Wednesday, October 20, 2010

Death and Taxes. Mostly Taxes, Actually

Hello friends.  In my real life I am an Enrolled Agent.  I represent taxpayers before the IRS in collections and audit issues.  I also assist my clients in tax preparation and corporate structuring and accounting in order to minimize their tax exposure.

By this point, you're saying, "who cares about you?!  Give me Dark Elf strategy!"

First, fuck off.  

Second, I'm going to give you the tools to save thousands of dollars a year so give it a shot, and pay attention.

I want to preface this advice with a few statements.  Foremost, this only applies to people who do painting or modeling for money.  I am a shitty to average painter, but I still make around $500 to $1000 a year in commissions, so I know a lot of you out there are making some serious bank.    And I know equally as much that you aren't reporting the income from it on your taxes.  Mostly because you think that it will cost you more money on your tax bill.  My response is, I have to advise you that not reporting the income is against the law and while unlikely, you could get into very serious trouble for not reporting it.  Also, you are LOSING money by not reporting it, and this essay will explain how later.  So like I said, this only applies to commission painters or modelers.  

The next statement I want to make is that this requires discipline, dedication, and basic accounting skills.  If you are not capable of these things (and based on the waistlines of many hobbyists I know you have zero discipline) you are only going to get yourself into trouble and waste money by trying this.  For those of you who have the ability to do this, read on!

1.  Go to your state's Secretary of State Website and go to the corporate registration.  It is important that your new painting business is a corporation rather than a sole proprietorship.  A sole proprietorship that doesn't turn a profit for a few years in a row is considered a hobby, and expenses are not deductible.  A corporation does not have this major limitation.  Creating a new corporation is very easy.  You pay around $150 and fill out the Articles of Incorporation, wait 6 weeks to get your corporate charter and you're in business!

2.  After you get your corporate charter, you go to the IRS website and apply for an Employer Identification Number.  You aren't going to have any employees, but this will give you the identification number you need to open a corporate bank account and file a corporate tax return.  The second thing you have to do is file IRS Form 2553, Entity Classification.  This is where you will tell the IRS that your corporation is an S-Corp.  Trying not to be technical, this is generally tax beneficial to small corporations and makes your returns at the end of the year immensely less complicated.

3.  With your corporate character and EIN in hand, go to your bank of choice and open a free business checking account.  It is absolutely imperative that from this point forward, all your purchases relating to the hobby are conducted through this account.  You must either write a check or use the debit card to pay for everything in order to ensure proper accounting.  Additionally, any income you earn from painting or modeling must be deposited into this account.

4.  Expenses.  This is the bread and butter.  Make business cards first thing.  Are you attending a Golden Daemon contest?  Your airfare, hotel, 1/2 of meals, entry fee, etc. are all deductible expenses.  Attending a painting contest is advertising, and a legitimate business expense.  Thus, the costs are legitimately deductible.  Your nicely painted personal army at any tournament is an advertisement for your business (so long as you bring business cards), so the costs to attend NOVAopen or BOLScon are deductible.  So is the cost of the miniatures, and the paint and the green stuff.  Did you have to buy a new brush set and a full line of GW paints, and a full modeling tool set?  Deductible.  So you can see the expenses are going to add up.  They will almost certainly add up faster than your income.  If you have to deposit personal money into the corporate account to pay your expenses that is OK, in fact, that is what you want.  Without getting too technical, when you give personal money to a corporate capital account, you are increasing your basis in the corporation, which is a good thing to have when the corporation is going to lose money, as I will explain below.

5.  Filing your returns at the end of the year.  Here is a hint that H and R Block don't want you to know: filing tax returns is easy.  For most people, you can prepare your returns in way under and hour.  Your corporation will file an 1120S Federal Corporate Tax Return and a State Corporate Income Tax Return.  All the income from the business (and there has to be some income or else this whole exercise is fraudulent and you are committing tax evasion and you will go to Federal Pound Me In the Ass Prison) is declare.  This will be easy to determine.  Get your corporate bank statements for the whole year, and any deposit that is money coming from a paying client or transferred from your Paypal Account should be totaled up and put down for gross income.  Your expenses should be easy to track as well.  Any money being spent out of the corporate account is an expense and should be placed into the proper category.  If you bought a $3 can of primer at Walmart, that will go under "supplies."  If you bought a $90 GW battleforce, that will go under "materials."  It helps to use Quickbooks every month to keep track of what category is what, but if you can't commit to that you can at least keep an excel spreadsheet breaking everything down.

6.  Your corporation showed a loss.  Surprise, surprise.  The corporation will issue you a K-1 statement and send a copy of the K-1 to the Internal Revenue Service and state taxing authority, which is sorta like a W-2 but for S-corp owners or partnership members.  This will show that you lost a certain amount of money.  When you file out your IRS form 1040, individual tax return you will file out Schedule E, and report the loss on Line 17.  This loss will lower your adjusted gross income.  Which will lower your tax rate.  Which will lower your tax bill.  Which will get you a bigger refund.  

