Today’s artists create new interest in old spaces, push boundaries, and continue to search for answers to timeless questions. However, these artists must also understand the importance of keeping proper financial records, including monthly balance sheets. Failure to maintain these records can lead to mistakes and hold surprising legal consequences.
This post will explore the basic components of an artist’s balance sheet, as well as common mistakes and the legal implications that could negatively affect the artist and the artist’s business.
What is a Balance Sheet?
A balance sheet is a snapshot of a business’s (i.e. the artist’s) financials on a particular date. It is made up of 3 basic components: assets, liabilities, and equity. This document may be used in various legal proceedings throughout the artist’s life. For instance, if an artist wants to sue for intellectual property infringement, the balance sheet may help bolster the artist’s case by providing a timeline of the idea’s development. If an artist is raising funds to expand their business, a transactional attorney may want to view the balance sheet to evaluate the potential risk on the expansion.
Assets
Assets are all things that the business owns. Assets can be tangible or intangible, and include everything from paint, completed works not yet sold, and unique artistic ideas. To qualify as an asset, the business must:
- Control the asset;
- Believe the asset will provide a future economic value to the business; and
- Be able to measure the value of the asset and reflect that value in the relevant currency.
Liabilities
Liabilities are what the business owes. Liabilities include money owed by the artist to commercial lenders (like banks) and utility bills. To be considered a liability, the business:
- Cannot avoid the duty to meet the liability or obligation;
- Must pay or meet the obligation and provide an economic benefit to another party in the future; and
- Must be able to measure the value of the liability or obligation as a result of a past transaction.
Equity
Equity is what remains after all liabilities are deducted from all assets. Most artists operate by themselves, which qualifies the individual as a “sole proprietorship” in business law. As a sole proprietorship, equity is found by combining the money or property contributed to and withdrawn from the artist’s business and the profits or losses earned by the artist over a particular period. For example, Art the Artist paid June’s $500 monthly rent for premier studio space on June 1 (liability), created a new artwork worth $250 on June 17 (asset), and sold another artwork for $1,050 cash on June 22 (asset). The following shows how Art would compute a total equity of $800 as of June 23:
($1,050 + $250) – $500 = $800
Assets – Liabilities = Equity
Common Mistakes, Legal Consequences, and Potential Solutions
1st Common Mistake: Failure to properly discern between assets and liabilities.
Legal Consequences: This can lead to improperly declaring income and expenditures under the Internal Revenue Code (IRC). As a result, an artist could fail to make a complete tax payment. If the amount owed is greater than $1,000, the artist could have to pay the amount owed in addition to underpayment penalties as calculated under 26 U.S.C. § 6654. Under 26 U.S.C. § 6651(a), the IRS can also impose additional penalties if it is found that the artist’s failure to pay was a result of willful neglect.
Potential Solution: With the help of an attorney, an artist may be able to prove that their failure to pay the complete tax was made with reasonable cause. The IRS bases reasonable cause on all facts and circumstances in a situation. If the artist was found to have used ordinary business care and prudence when completing tax forms, the IRS would likely drop the underpayment penalty.
2nd Common Mistake: Failure to properly account for all assets, such as commission, grants, and donations.
Legal Consequences: This is a failure to properly recognize income under the IRC, which can lead to criminal and/or various civil penalties under the IRC. I.R.C. § 61(a)(1) defines gross income as “income from whatever source derived, including but not limited to compensation for services, including fees, commissions, fringe benefits, and similar items . . . [and] gross income derived from business.” Therefore, if an artist receives commission to paint a mural or a donation to assist with purchasing supplies, both would qualify as “income” to be accounted for in the balance sheet and in taxes owed.
Potential Solution: As above, an artist may be able to prove that their failure to pay the complete tax was made with reasonable cause. Again, an attorney will be able to help navigate the necessary steps to rectify the situation and, ideally, address the mistake with minimum penalties.
3rd Common Mistake: Failure to adjust for inventory and/or intangible services provided.
Legal Consequences: This is similar to the two prior mistakes because all have to do with improperly classifying “income”; however, this final mistake reflects immediate losses for the business, as the artist will end up paying more taxes than necessary while simultaneously undervaluing their business’s worth and narrowing their profit margin.
Potential Solution: The IRS may include the overpayment on the artist’s tax refund. However, if the artist’s numbers are wrong then the IRS will likely not know where there is an overpayment. At this point, an artist should hire an attorney to evaluate the situation and how to proceed with the business financials moving forward.
Looking for Other Solutions?
These mistakes and many others can be addressed with a basic knowledge of accounting terminology and an initial thorough examination of an artist’s financials. As noted above, many of these mistakes require an attorney’s help to properly navigate the IRC and other applicable law. Remember, it is always better to ask for assistance before penalties get out of hand.
Sources
https://www.irs.gov/irm/part20/irm_20-001-003r
https://www.irs.gov/pub/irs-drop/rr-07-19.pdf
https://www.law.cornell.edu/uscode/text/26/6651
https://www.law.cornell.edu/uscode/text/26/6654
https://www.law.cornell.edu/uscode/text/26/61
https://www.law.cornell.edu/uscode/text/26/6401
https://www.skrco.com/avoiding-irs-underpayment-late-payment-and-late-filing-penalties-2/
Photo Credit
http://papathanasis.eu/en/balancesheets
https://media.istockphoto.com/vectors/art-easel-and-blank-canvas-space-ready-for-your-advertising-vector-id545362428?k=6&m=545362428&s=612×612&w=0&h=mtj0VwhF1CL3jeb7Bi_5nX2mUKBDey2oz0VN4GRBHCw=
https://images-na.ssl-images-amazon.com/images/I/416moTkD39L._SR600%2C315_PIWhiteStrip%2CBottomLeft%2C0%2C35_SCLZZZZZZZ_.jpg
https://www.wsj.com/articles/art-collectors-pay-your-taxes-1505095500
https://images.squarespace-cdn.com/content/v1/5476bb09e4b08b27211adee4/1486185811309-BO96LUEOCL6Y94CPDY4T/ke17ZwdGBToddI8pDm48kFWxnDtCdRm2WA9rXcwtIYR7gQa3H78H3Y0txjaiv_0fDoOvxcdMmMKkDsyUqMSsMWxHk725yiiHCCLfrh8O1z5QPOohDIaIeljMHgDF5CVlOqpeNLcJ80NK65_fV7S1UcTSrQkGwCGRqSxozz07hWZrYGYYH8sg4qn8Lpf9k1pYMHPsat2_S1jaQY3SwdyaXg/4_emmanuelle_moureaux_Forest_of_Numbers.jpg?format=1500w
First off, I loved the joke about the balance sheet being Greek. I laughed way harder at that than I’d like to admit. Beyond that, this post is very well written and organized. The use of lists to guide the reader is really helpful, especially for readers who are less business savvy.
I really liked this post, and it started right from the get go. Great job with the title, it drew me in and made me smile. I also really appreciated how you took the three components of the balance sheet and explained them thoroughly. As someone who is terrible at finance (or at least the terminology), I appreciated that these sections were in easy to digest explanations. I also really appreciated the mistakes, consequences, and solutions sections. I found the whole post to be very well organized, both thematically and stylistically, very informative and a good read. Great job.
Good accounting practice is invaluable in any business, but certainly is different from industry to industry. I like the simple way this article applies basic accounting principles to a unique industry.