out-of-state show, but I'm guessing those are notoriously unreported
) If you sell to out-of-state buyers off your website or CD Baby, you don't have to do anything
-- Do I have to set up a separate account? Can I use the one I already have?
-- Since this is my first independent release, I'm not sure how many I'm going to sell, and therefore I don't know how much money I'm going to make.
OK, the hobby loss rules. After you write off everything you can think of, if you have a net loss, the IRS may challenge the business nature of your activity. If it is deemed to just be a hobby, you can't offset other income (like your day job) with that loss. Worse, many of the deductions will be considered miscellaneous itemized deductions, which in effect takes away a good chunk of them, depending on the rest of your tax situation.
So it's a bad thing to be considered a hobby. There is no objective test, you have to look at a bunch of factors:
http://www.irs.gov/businesses/small/article/0,,id=99239,00.html
The profit in 3 (not 2) of five years test is actually a safe harbor--if you can show that, you are presumed to be a business & you aren't subject to the hobby limitations. If you can't, then you have to be able to argue the 9 points in that link. Hence the advice for a separate bank account--you want to make it look businesslike. Have a business plan--a projection of profits from the CD. Have a marketing plan--sales channels, advertising, etc. Register for sales tax and get a local business license, if applicable.
This might all seem like a big hassle, and it is. So if this is a one-time small pressing deal, you might as well either 1) pay tax on the gross, because you won't get much out of the hobby loss rules or 2) don't worry about it unless CD Baby sends you a 1099.
By the way, I never said to do #2
First off if you turn a profit ever in your studio then you're considered self employed which has an extra 15.8% increase to you're normal income tax, so if you do turn a profit you'll want to set yourself up as a personal corporation and save a butt load.
Finally--sorry dude, but this is really terrible advice. The rate is 15.3%, and effectively it's a bit lower because there is a deduction for a portion of the tax. But the advice about the 'personal corporation' only works if the IRS doesn't audit you (which wouldn't be a big surprise, the audit rate is really low) or if you have an extremely stupid auditor. Read this, maybe:
http://www.finance.cch.com/text/c60s15d715.asp