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 The following is an excerpt from Chapter 16, ‘Paying Your Taxes’ of my book,MusicLaw: How to Run Your Band’s Business© 2009Nolo
Income Taxes: Different Rules for Different Band Businesses
Each band business form—sole proprietorship, partnership, corporation, or LLC—hasits own tax rules and procedures. As a general rule, taxes are much simpler forunincorporated businesses such as sole proprietorships and partnerships. That’sbecause income from unincorporated businesses is simply treated as personalincome to the owners. In other words, the business itself is not taxed. For example, if your four-person band is a partnership, any profits the band makes are dividedamong the four owners, who report them as personal income much like income froma job or investments. Corporations, on the other hand, are considered to be separateentities from their owners, and they pay their own taxes. This section will explain howtaxes apply to each different business form and how to file them. For moreinformation on business forms, see Chapter 2.
Flow-Through and Entity Taxation, Defined
In this section we use two common tax terms—flow-through (or pass-through) and entitytaxation (which is related to double taxation).Flow-through occurs when your band business profits and losses are reported on yourindividual tax return—that is, they pass through the business to you. Sole proprietorships,partnerships, and, in most cases, LLCs operate as flow-through businesses.Entity taxation occurs when the IRS considers your band business as a separate tax-paying creature. (Corporations and some LLCs operate this way.) Under an entity-taxationbusiness form, the corporation or LLC must pay taxes and file a tax return.
Reporting Band Income
 The IRS has become sophisticated in sniffing out band income. For example, the IRS guideto auditing musicians advises examiners to contact booking agencies and unions forverification about musician income. Auditors are trained to search out income from recordand merchandise sales and may even ask for copies of partnership or individual bankaccounts.It is a crime to deliberately fail to report income or to lie to the IRS. If you underreportyour income, you could be subject to additional taxes and serious financial penalties—even jail time. In other words,
report your band income
. When in doubt about whether a paymentis considered “income,” speak to an accountant or tax expert for advice.
 
Partnership Taxes
Most bands are partnerships, because any business in which two or more persons arethe owners is a partnership. A formal agreement is not necessary to create apartnership, although we recommend that your band use a written band partnershipagreement to establish the details of how the partnership will operate. (A sample isprovided in Chapter 2.) Technically speaking, a partnership itself does not pay taxes. Instead, any profit orloss of the business is divided among the partners and reported with their personalincome tax returns. Since income simply passes through the business to the owners,partnerships are called “pass-through” tax entities. (See the sidebar “Flow-Throughand Entity Taxation, Defined,” above.) Though a partnership does not owe taxes, itmust complete and file a tax return to report any income or losses. Form 1065, U.S.Partnership Return of Income, is used. Since no taxes are ever due with Form 1065, itis called an “informational return.”Whoever files Form 1065 (a partner, an accountant, or a lawyer, for example) mustalso give each partner a report called Schedule K-1, which contains all the relevantprofit or loss information about the partnership. Based on the information in the K-1form, and based on the partnership agreement regarding each partner’s share of profit or loss, each band partner declares a portion of the profit or loss on his or herindividual tax returns. Each partner reports his or her share of band income or losseson Schedule E, which is submitted with that person’s individual 1040 form. If a bandpartner has a day job and the band loses money, the partner can deduct his or hershare of loss from the other income, which can reduce his or her tax bill.
EXAMPLE:
Bob is a member of the El Niños, a band that lost money in 2009.According to Bob’s K-1 Form, Bob can deduct a $2,000 band loss from his totalincome, which includes wages from working at a music equipment store. Bydeducting the band loss, Bob pays less income tax for 2009.In addition to income taxes, all band partners must pay self-employment tax onband profits. See the section above on self-employment taxes. Your band will need a federal employer identification number (FEIN) to file apartnership tax return. Later in this chapter we explain how to get one. The FEIN willhelp your band to open a bank account and deposit checks under your band name.In summary, if your band is classified as a partnership by the IRS, here are somerules to remember:•Partnerships, though not taxed separately, must prepare and file a Form 1065,usually filed on April 15.•The partnership must issue a K-1 form showing each partner’s share of theincome or loss. The K-1 is filed with each partner’s individual return.•Each partner must pay a tax based on his or her “distributive share,” not onwhat the partner may have actually received. Unless a partnership agreementsays otherwise, all partners are presumed to have an equal distributive share inthe partnership.
 
•Even if the partnership leaves profits in the business, the partners must paytaxes on those profits. (If your partnership is able to retain profits each year,consider forming a corporation.)
•Partners must pay quarterly estimated income taxes, as well as self-employment taxfor social security and Medicare contributions.
Sole Proprietorships
A sole proprietorship is a business that is run by just one person. Unlike apartnership, which must submit an informational return, sole proprietorships do nothave to file any tax returns for the business. Only the owner reports the income witha personal return. Like partnerships, sole proprietorships are pass-through taxentities. Income from the sole proprietorship is reported on Schedule C, which issubmitted with the individual 1040 form. If the sole proprietorship loses money, thesole proprietor can deduct that loss from income from other jobs, reducing the taxobligation.Filing as a sole proprietorship is appropriate if the band is run by one person (theband leader) who hires musicians to perform in the band and pays each musician afee or a salary. The paid musicians do not have an ownership interest in the band. Inthat situation, the sole proprietor/band leader may have to file payroll taxes if theother band members were treated like employees. Keep in mind that havingemployees raises a host of legal issues that you may want to avoid. (See the sectionbelow on employees and independent contractors.)An FEIN is not necessary for a sole proprietor to file taxes, because the personalsocial security number of the owner may be used. However, some tax expertssuggest obtaining and using an FEIN for business taxes anyway, in order to keepbusiness and personal tax records separate.Sole proprietorships must pay self-employment taxes.In summary, if the band business is owned by you and you haven’t formed an LLCor corporation:•You must report your business income or loss on a Schedule C, filed with yourindividual or joint tax return.•You must pay quarterly estimated income taxes, as well as self-employment taxfor social security and Medicare contributions.•You are eligible for tax-sheltered retirement plans.
Preparing Taxes
Consider hiring a tax preparation expert or accountant knowledgeable in the musicbusiness when preparing your tax return. While you can expect to pay $100 to $500 forpreparation of tax returns, a savvy tax professional will probably save your band the cost of this fee and more. You may not have to use a professional for each year you file, but it issometimes helpful to have a professional tax preparer create your returns at least for thefirst year, so that you can see the form and style that will be suitable. You should also utilizean accounting software program such as Microsoft’s
Money 
or Intuit’s
Quicken
to track yourband’s income and expenses.
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