Thoughts for Entrepeneurial Musicians

Much has been written on the theme of musicians as entrepreneurs. In true full-circle fashion, the word entrepreneur actually stems from a 19th-century French word that denotes the director of a musical enterprise. While the pace of change in the modern music business presents challenges that Ravel or Debussy could not have imagined in their most fevered dreams, the need for thoughtful stewardship has never been greater. Certainly, there’s great appeal in being your own boss and receiving direct rewards for your efforts. Still, the independent-contractor nature of today’s music business creates unique financial risks that can derail a career if you’re not diligent.

The news outlets are filled with anecdotes of musicians suffering from financial woes; Mary J. Blige, Cat Power, and Willie Nelson are just a few examples of musicians who have been dealt major financial setbacks despite successful artistic careers. Many of these situations are characterized by poor financial decision making: indiscriminate spending, high debt loads, aggressive tax positions (leading to equally aggressive IRS collection efforts), legal problems arising from failed ventures, and an aversion to planning for the personal and business risks that all freelancers face.

When combined with today’s complex financial markets and rapidly changing music industry, the challenges of being an entrepreneurial musician create exposures that can afflict the anonymous and high profile alike. With some forethought and careful planning—often with the help of a financial planner or business manager—you can avoid many of these pitfalls by taking the time to carefully assess your financial situation and goals.

Despite the natural aversion of many musicians to financial planning, it is no more an obstacle to creative freedom than music theory; both provide a structure that supports rather than detracts from artistic expression. By carefully considering their risks and options, musicians who take a holistic and long-term view can minimize the chaos that comes from facing financial issues as they arise. A comprehensive financial plan involves budgeting and cash management, tax planning and compliance, risk management, investment planning, retirement planning, plus gift and estate planning.

Let’s start with the obvious: everyone, from established artists to fledging indie bands, needs to track in detail where their money comes from and how it’s spent. Whether it’s keeping records with the assistance of an accountant, full-featured financial solutions like Quicken, smartphone money trackers, or even a basic spreadsheet, the approach you take is less important than the commitment to starting and maintaining it. Even a few minutes of record keeping a day provides valuable insight into spending habits and capacity. This is a critical viewpoint when resources are limited.

Tax Planning and Compliance

Although it may sound needlessly complicated for a creative professional, the business structure you choose (e.g., sole proprietorship, partnership, LLC, or corporation) is an important consideration. It determines (a) the legal protections available in the event of serious financial difficulty, and (b) how the income and losses from the business flow through to you and your creative partners. A corporate or LLC structure may also allow you and your bandmates to qualify for group health or disability insurance at reduced monthly premiums.

Again, maintaining detailed records is critical. Like other entrepreneurs, the self-employed are an easy audit target for the IRS. Many income sources aren’t documented through typical forms like the W-2 or 1099, and tax returns that reflect obviously understated income or inflated or poorly documented deductions can subject you to years of penalties and back taxes. However, with proper documentation, tax compliance need not be overly difficult and can produce substantial and legitimate tax reduction opportunities. Use TurboTax or a tax preparer to minimize the risk of inadvertently calling attention to yourself.

Risk Management

Like it or not, every business owner needs to plan for the financial risk of early death, illness, disability, and loss of property. Some of that protection can come from the structure of the business, but specialized insurance coverage is often needed to prevent the business—and those who depend on it—from failing in the event of a disaster or extended illness. These include life insurance (if others are depending on your income for support), health insurance, disability insurance, and equipment insurance.

Concentrate on those “disastrous” risks you could not afford to cover yourself, as premiums on emotional or mildly bothersome risks often outweigh the long-term benefits that insurance protection will provide.

Retirement planning

For many musicians, retirement is a foreign concept. After all, you’re presumably doing what you love, so why not continue indefinitely? Don’t think of it as retirement planning in the traditional sense, but as a “freedom fund” that will provide supplemental income when you lighten your schedule. There are tax-deferred retirement vehicles available only under a corporate or LLC structure (such as a SEP-IRA) that will allow the investment of amounts considerably larger than what is permissible for the typical individual IRA and Roth accounts available to nonbusiness owners.

If you’re young: get started now. Even if you can’t afford to make large contributions, let the magic of compound interest (i.e., interest earned on interest) work for you. If you invest just $95 a month starting at age 20, you can create a $500,000 tax-deferred retirement account by the time you’re 65 assuming an 8 percent rate of return. Waiting to start until age 30 will require a much larger deposit of $218 a month to accumulate that same $.5 million by age 65.

Investment planning

Most businesses are self-financed by business owners, and profits are typically reinvested. Any “excess” profits should go first toward building an emergency fund of three to six months of living expenses to protect you from temporary career setbacks. If you’re able to accumulate additional amounts and build an investment portfolio, remember that the most critical consideration in allocating those resources is to diversify and reduce the concentrated risk you’re likely taking in your business.

Gift and estate planning

If your business grows to produce substantial current or future income, simple wills or family trusts set up for personal affairs may no longer suffice for the transfer of the business. More sophisticated financial planning techniques may be necessary to ensure that your assets are distributed to the people and causes you choose, reduce estate taxes, and provide the cash necessary for your heirs to pay those taxes. A recent prominent example of poor planning was revealed by the tragic death of actor Phillip Seymour Hoffman. In a misplaced desire to avoid raising “trust fund kids,” he has apparently subjected his heirs to needless taxes, as well as the expense, aggravation, and vagaries of probate (i.e., the state deciding who gets your money). Without a clear expression of your wishes, events like marriage, divorce, long-term relationships, or children from multiple relationships can create a contentious battle for control of your remaining assets or royalty streams after your passing. Lastly, regardless of your age, don’t ignore the need for a health-care proxy, which can dramatically ease end-of-life issues for you and your family.

Unless you’re well versed in financial and legal matters, the do-it-yourself drive that created your musical works may not serve you when it comes to managing financial issues. Seek the expertise of a professional to fully protect yourself, your business partners or bandmates, and your loved ones.

Alan “Al” Reese, CPA, is a wealth manager with U.S. Wealth Management in Boston, and a former Berklee trustee. He can be reached at areese@uswealthboston.com.

The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.