The Brass Tacks

Fake IRS Email

I received an email this morning pretending to be from the IRS and telling me that I had a refund to claim of $139.30. The email contains IRS graphics and looks kind of convincing.

If you receive a similar email, don't click on any links or reply to it. The email should just be deleted.

From the IRS: Updated Aug. 24, 2007 — The Internal Revenue Service today warned taxpayers of a new phishing scam, in which an e-mail purporting to come from the IRS advises taxpayers they can receive $80 by filling out an online customer satisfaction survey. The IRS urges taxpayers to ignore this solicitation and not provide any requested information. The IRS does not initiate contact with taxpayers through e-mail.

Beacon Hill Brass to Present a Three-Concert Series

The Beacon Hill Brass will perform three Christmas concerts this year in Market Square, downtown Victoria. The dates are Dec. 8, 15, and 22–all concerts from 1:00 - 2:00 pm. We will deploy three different groups for this series: brass trio, trombone quartet, and brass quintet.

Our Christmas concerts played to very enthusiastic audiences last year. It's worth checking them out!

I Can Deduct CD Production, Right?

Guest Author: Alan M. Friedman, CPA

Recently, there has been an explosion in independent CD recordings, often made at a musician's own expense on digital home recording equipment we could have only dreamed of 20 or 30 years ago. Consequently, every March and April, as my firm prepares scores of tax returns for musician clients, the question of deducting CD production costs is inevitably raised.

The variety, magnitude, and timing of production costs is usually what causes a musician to become confused over the deductibility of CD production and replication–and for good reason. The answers are not straightforward, and they have been changed over time by the Internal Revenue Service (IRS).

Deducing Deductions
  I used to think CD production costs were somewhat minimal, essentially a one-time investment in recording gear. But production gear is constantly evolving, and naturally that eight-track tape recorder gets replaced by a digital recorder/mixer. Then there's ProTools hardware and software to buy, higher and higher fidelity microphones, digital effects, cables, racks, and so on. A professional musician can end up spending tens of thousands of dollars.

And that's only one stage in recording. Those tunes have to be mixed by a professional, and after that, the entire CD needs to be mastered for uniform clarity and volume. Lastly the CD master needs to be reproduced and a CD jacket needs to be designed. The cost of photography and graphic design adds more dollars to CD production, and that's before it is duplicated for public consumption.

It's no wonder that any musician producing his or her own CD will inquire about a tax deduction. Unfortunately, the IRS has some different thoughts about you simply taking a "current year" deduction for all of these costs and letting you reduce your taxable income.

UNICAP Rules
  In 1986, a new tax act created Section 263A of the Internal Revenue Code, which governs the tax treatment of costs incurred in the production of tangible personal property, such as sound recordings. This new section (referred to as the Uniform Capitalization Rules, or UNICAP rules) was enacted, in part, to prevent taxpayers from inappropriately mismatching income and expenses which, in turn, create a current deduction of production costs that have future value.

Under Section 263A(b), our internal revenue code requires the artist/songwriter to "capitalize" (not immediately deduct) the costs to create, research, write, prepare, and record the body of work. These costs also include any travel, rent, equipment depreciation and repairs, office overhead, interest, and any other costs relating to the production of tangible personal property, including labor costs for any persons involved in the production activity.

In compliance with the UNICAP rules, the taxpayer must "amortize" (ratably write-off) the production costs under the "income forecast method." This method requires the taxpayer to estimate the future expected income to be received from (in this example) the sound recordings, in addition to only allowing the deduction for tax periods that report income from the sound recordings.

Shortly after the IRS enacted UNICAP rules, they started to receive numerous inquiries and complaints from authors, recording artists, photographers, and other persons expressing concern regarding the application and administrative complexities of these new rules.

In response to this concern, Congress granted the Treasury Department authority to "adopt other simplifying methods and assumptions, where the costs and other burdens of compliance with the code may outweigh the benefits." In other words, Congress was strongly suggesting the Treasury find a simpler way for taxpayers to comply with the spirit of the new tax law.

