Tax Time Again

This article is a combination of that article (based on notes and lectures from a November 2010, class taught by Diane Kelly) updated with information I learned last week in the class "Taxes and the Writer" through RWA University taught by Stephanie Feagen.


1. Business or hobby – first and most importantly, you need to look at your writing and determine whether the IRS would consider it a business or a hobby. If it is a business, you can deduct all of your expenses, even if it results in a net loss. Yeah! As an author who has spent a lot of money on conferences, classes, etc. and done some presentations without making any money in 2010, I was happy to hear that. Even though 2011 has been better to me, I’ll still have a net loss. Even though I have no monetary gain, I’ve advanced my career and that is a VERY important first step to me.

There are actually nine factors that the IRS looks at to determine whether you’re writing activity constitutes a business or a hobby. No single factor alone should disqualify your activities from being considered a business, but the more factors in your favor the better:

A. Do you operate in a ‘business-like’ manner? You are likely operating in a business-like manner if you do some or all of the following:
1. become involved in professional writing organizations either in person or online. [If you are reading this, you’ve likely joined Savvy Authors (yeah); join RWA, your local chapter of RWA, and a specialty online chapter of RWA or whatever variation that fits your writing, etc.]
2. make attempts to network and promote yourself and your work through business cards, newsletters, websites, online networking sites, etc. [merely being on Savvy authors is a form of networking, websites are wonderful, as is the open ended scope of social media, blogs, glogs, etc.]
3. keep records of your submissions and responses. [Any author submitting a manuscript or pitching should always keep records of this – it should be a no-brainer.]
4. maintain a file of your published clips, if any. [Short stories, articles here on Savvy Authors, magazine articles, flash fiction etc.]
5. invest in your business by purchasing equipment, supplies, and services that will enable you to operate effectively and efficiently. [This includes everything from big purchases as laptops, printers, video cameras, e-readers to small things like paper, paper clips, pens etc. KEEP YOUR RECEIPTS]
6. subscribe to writing magazines, read books on craft and business of writing and attend writing-related conferences, seminars and classes. [Savvy Author members would meet this for the workshops and chats you attend here, classes through Savvy University, subscriptions to ‘The Writer Magazine’, Writer’s Digest etc, books on craft {everyone has at least bought one book on craft during the past year, right}]

The logic is that a writer who is merely writing as a hobby generally doesn’t bother with record keeping, building a network or joining professional organizations.

B. Do the time and effort you put into your writing indicate an intent to make money? Even if you haven’t earned a penny for your work, the fact that you put significant time and effort into your writing evidences an intent to earn money from your activities. You spend time crafting written pieces, you are in a critique group, you attend writing classes, reading and studying your craft, you might be a member of an e-mail loop dedicated to writing-related matters, and/or maybe you entered a contest. All of these examples show time and effort spent on your writing business. Yay! [Now in case the IRS ever decides to audit you, it is essential that you KEEP RECORDS by date and time of classes, emails showing your critiques or comments posted on an e-mail loop.]

C. Do you depend on the income from your writing for your livelihood? Yeah, when I start to earn money, I definitely intend to use it to maintain my livelihood. Most writers especially at the beginning don’t earn enough money by their writing alone to support themselves or their families. Given the nature of the beast we call the ‘publishing industry’, the fact that your writing income is nominal or merely supplemental to other earnings shouldn’t disqualify your writing activities from being a business. [So hubby doesn’t get to retire yet *grin*]

D. Are your losses due to circumstances beyond your control or are losses normal during the start-up phase of your type of business? If writers controlled their sales, we’d all be on the NY Times bestseller list, but the hard truth is that a lot of our work is beyond our control. Getting the right smash hit book in front of the right editor at the right time in the market is tricky to say the least. Moreover, it is likely that an author will write a couple of books before getting that ‘call’ selling that first manuscript. The reality is that losses are absolutely normal during the early phase of a writing career. You purchase equipment to write the book, you buy a domain name and set up your website, you join organizations to network and this is all done before that first sale. So congratulations, you’re in the same boat with me – this year I will again be declaring a loss on my taxes from my writing career. Also, even best selling authors have dry spells in which they have no sales or slow sales.

E. Do you change your methods of operation in an attempt to improve profitability? Have you tried different methods to increase your effectiveness or productivity such as NANOWRIMO, or Savvy Authors boot-camp, joined critique groups, different methods of outlining etc. Do you enter contests and use the feedback to improve your technique? These are all methods used in an attempt to improve profitability.

