Keeping track of business expenses is a crucial piece tax preparation. This article is written for the professional artist that is self-employed. Self-employed individuals file a Schedule C as part of their regular 1040 income form. Schedule C is also where you report your business write-offs.
Your basic work related expenses include travel (hotel, meals, etc.), vehicle and transportation costs, equipment, art supplies, home studio expenses, legal and professional fees, gallery costs & commissions, etc. Let’s review one of the more complex and contentious deduction areas – Inventory. This was the first question that I was asked when audited by the IRS a couple of year ago – how are you calculating ending inventory. I know this subject is not very exciting but it is a very important to understand if you get audited!
Inventory: Inventory is often problematic for many artists. The IRS will ask you the method you are using to inventory your art. Generally, consistency in the choice of inventory valuation method is essential for accurate financial reporting and comparison over time. For many artists that would be “cost”. You need to take an inventory at year-end of ALL your art not sold, this can include art from previous years. Traditionally Cost of Goods Sold is calculated using the following formula: Starting inventory (what is left at the end of the year) +(purchased+labor+materials) – ending inventory.
A simple example using a painter. At the end of the year, the artist has three unsold paintings. To calculate the ending inventory, you need to determine the value of these unsold paintings.
Steps:
- Assign a Cost to Each Painting:
- Begin by assigning a cost to each painting in your inventory. This cost should include all the direct expenses incurred in creating the artwork, such as the cost of materials (canvas, paint, brushes, framing) and any other associated production costs.
- For simplicity, let’s assume you spent $50 on materials for each painting, and there are three unsold paintings.
- Cost per painting = $50
- Multiply Cost per Painting by the Number of Unsold Paintings:
- Now, multiply the cost assigned to each painting by the number of unsold paintings. This will give you the total cost of the ending inventory.
- Total cost of ending inventory = Cost per painting * Number of unsold paintings
- In our example, this would be $50 * 3 = $150.
- Record the Ending Inventory:
- The resulting figure, $150, represents the value of the ending inventory for the artist. This amount should be recorded in the artist’s accounting records as the value of unsold paintings at the end of the accounting period.
It’s important to consider that this is a simplified example. In reality, we usually have more complex inventory systems, especially if our art materials and production costs vary. The nature of the art and the uniqueness of materials will influence the choice of method.
The choice of inventory valuation method can significantly impact how these costs are accounted for (example – jeweler need to address precious metal value fluxations during the year).
Four common methods of more complex inventory accounting are the Specific Identification Method, FIFO (First-In, First-Out), LIFO (Last-In, First-Out), Weighted Average Cost. Specific identification is suitable for unique or high-value items, while FIFO and LIFO are more common for homogeneous goods. Each method has its advantages and considerations when accounting for differential costs (warning – have a cup of cofee before reading this next section – it is all about the math) You can find this section in the March 2024 Art Festival Newsletter and read more at https://conta.cc/4ccmnM2