Safe Harbor
  Based on these numerous complaints and concerns, the IRS provided an elective three-year "safe harbor" for certain authors, artists, and taxpayers who were now required to comply with the new UNICAP rules. Under the three-year safe harbor, taxpayers could aggregate and capitalize all of their "qualified creative costs" incurred during each tax year, and then amortize (deduct) 50% of the aggregated costs in the year they're incurred, 25% of the costs the following year, and the remaining 25% in year three.

This safe harbor election greatly reduces the administrative complexities of complying with the UNICAP rules by eliminating the necessity to amortize these costs using the subjective income forecast method, as well as eliminating the need to figure out which costs should be capitalized versus expensed.

Although safe harbor generally applies to individuals only, a corporation or partnership may use the three-year safe harbor election if the corporation or partnership is substantially owned by a "qualified employee owner," an individual who owns at least 95% of the corporation's stock or at least a 95% partnership interest.

Qualified taxpayers may automatically elect to use the three-year safe harbor by filing their federal income tax return in a timely fashion and noting the election by typing or legibly printing "Three-Year Safe Harbor Adopted Under The Provisions of Notice 88-62" at the top of Form 1040, Schedule C, Page 1 (for a sole proprietorship or single-member LLC); or Form 1065, Schedule A (for partnerships); or Form 1120/1120S, Schedule A (for corporations).

Taking Inventory
  Now that you've incurred the cost to create the CD master and artwork layout, you have the final task and cost of duplicating and packaging. Here's where the deductions get a little tricky!

Let's say you just spent $2,000 for a 1,000-piece run of your new CD–the cost per CD is $2. You start selling your CD online and at your shows for $10 each. At the end of this year you determine you've sold 600 CDs, with 400 CDs in "inventory." Can you deduct the full $2,000 you spent on the CDs? No. But you can deduct $1,200 ($2 cost x 600 sold) against the $6,000 ($10 list x 600 sold) of CD sales income you've earned–netting $4,800 ($6,000 less $1,200) in gross profit.

Why can't you immediately take a deduction for the $2,000 of CD duplication costs? The IRS considers your CD inventory an "asset" (something having future value) until it's sold. Only upon disposition can you take a deduction for the cost of the CDs sold or disposed of. The good news is, if you give away 100 CDs as part of the promotion of your CD, you can take an immediate $200 ($2 cost x 100) deduction.

In Conclusion
  The IRS has recently announced some other tax benefits, including a special deduction for certain domestic production activities (including sound recordings) as well as capital gains treatment for the sale or exchange of musical compositions or copyrights in musical works.

By the same token, there are some stringent IRS guidelines that determine whether your musical endeavors are truly part of a "business" or are part of your "hobby." Although the IRS generally requires a "net profit" (as opposed to recurring losses) to be shown three of the last five years from any musical endeavor treated as a business, there are other factors the IRS considers in determining the tax status of musical endeavors.

Just as most of us wouldn't do our own plumbing, I suggest you consult with a CPA or other tax advisor familiar with these somewhat complex rules. But just like your investment in a music editing software upgrade or CD mastering services, the benefits from using a good tax preparer will most likely far outweigh the cost.

So keep track of your CD production cost receipts and invoices, as they save you money by reducing tax liabilities and minimize headaches if or when Uncle Sam comes knocking at your studio door.

Many thanks to Alan Friedman for permission to reprint his article here. Mr. Friedman is a partner in the CPA firm Friedman, Kannenberg & Company, P.C., based in West Hartford, Connecticut.

Related Websites

Official website of Alan Friedman, CPA, guitar player and founding member of The Accounting Crows

Alan Friedman's CD The Test of Time on CD Baby

Alan M. Friedman, CPA, Partner

How United States S-Corporations are Taxed by Canada

A client of mine, a US citizen living in Canada, would normally have a straightforward situation except for one thing: he is a shareholder in a United States S-Corporation (or S-Corp). My client faces double taxation, as we shall see, and he can't use corporate losses to offset other income on his Canadian tax return.