F. Do you have the knowledge needed to carry on a successful writing business? Some writers get an MFA, others [like me] have no formal education in writing or literature. None is needed to become a successful writer. However, that said, any writer knows the importance of attending classes [online or in person] and conferences, reading articles and books on craft etc. [If you can show the IRS that you’ve obtained at least a basic knowledge of the craft of writing and that you are continuing to expand your knowledge, you’ll be fine.]

G. Were you successful in making a profit in similar activities in the past? If your day job involves writing, or if you previously had a job in which your writing skills were utilized, that shows the IRS that you have earned money from your writing in the past. However, don’t think that because you haven’t had such a job means that you’ll be disqualified – this is only one factor. [Ex. While I was working full-time as an attorney I did a lot of legal writing for court cases and made money as an attorney – that falls here. Think outside the box.]

H. Does your writing make a profit in some years, and how much profit does it make? In the writing business even if you have sold a couple of manuscripts, most advances and royalties aren’t extremely generous. If you can show some revenue, even a meager amount, you are still doing well. [Remember lack of income alone will not disqualify you – yay! This is my mantra.]

I. Do you expect to make a future profit from the appreciation of the assets used in the activity? The writer’s best asset is your brain and it doesn’t really appreciate in value. Any computer or other equipment purchased will likely decrease in appreciation over time. This factor doesn’t really ‘fit’ the writing industry, but again it is only one factor.

The rule is that the IRS will presume you are running a business if your activity produces a profit in at least three of the last five tax years.

Bottom line – If your writing constitutes a business, you are entitled to deduct your losses no matter how many years in a row you have a loss. Many writers, especially newbies, will report tax losses in their writing business for many years before earning a profit and that is perfectly legal. Yay! As long as the loss is reasonable, justified and supported by receipts and documentation, and you can explain it to the IRS you are in the clear.

2. The beloved various tax forms: The following are various tax forms that might fit your situation. Others might be irrelevant. The following were forms discussed in the tax class that I took. All forms, instructions and publications can be downloaded from the IRS website, www.IRS.gov.
a. Form 1040 – U.S. Individual Income Tax Return
b. Schedule C – Profit or Loss from Business
c. Form 4562 – Depreciation and Amortization
d. Form 8892 – Expenses for Business Use of Your Home
e. Schedule SE – Self-Employment Tax
f. Form 1040-ES – Estimated Tax for Individuals
g. Form 2210 – Underpayment of Estimated Tax by Individuals etc.
h. Form 2241 – Child and Dependent Care Expenses

I’m not going to go into all of these tax forms in-depth because well, hell I’m still learning about them myself. Any questions I would refer you to Diane Kelly, my instructor whose information is at the bottom of this article. But I will go over Schedule C.

3. Schedule C – "Profit or Loss From Business" - This is the most important tax form for your writing business. It’s where you’ll report your income and expenses and compute your net profit (or loss) for your writing business. Take a look at instructions for Schedule C in Publication 535 “Business Expenses”, and Publication 334 “Tax Guide for Small Business.” These publications contain lots of useful information.

a. Line A-H – Name of proprietor: Use your real name, A Principal business or profession: Independent Writer, B Code: 711510 – this is the code for independent writers, C Business name: This is where you put your pseudonym, if you use one. This is ONLY if you’ve published a book under a pseudonym. If not, don’t enter anything here. D Employer ID number: Unless you hire employees, you won’t need an EIN. Leave this blank. E Business address: This will either be your home address or your office address if you have a separate office where you write. F Accounting Method Check ‘cash’ which applies to most individuals who will report only payments actually received during the year. If your publisher, your agent, or another party makes a payment to you of $600 or more, they are required to issue a Form 1099 to report the payment to you and the IRS. G check the ‘yes’ box to indicate that you did ‘materially participate’ in the operation of your business. H, check the box on the right only if this is the first year you file a return for your writing business. Otherwise leave blank. I, If you paid an individual over $600 for services, you need to file a 1099-Misc with the IRS. Instructions for 2011 Form 1099-Misc are here: http://www.irs.gov/pub/irs-pdf/i1099msc_11.pdf Say for example you hired an assistant. J Self explanatory

b. Part I ‘Income’ - This section is structured to accommodate all types of businesses, including those selling products, so many of the lines don’t apply to the writing business and will be left blank.

Line 1a…Merchant & third party payments: Enter -0-

Line 1b…Gross receipts: Enter all advances and royalties received during the year. This should match the amount on the 1099-Misc you receive from your agent or publisher. In the event you disagree with the amount they report, contact them immediately after you get the 1099 and alert them so they can file the correct 1099-Misc with the IRS. Recipient copies of 1099-Misc are due by January 31, but the IRS copy isn’t due until February 28, which gives payors time to make corrections for the recipient before they file with the IRS. If you do nothing else right, make CERTAIN you pick up all of your income, and make certain the exact number on your information forms (like 1099 and W-2) are reflected on your return. If you have more than one 1099-Misc for writing (from 2 or more publishers or agents), make sure the total of all of them is reflected on your Schedule C. You are required to report ALL of your income regardless if the party who paid you had to file a 1099 or not.