So what did we accomplish?  Basically, your hobby became a legitimate business that lost money, and the money you lost on this business is money you don't have to pay taxes on.  So let's say you spent $3,000, on GW related minis, paints, tournament attendance/travel, modeling tools etc, and made $500 off commissions.  We will also assume you're in the 25% tax bracket.  You just got a $625 larger tax refund.  So that works out to a 21% discount on your GW related purchases for the year.  Not bad.  This will take a half-dozen hours of your time per year in accounting and preparing your returns.  It will also cost you around $100 to re-register your corporation every year with the state.  Whether all this is worth your time depends on how much you spend on GW stuff, and how much you spend on attending tournaments you have to travel to.  Some people may say that to save $500 or so isn't worth the effort, and that's totally understandable.  But if it is worth your effort, by all means go for it. 

If anyone has any questions, please feel free to ask and I'll be happy to answer them.


  1. Awesome. I had been toying with the idea of shooting for minor commissions or paint & sell on ebay. I don't know if I'll go down that road myself, but thanks for the free, detailed advice.

  2. First off, I love seeing hobbyists apply work knowledge to our hobby. You, Kennedy with his Lawyering, and Dethtron with his business are a few.

    Secondly; Wow! I had no idea that it really was that easy. Something to consider if I ever move out of the "private painting" sector.

    Lastly, a question; Is the $100 (and for that matter the original $150 filing fee) re-register fee also deductible on the return?

  3. It is. Business Licenses and Taxes would be the category you'd use.

    Yeah it really is easy. Despite the cries of "socialism" you hear from some people, America makes it as easy as possible to start a business, or to turn the hobby you love into a business.

    The only thing I want to stress is you actually do have to get commissions or sales. You can't just say, "I had no sales and I bought myself a new army, so gimme a tax break." It has to be a legitimate business effort.

    But remember, part of that legitimate painting business could be having a show army that you take to tournaments to advertise your skills. Or maybe that new laptop you bought because you want to start eBaying some painted minis. ;)

  4. What would be considered legitimate income? Does selling old painted, or otherwise not-super-high-quality miniatures count? Or does it have to be all shiny, new product?

    Is there some level of income vs expense required to remain legit? I imagine repeatedly having $8 income with thousands in expense would look sort of fishy.

    Basically what I'm getting at is, would this be feasible for non-serious sellers? If I am not qualified to put up minis on eBay with tags like "Pro Painted..." and hundred dollar buyouts, but have been thinking about seeing if I could sell a few things here and there just for some extra pocket change, might this be an option?

  5. Sorry to double post, but for the sake of clarity by "sell a few things here and there" I mean painting models to sell. Not so much old things that I don't use anymore.

  6. You can sell old stuff as well as new. Quality of the paint job does not matter.

    As far as level of income vs. expenses, it has to pass the "laugh test." If you can tell me you made an effort to turn a profit and explain your expenses to me and they aren't laughably bad its generally acceptable. Flying to a GT to try to win best painted, legitimate. Flying to a strip club with buddies from your LGS and trying to write it off as a company meeting, not legitimate.

    Unfortunately, there is no hard or fast % that you need. If you were my client, I'd say you probably want at least $500 of income, and you want to shoot for a 1:3 ratio of income to expenses or better. That way if you're audited, I would honestly be able to tell the auditor that it was legit and wouldn't feel like I was lying.

    It also helps if you can prove you're making a genuine business effort. Like having real business cards, setting up an active eBay store.

    The IRS is like a comped tournament, if they give hard and fast rules for what is or isn't acceptable, people would figure out a way to break that. But if they use terms like "proper expenses" and keep it vague, they can slam people when they need to.

    So all in all, let your conscience be your guide. If you feel like what you're claiming isn't fair, it probably isn't. If you can stand behind your returns proudly, it's probably fine.

  7. Since we're talking about creating a business here, isn't there an issue of licensing? Would you not need to apply for some sort of commercial sales license, or at the very least get permission from GW to sell their products commercially? Or would this fall into the 'sufficiently transformative' aspect of fair use?

    Doing this takes your resales out of the protection of the private sector, and I can see how GW might not be too keen on it.

    I really appreciate the recommendation. Sharing this sort of stuff is a great service to the community. (Maybe one day we'll have a big brotherhood of gamers all helping each other out. We can have special rings to identify each other by and everything. We can be the Warmasons, or some such.) I am just a bit skeptical, however. Nothing is 'just that easy' when the IRS is involved...

  8. Selling your paint job is totally legal with GW. They have no legal ground to stand on to say that you can't sell your services as a painter or modeler to anyone else. Just be careful how you use their IP.

    As far as local business licenses, that's generally avoided by not operating a bricks and mortar location. Certain professions, like contractors/plumbers etc have to have an occupational license, but others can get by. That sort of thing is a bit outside my area of expertise, but if you're concerned contact your local Chamber of Commerce and ask them.

    Sales tax may be a much more important consideration. My advice would be to either collect sales tax according to the state requirements, which is relatively easy to do OR just make sure that the person paying for the paint job buys their own minis and you are just applying the paint. It is easy to defend the paint job income as tips, but if you are buying the mini too it is impossible to say it isn't you selling a mini.

    So rule of thumb, buy a mini, paint it, and sell it online to out of state customers only. For local customers, make sure the customer provides the mini so you are selling them your time, not a product. That will keep you off the sales tax radar.

  9. What about corporate reports? Don't you have to have a meeting and report your actions, etc at least once a year?

  10. That's what the $100 re-registration fees that states charge cover. The "annual reports" thing is how they shake you down for some coin. The only people that have to publish minutes and do real annual reports are publicly traded companies.