The Home Studio – my final entry for Tax Deductable Business Expenses

The home office or studio deduction has been one of contention for some time but it is really quite straight forward. To take the deduction you must use your studio exclusively for your business. It doesn’t have to be an entire room but the square footage that you use to calculate your deduction must be partitioned and used exclusively business. That is, if you have a 300 square foot family room and you partition half of the space for your studio, the deduction calculation will be based on 150 square feet. If you have a 2000 square foot home you will deduct 7.5% of home related expenses on Form 8829 (Expenses for Business Use of Your Home). Uses of the room in addition to studio space might include storage of artwork and supplies or office space for record keeping and other business expenses. The costs that you could deduct might include rent, mortgage interest, real estate taxes, condo fees, utilities, insurance, repairs, etc. If your studio qualifies, this can be a powerful deduction for your business.

Assets and Depreciation: Equipment

The cost of equipment purchases may either be fully deductable in the year it was put into service or depreciated over time, usually over 5 to 7 years for art equipment.   There are IRS limits to the amount that can be deducted.  Generally, the maximum deduction is $250,000 for property placed in service in 2009.  If your purchase is within the IRS limitations you may take the “section 179 expense election” and deduct the full cost of the equipment in the year you placed it into service.  If the useful life of the equipment is greater than one year and the cost is greater than the IRS limitation you will take the expense over the useful life of the equipment.  Either way, the full cost of the purchase will be depreciated and deducted for income tax purposes.

Art equipment purchases that you will depreciate may include items such as a computer, a kiln, a printing press or other types of machinery.  Items that are directly expensed are the supplies for your art such as clay, paint, brushes, film, etc. 

If you are depreciating equipment over its useful life the accounting entries will look like this:

Furniture and equipment           $xx.xx
      Cash                                                          $xx.xx
                Computer purchase

Depreciation expense                $xx.xx
       Depreciation: Furniture & equipment    $xx.xx
                Computer depreciation

The first entry is made for the full amount of the purchase.  The second entry is for the amount of depreciation taken in the tax year and will continue to be made in subsequent years until the equipment is fully depreciated.

Tax Deductable Business Expenses - Travel & Meals

Overnight business travel for the artist is a tax deductible expense.  Some of the associated expenses that are deductible are airfare, hotel and lodging, tips, phone calls and meals, though meals are only 50% deductible.  Deductible direct travel expenses include the cost of art fairs, visiting galleries, delivery of artwork, etc. 

When traveling, the IRS allows a meal “allowance” instead of having to keep records for all meal expenses.  Visit www.gsa.gov to find the rate that applies to your destination.  While you don’t have to keep receipts for meals to take the allowance you do have to be able to substantiate the travel.  Also, if you have traveling companions, their expenses are not deductible unless they are employees of your business. 

Remember, meals are deductible (50%) as a business expense when you are not traveling as long as the purpose is business related.  You may be meeting with a gallery owner, other artists or with professionals such as your accountant and lawyer.  For your records, keep a log of who was present and the nature of the meeting.  Business cards are good for documentation as well.  You will want to keep receipts for business meal expenses unrelated to travel.

Tax Deductable Business Expenses

For the next few entries I’ll be writing about business expenses that are tax deductable for the artist.  First let’s take a look at automobile vehicle expenses.  There are two ways you can take a deduction for auto related expenses.  There is the standard mileage allowance, which for 2010 is 50 cents per mile, or there is a direct right off of incurred expenses. 

To use the standard allowance you will keep a record of all business related travel.  It’s not required that you keep an odometer reading but you will need to keep good records of all of your travel.  This may include gallery trips, trips to classes and workshops, shopping for art supplies, etc.  If you record all these trips on your appointment book you will have a handy reference to tally the total travel for the year.  Your deduction will be the total business mileage multiplied by 50 cents.

The other method is to take a direct right off of actual expenses.  You will have to keep a record of fuel purchases, repairs, insurance and also depreciate the cost of your vehicle.  If you use your vehicle for both business and personal travel your deduction will be based on the business percentage of the total use. 

Sales Returns and Allowances

On some occasions you might find it good business practice to accept the return of an item that you sold and then issue the customer a refund.  Maybe you made an internet sale of wearable art and the customer just didn’t like the way it fitted.  Maybe the item was lost or damaged in the mail and you need to refund the purchase price (hopefully you purchased shipping insurance).   A sales allowance occurs when the customer agrees to keep and pay for an item while you offer a reduction in the price.  The reduction amount is the allowance.

The sales returns and allowances account is a contra account to the sales account.  A contra account has a normal balance opposite of what is usual.  The sales account carries a credit balance and the sales returns and allowances account carries a debit balance.  Usually the two accounts will be subtotaled to Net Sales.  On the income statement it will look like this:

Sales                                       $2,500

Sales returns and allowances           50

   Net sales                              $2,450

Let’s say you sold an art-to-wear necklace for $175 that you accepted for return because it was too short for the customer’s heavy-set neck.

Journal entry recording the sale:

Cash                $175

            Sales               $175

                        Necklace sale

Record the return:

Sales returns and allowances              $175

            Cash                                                    $175

                        Refund for return of necklace

Maybe the customer is willing to take the necklace to a jeweler to have an extension put on it and you agree to offer a discount.  The journal entry to record the sale would be the same as above.  

To record the discount:

Sales returns and allowances              $25

            Cash                                                    $25

                        Discount given on necklace purchase

It’s good accounting to keep a separate account for return and refund amounts.  You will have a record of total sales and be able to monitor and identify if there are problems occurring.

After you’ve checked your merchant statement for accuracy you will make the following journal entry:

Cash                                                            $1,625
Merchant transaction fees                                  225
Terminal Rental & merchant expense                   50
Sales returns                                                     100
           Sales                                                                        2,000
                       Record credit card sales for May

(Remember, debits on the left and credits on the right)

As I wrote previously, the transaction fees will either be deducted as a cost of sale or as an expense. If you had merchant transaction fees of $225 you will see below the two different ways it might appear on your Profit and Loss Statement. In either case the monthly gateway and terminal fees will be expenses. The example shows $50 in monthly merchant statement and rental fees. (I’m not showing the expense side in the first example, the statement and rental fees would be listed as in example 2.)

Example 1:

Sales                                                                       $2,000
           Cost of Goods Sold
                   Supplies                                    $300
                   Merchant Transaction Fees          225
            Net Cost of Goods Sold                                $525

Gross Profit on Sales                                              $1,475

Example 2:

Expense
       Office Expenses                                 $100
       Postage                                                 88
       Marketing                                            120
       Merchant Transaction Fees                  225
       Terminal rental & merchant exp              50
Total Expense                                                            $583

Merchant Statements continued

The next part of your Merchant statement contains the transaction detail.  It shows the daily detail of your batch processing.  Included are the day of the month, reference number, the transaction code (deposit, chargeback, adjustment or reversal), type of card used, number of sales and amount of sales.  If you are set up for a daily discount program, previous discount payments would be included also.

The next section is your fee totals.  You will be making a journal entry based on the information included here and in the next section.  Some of these fees might include the monthly terminal rental and per transactions fees incurred.   The statement totals are found in the final summary section.  You will be making an entry for any statement fees and minimum discount fees charged (if you didn’t reach the minimum required for the month).

The IRS allows some merchant fees to be categorized as Cost of Goods Sold (COGS).  So, depending on your accounting, they will either reduce Gross Income or be an expense.   I should make a note here that the gateway fees (what you pay monthly for processing) are not considered COGS but are a dues and subscriptions expense.   I’ll follow with sample journal entries at my next writing.