Line 2…Returns and Allowances doesn’t apply to a writing business so enter zero.

Line 4…Cost of good sold as Stephanie says “there’s no way to attach a monetary value to our blood, sweat and tears, so our cost of goods sold is zero. Leave blank.”

Line 6 …Other Income: This is where you’d report writing related income that’s not from the actual sale of books. For example, say you won a contest and received $25. Or if you taught an online class, this is where you would report the income.

c. Part II “Expenses” – This is where you will provide the IRS with the totals for the various categories of expenses you incurred during the tax year. Because Schedule C is a one-size-fits-all some of the lines will have nothing to do with writing. **Be sure to save all your receipts for your expenses and other documentation to support your expense.** Some writer expenses such as dues to professional writing organizations, conferences or contest entry fees, subscriptions to writing magazines don’t fall neatly into any of the categories so report them on Line 27 “Other expenses.” Stephanie states that it really doesn’t matter on what line you put your expenses. Put your expenses where they make the most sense to you. If you consider your website and other promo materials to be advertising, by all means, put those expenses on Line 8. I prefer to list them separately on page 2, under the ‘Other Expenses’ section, but that’s strictly my preference.

Line 8…Advertising: See above. This could include the cost of listing your books in Romance Sells, or an ad in RT or RWR. It could also include costs of bookmarks, or website contest prizes. I’ve been asked if a writer can deduct the cost of publisher provided books as promo expense. The answer is no. If you didn’t buy it, you can’t write it off. If you buy books to give away, then yeah, get after it.

Line 9…Car Expenses It is critical that you keep good records of your mileage and car expenses, or the IRS can deny your deductions! Car expenses are one of the most common audit items for small business owners.

Some examples of business use of your car in your writing career include driving to chapter meetings, the post office, the library (if you’re going for research purposes), a meeting with your agent or editor, or meeting your critique group. Also, if you drive to a conference, this is where you’d deduct the cost. In order to take a deduction for car use, you are required to keep a log of business miles driven. I suggest you buy an auto log – a small, paper thing that costs maybe 3 bucks, which you can find at any office supply store. Keep it in your car and whenever you drive somewhere for business reasons, write down your mileage. You don’t have to have a special log – a tiny spiral will do fine. Trust me, keeping up with your mileage in this way is much easier than trying to reinvent the wheel in the case of audit. And you will be asked for your mileage log if you’re audited. Save yourself the headache and keep a log. There are two methods to write off auto expense: standard mileage, and actual expenses.

Standard mileage rate is easier to compute and requires less recordkeeping. You only need to maintain a log of your mileage, keep receipts for parking and tolls, and maintain documentation for any state or local taxes and your auto loan year-end interest statement.

Actual expense method – you need mileage log, AND receipts and other documentation for – gasoline, oil changes, insurance, repairs, and tires etc. To get your deduction amount, you multiply the total of these expenses by your business use percentage, which is the business miles driven, divided by the total miles for the year. To this amount, you add depreciation on the vehicle.

For the standard mileage rate deduction for 2011, it is a little complicated since the standard mileage rate changed mid-year. (Another reason to keep excellent records) For 2011, the standard mileage rate is 51 cents/mile prior to 7/1/11 and 55.5 cents/mile thereafter. If you incur state or local taxes relating to your car, or if you financed your car, you can pro-rate the amount of the taxes and auto loan interest, by the relative business miles in a given year. Check the IRS publications for more information.

Line 10…Commissions and fees: Put the commissions you paid your agent on this line.

Line 11…Contract labor: If you have an assistant who you do not pay a salary, who you pay by the hour on a contract basis, this is where you would deduct the cost. Be aware, if you pay contract labor, you’re required to provide them with a 1099 if you paid them $600 or more.

Line 12…Depletion: Depletion would never apply to writing. Ignore.

Line 13…Depreciation and section 179 expense deduction – rules are pretty nit-picky. Buy tax software that can compute it for you. This will refer to computers, desks, chairs etc. This topic goes beyond the scope of this tip – check the IRS publications for more info. This is where you put the total of the depreciation you calculated and reported on Form 4562. Any purchase over $100 can be depreciated.

Line 14…Employee benefit programs: If you have an employee and you pay for their health insurance, or dependent care, this is where you would report those expenses.