Before we roll up our sleeves and dig in, let me say that I am not sure I have it all right! The situation is complicated by barely comprehensible language in Canada's Income Tax Act (ITA). I invite and welcome other tax professionals to comment on this article! Perhaps if we work together we can clear it all up.

The problem is that for US tax purposes S-Corps are treated essentially the same as partnerships, with income flowing through to the shareholder's returns to be taxed on the individual level. In Canada however, S-Corps are considered to be corporations by Canada Revenue Agency.

Double taxation, according to Wikipedia, is “a situation in which two or more taxes may need to be paid for the same asset, financial transaction and/or income and arises due to overlap between different countries' tax laws and jurisdictions. The liability is often mitigated by 'tax treaties' between countries.”

Let's take a look at the Convention Between Canada and the United States of America With Respect to Taxes on Income and on Capital, which has the following to say in Article XXIX(5):

Where a person who is a resident of Canada and a shareholder of a United States S corporation requests the competent authority of Canada to do so, the competent authority may agree, subject to terms and conditions satisfactory to such competent authority, to apply the following rules for the purposes of taxation in Canada with respect to the period during which the agreement is effective:

1. the corporation shall be deemed to be a controlled foreign affiliate of the person;
2. all the income of the corporation shall be deemed to be foreign accrual property income;
3. for the purposes of subsection 20(11) of the Income Tax Act, the amount of the corporation's income that is included in the person's income shall be deemed not to be income from a property; and
4. each dividend paid to the person on a share of the capital stock of the corporation shall be excluded from the person's income and shall be deducted in computing the adjusted cost base to the person of the share.

Wow. Did you get all that?

S-Corps could be considered to be “Controlled Foreign Affiliates” under ITA 95(1). Shareholders of Controlled Foreign Affiliates must report “Foreign Accrual Property Income” (FAPI) to Canada under ITA 91(1), even if that income has not been paid out to them directly. I did my best to plow through these complicated sections of the ITA–didn't get very far–but came away with the impression that Canadian-resident shareholders in US S-Corps, where the corporation falls under the definition of a Controlled Foreign Affiliate, have to report their share of interest, dividend, and certain other kinds of income earned by the corporation (defined under the FAPI rules) on their Canadian tax returns, but not necessarily other income of the corporation, such as business income.

There also appear to be two forms that an S-Corp shareholder should consider filing:

• T1134-A - Information Return Relating to Foreign Affiliates That Are Not Controlled Foreign Affiliates; and
• T1134-B - Information Return Relating to Controlled Foreign Affiliates

There is no guidance available on the CRA website related to these forms, other than the instructions to the forms themselves. It is suggested in Preparing Your Income Tax Returns Section 495 (Michael Mallin) that CRA is able to levy up to $2,500 in fines for failing to file these forms. From this I deduce that it would be prudent for S-Corp shareholders to file one of them. The due date would be 15 months after the end of the taxpayer's taxation year.

An Example

Let's look at a simplified example and see what might happen. Consider the hypothetical case of a Canadian resident who owns 100% of the stock of a US S-Corp:

• In year 1, the corporation posts a $5,000 loss.
• In year 2, the corporation earns $10,000 of business income and $500 of investment income and keeps it in the bank.
• In year 3, the corporation earns no income but pays $5,500 of salary to the shareholder, cleaning out its bank account.

Here's how the US will tax the shareholder:

• In year 1 the corporation will issue Schedule K1 to the shareholder. The $5,000 loss will flow through to the shareholder's 1040 Line 17, to be deducted against any other income he might have.
• In year 2 the corporation flows $10,500 of income through to the shareholder's US 1040 return to be taxed.
• In year 3, the corporation issues a W-2 slip reporting the $5,500 of salary income, which will be reported on Line 7 of the shareholder's 1040. However, the corporation has incurred a loss in that year of $5,500 that flows through to Line 17. The result is a wash, with no extra tax paid in year 3.