Line 15…Insurance: If you buy liability insurance to cover yourself in the event a reader, agent, or publisher sues you, this is where you’d deduct it. I don’t know any writers who have this, but I’d guess there are some. Do not deduct your health insurance here!

Line 16…Interest: This is interest you paid for business loans. If you bought a building in which to write, and took out a mortgage, you’d deduct the mortgage interest here. The other interest line is for loans that are not mortgages, like, for instance, a car. However, you are only allowed the business percentage of any interest. If our business usage of the auto is 10%, and 100% of the auto loan interest is $700, our deduction is $70.

Line 17…Legal and professional services: If you hired a CPA to do your tax return last year, include the fee here. If you file for a LLC, you can take the deduction for the cost of the legal fees on this line.

Line 18…Office expense: Think paper, office supplies and postage.

Line 19…Pension and profit-sharing plans: This is for the cost of any retirement plan contributions you make on behalf of your employee(s). Do not deduct the cost of your own retirement plan contributions here!

Line 20…Rent or lease: This is where you deduct the business portion of any lease expenses you may have. For instance, if you lease your car, you’d put the business percentage of the lease payments here, instead of on line 9, Car Expenses. You would only do so if you elected to use actual expenses, instead of the standard mileage allowance. In that event, you’ll need to add back the inclusion amount, defined in Publication 463.

If you lease office space to do your writing, deduct it on line 20b.

Line 21…Repairs and maintenance: This is where you deduct the gazillion dollars you had to pay Computer Whiz Kid to clean all the viruses off your computer. If you have an office-in-home, don’t deduct repairs to your office here. They’ll be taken on the proper form and included in line 30, later.

Line 22…Supplies: Some people deduct their paper clips here. But it’s a matter of preference. If you want to deduct your paper and toner cartridges here, go for it.

Line 23…Taxes and licenses: As both Diane and Stefanie mention, here is where they are able to deduct their CPA license renewals every year. As an attorney, this is where I deduct my attorney biennial license renewals as well as my continuing legal education classes. This is also where you’d report any property taxes you had to pay on business assets. Some states/counties/municipalities require you to declare your business furniture, fixtures and equipment to them, so that they can tax you.

Line 24…Travel, meals and entertainment: Travel includes airfare, trains, shuttles, taxis, trolleys, hotels, bellboy and housekeeping tips, pretty much anything related to traveling away from home – on business – that doesn’t include something you stick in your mouth. See IRS publication 463.

Meals and entertainment is pretty self-explanatory. Be advised, however, that you are only allowed to take 50% of your meals and entertainment cost. If you spent $500, you get a $250 deduction. Meals you should deduct include all your food during a trip away from home – on business – lunch or coffee with your critique partners, lunch with your editor or agent, and the cost of a luncheon provided by your chapter. You should retain your receipts, and note on the back the following: Date and place, who was at the meal, and what was discussed. Nutshell – “My recent proposal”, or “Possible agent representation”, or “Brainstormed my wip, SWEET, SAVAGE, IRS AGENT.”

In the event you didn’t follow my advice and keep up with your receipts while you were traveling, there is still a way to get a deduction for that portion of your business meals for the year. This is the standard meal allowance, which you can find here:
http://www.irs.gov/pub/irs-pdf/p1542.pdf

If your spouse or family goes with you on the trip you can’t deduct their transportation cost like an airline ticket.

Line 25…Utilities: This is where you put the cost of any utilities you paid for a structure that’s not your home. If your office is in your home, you’ll take utility costs on the proper form and input the total on line 30, later. Some people put their telephone costs on this line. Here’s the deal with telephones: If you have a separate line installed for business, you can write it off. If you have only one phone line, it’s considered personal, and you can only write off the cost of long distance business calls as long as you keep a record.

This is also the line where you may want to deduct cell phone and Internet charges. These days, with all the bundling communication companies are offering, it’s a bit muddling to figure out what to deduct, and what will hold up in an audit. It may also be dicey to determine ‘business usage’ which is all you’re entitled to deduct. If you have family who access the Internet, that counts. Let’s say you have a family of 4 and everyone uses the Internet. You’d be entitled to 25% of Internet charges as a deduction, then you’d need to apply whatever percentage of time is applicable to your writing business. I’m not much for web surfing. I’m on Twitter and FB and I read blogs of writers and readers. I occasionally order something online, like wedding and Christmas gifts, and I receive a few personal emails every month, but I feel completely confident in claiming 90% of my Internet time is writing related. It’s just me and my husband, who also uses the Internet, so I take 90% of one-half of the Internet charges for the year. It’s not completely accurate, but how could it ever be? It’s reasonable, however, and I’m consistent – I do this every year. If you are audited and questioned about this expense, you’d have the calculation right there to show them how you came up with it, along with your bills from your Internet provider.