Here's how Canada would tax the shareholder (without taking into account the Canada/US treaty):

• In year 1 the S-Corp loss would not be allowed as a deduction by Canada.
• In year 2 the shareholder would report the $500 to CRA under the FAPI rules.
• In year 3 the shareholder would report the $5,500 of salary income to Canada and pay tax on it. The $5,500 loss would not allowed by CRA.

The shareholder has paid tax on the $5,500 income twice, once to the US over years 1 and 2 ($10,500 - $5,000), and then again to Canada in year 3! He/she can't mitigate the situation with Foreign Tax Credits because the income was reportable to Canada and the US in different years.

Things look grim for the beleaguered shareholder. However, I can think of two solutions that might make things better.

Possible Solution A - Treaty Based

To its credit the Canada/US treaty does its level best to fix the problem, but the treaty provisions don't work very well in the above example because of the corporate losses in years 1 and 3, which are not deductible in Canada. Any time corporate losses are flowed through to the shareholder's 1040, income is probably going to be overstated on the Canadian side, and double taxation will rear its ugly head.

It would help if the losses could be claimed as investment expenses, but I have received conflicting reports about whether or not such investment expenses would be allowed. I don't see anything in Canada's definition of an investment expense that allows S-Corp losses, so I wouldn't want to chance it.

Application of the tax treaty rules might save some tax if the shareholder structured the corporate income to get rid of any loss flow-throughs. The income reporting would perhaps match up better between the two countries, with the shareholder able to make some use of Foreign Tax Credits to reduce double taxation.

The competent authority of Canada (CRA) has to agree to the treaty interpretation, which means permission would probably have to be obtained from the Rulings Directorate before filing the tax return, taking some major advance planning on the part of the shareholder. For this reason, I feel that application of the treaty provisions would rarely be useful.

Possible Solution B - Non-Treaty Based

A simple approach the shareholder could take, with no need to resort to the treaty or get rulings from CRA, would be to pay out all of the S-Corp's net income in any given year in the form of salary or bonus, cleaning out the corporate coffers as it were. This technique would match up income between the two countries and allow Foreign Tax Credits to be used. The shareholder's Canadian income tax preparation would also be greatly simplified, meaning less accounting fees paid out!

Embouchure Problems

Lucinda Lewis has published a lengthy article on embouchure problems: The Greatly Misunderstood Subject of Embouchure Overuse and Embouchure Dysfunction Common in Brass Instrumentalists

Method Books for Trombone

Here are some key method books that every serious trombone student should have in his/her library!

Elementary Method for Trombone
N. Long
Rubank, Inc.
Level: beginner to intermediate

55 Phrasing Studies for Trombone
Jaroslav Cimera
Belwin Mills
Level: beginner to intermediate

The Remington Warm-Up Studies
Ed. by Donald Hunsberger
Accura Music
Level: beginner to intermediate

Daily Drills & Technical Studies for Trombone
M. Schlossberg
M. Baron Co.
Level: beginner to advanced

Sixty Selected Studies for Trombone
C. Kopprasch
Carl Fischer, Inc.
Level: intermediate

Mastering the Trombone
Edward Kleinhammer & Douglas Yeo
EMKO Publications
Level: intermediate to advanced

Clef Studies for Trombone
V. Blazhevich - Ed. by Donald Hunsberger
MCA Music
Level: intermediate to advanced

Melodius Etudes for Trombone, Vol. 1
Arr. by J. Rochut
Carl Fischer, Inc.
Level: intermediate to advanced

6 Cello Suites
J.S. Bach, Arr. by Keith Brown
International Music Company
Level: intermediate to advanced

The Brass Gym
Sam Pilafian & Patrick Sheridan
Focus on Excellence Publications
Level: intermediate to advanced
(more focused on valve instruments, but useful for trombone too)