Line 26…Wages: If you have an employee to whom you pay wages and withhold federal income tax and employment tax, this is where you’d deduct their gross wages. You’d deduct your share of their employment taxes – FICA & Medicare – on line 23, above.

Line 27…Other expenses: This is a total from page 2 of Schedule C. This line is your friend. Here you would include expenses such as conference fees, contest fees, dues and subscriptions (dues to RWA, NINC, and subs to RT, Writers Digest, Publishers Marketplace, or BookScan), postage, promotion/website, research & craft books, and seminars. If you are self published and you hired an editor or cover designer, etc. this is where you’d deduct those costs. Be aware, if you hire a self-employed editor, cover artist, or web designer and pay her over $600, you should send her a 1099. You may meet with some resistance to this, but if you want to do this right, you need to ask for their Social Security number and mailing address and send them a 1099 the following January. Also, a word about books you buy for research purposes. All writing business/craft related books are deductible, but what about fiction? If you’re studying a particular line or genre, it’s perfectly acceptable to write off the cost of books you buy for that purpose. It’s a stretch to write off every book you buy, but this is our business. We can’t write and sell in a vacuum.

Note Section IV on the second page. This is where you’d input your car information if you weren’t filing Form 4562 Depreciation. Form 4562 would also be used for depreciation on computers and other business assets.

Line 31…Net profit or (loss) If you have a loss continue on to line 32. If you have a profit, go to Schedule SE “Self-Employment Tax” and fill out that form. Again see the IRS website for more information.

Line 32…At Risk: This only applies if you have a loss on Schedule C and money tied up in assets of the business. Check the box for 32a to indicate that all of your investment in your business is at risk (meaning that you will truly be out of pocket for the expenses you paid relating to your business. Note this figure back on your 1040 Line 12 “Business income or (loss). Remember to put in any loss in parentheses to indicate a negative number.

If you’ll have a net loss on your writing business for the year, you don’t need to worry about estimated taxes since you won’t owe any taxes on your writing business. If you’ll have a net profit, you will owe income tax and self-employment taxes and should make payments during the year. See forms 1040-ES, which are vouchers for payments made four times a year. Due dates for the payments are April 15th, June 15th, September 15th and January 15th (of the following year).


4. Summary – Keep accurate records!! The time period during which the IRS can review and make changes to your return (“statutes of limitations”) is generally three years. But as Diane Kelly pointed out in her class, the IRS can go back six years in cases where taxpayers underreported income by 25% or more. So I intend to keep my tax records for six years just to be on the safe side.

Be sure to keep receipts and documentation relating to items that you depreciate until as least three years after it has been fully depreciated.

For receipts for business lunches etc – on the back write the name of who attended, the event and date (ie Lunch with Suzy Q. Writer and Jan Author after RWA chapter monthly meeting). Keep detailed mileage log. Keep canceled checks, bank statements AND original receipts.

For home office deductions, keep copies of your utility bills, mortgage statements, insurance, property taxes, repairs etc.

In essence, think like this – is this something that (if I’m ever audited) I can explain to the IRS as to why it should be an expense to my writing career? If the answer is yes, then you probably can deduct it. Just imagine worst case scenario – can you explain how it affects your writing business.

Check your own state for state tax issues.

Remember – this is advice only and is not meant to be legal advice or tax advice.

Information used in this article was obtained from notes and lectures from the workshop 'Everything You Never Wanted to Know About Taxes' taught by Diane Kelly, CPA/Attorney at Law/Author, copyrighted by Diane Kelly. For more information on this subject, I'd strongly suggest taking this class the next time Diane offers it. You can find out information on Diane and other workshops she will be teaching at her website www.dianekelly.com. Diane is the author of the 'Death and Taxes' romantic mystery series from St. Martin's Press. Her debut novel, 'Death, Taxes and a French Manicure' won the 2009 Golden Heart award and the second novel in the series, “Death, Taxes and a Skinny no-whip Lattee was released March 1, 2012. Congratulations Diane!!

Stephanie Feagan is a CPA with a BBA in accounting who is self-employed with a practice consisting solely of tax clients. She also writes YA as Trinity Faegen.

Disclaimer:
Savvy Authors and ‘Writer's Court’ specify that this blog is for informational purposes only and is not intended to give legal advice or create an attorney-client relationship. If you have a specific legal question that needs addressed, you are encouraged to seek counsel from an attorney licensed in your jurisdiction.