Be a “Professional” Writer — All Year Long

By Gary A. Hensley, MBA, EA

If you are new to the writing life, or even a veteran, you are in the business of writing if your intent is to write long-term and make a living (or at least a profit) from your work. You are self-employed (you work for yourself) and that means you are a sole proprietor for tax purposes. You will need to file a Schedule C with your federal Form 1040 to report your writing income and expenses.picture004

If you visit www.irs.gov and type Schedule C in the search box, you will see some of the expenses allowed. Part of your business responsibility includes keeping accurate business records, during the calendar year (not after), to track your income and expenses. You will be on the “cash basis” of accounting, i.e. you report your writing income when it has actually been received and your expenses when they have been paid.

Most of you hire someone to “prepare” your annual tax return. Many of you keep your participation to an absolute minimum. This is akin to turning in a partially-completed manuscript, replete with grammatical errors, to an editor, and then expecting him or her to return a bestseller to you.

You need to accurately summarize your income and expense records before you meet with your preparer (or do the return yourself). One example: make sure you have added up all your business miles for 2014 and multiplied them by 56 cents per mile. The law requires that you maintain a “contemporaneous” record of your business mileage during the year. Get a $5 day-planner at Walmart and put it in your glove compartment. Use it each time you head out on business. Jotting down the beginning and ending odometer readings, and the business purpose, makes you bullet-proof if you are audited. You will be amazed at the total amount of business miles (and very happy with the large expense deduction). Proper recordkeeping in other areas will yield the same results.

In addition to proper recordkeeping, you need to take additional steps to document (or support) your professional (business) status as a writer. A diary of your various business activities will be very helpful. A manuscript submission/rejection/resubmission record will show continuous activity. Attendance at a writer’s club and writing seminars will indicate you are trying to improve your skills. A separate bank account/debit card for the business is critical.

It’s not unusual for any new business to sustain losses during the early years; however, to have those losses allowed, you must be able to demonstrate that you are “active” in the business.

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This article originally appeared in the January 2014 newsletter The Write Life.

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When Does Your Writing “Business” Actually Begin? Part 1

By Gary A. Hensley, MBA, EA

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Gary A. Hensley

WarningGrab a hot cup of coffee or tea before you begin reading this dry, although critical, unbuttered toast of a blog.

The title of this blog presents a straightforward question.  However, for writers, authors, and illustrators the answer may seem elusive.    A major part of this problem stems from the fact that writers are not “certified,” “registered,” or “licensed” like dozens of other professions.  There is usually no tangible evidence to nail down the “moment” you become a “professional” writer.  For example, lawyers, CPA’s, doctors, plumbers, cosmetologists and electricians are licensed which gives them a specific entry date into their profession.

It may be (and usually is) months or years before a writer, author or illustrator has something published (tangible evidence) and they are compensated for that work.  We generally associate the receipt of sales (or revenue) as the acid-test for “being” in a business.  But is a sale (or revenue) actually required to be in the “business” of writing?  The short answer is “no.”    Can you have “business” losses for several years and still be in the “business” of writing?  The short answer is “yes.”   [See a recent Tax Court decision on this point on my blog].  Also, refer to my previous blog “Professional Writer or Hobbyist?” for essential background information that will not be repeated in this blog.

Artistic Endeavors Take Longer to Bear Fruit

Congress and the Tax Court have both acknowledged that artistic endeavors take longer to bear fruit.  The Internal Revenue Code (IRC) and the associated Treasury Regulations provide the statutory guidance in this area while various court decisions provide interpretations that are binding in all jurisdictions (such as U.S. Supreme Court decisions) or in only some jurisdictions (such as Court of Appeals decisions).

Tax Treatment of Prepublication Expenses of Authors

After many years of IRS entrenchment and contrary court decisions, Congress finally added section 263A(h) to the Internal Revenue Code (IRC).   IRC § 263A(h) allows “freelance authors, photographers, and artists”  to deduct currently business expenses incurred in working on manuscripts that may or may not be published.  Prior to this, expenses had to be deferred (inventoried) and were only expensed at the time the manuscript was sold or started generating royalties (in many cases, years after they were incurred).

The rationale for this income and expense matching concept made sense for many other businesses that develop or construct assets over several years but not for authors that, heretofore, were subject to the same requirement. My point:  Congress and the courts have recognized some of the unique challenges involved in artistic endeavors and have responded with special legal relief.   IRC § 263A(h)(3) defines a writer as “any individual if the personal efforts of such individual create (or may be reasonably expected to create) [emphasis added] a literary manuscript, musical composition (including any accompanying words), or dance score.”    This means that all of your business expenses incurred during the year (under IRC § 162), for short-term and long-term projects, are deductible in the current year as a professional writer (not a hobbyist).

More Than One Occupation

The Tax Court has, on numerous occasions, affirmed that one can be a full-time employee (or self-employed) in one occupation and also have a “business” in another occupation.  Put another way, you are not limited to being in one business at a time.  Excellent financial recordkeeping (including separate bank accounts and debit/credit cards) and your documentation of “time-on-task” are essential to substantiate your multiple business activities.

In Part 2, I will recap and expound upon the “entry” requirements to nail down your “professional writer” status and review the needed documentation.

Recent U S Tax Court Decision Allows Long History of Annual Losses

In a recent decision (August 14, 2013), the U S. Tax Court ruled that a musician’s long history of annual losses won’t trigger the hobby loss rules [Gullion, Tax Court Summary Opinion 2013-65].  Further, the Court recognized that it takes longer to achieve success in the arts than in other fields.  The taxpayer had substantial losses for seven years (2004-2010) totaling $130,203.  In 2011, the taxpayer finally made a small profit ($647) which was helpful in his argument before the Court.  This decision provides insight into the Court’s thinking regarding the application of the hobby loss rules (which limits deductions to the amount of income) as it relates to those in artistic endeavors.    The umbrella of artistic endeavors, in my opinion, would also include authors, writers and illustrators.

The taxpayer’s documentation of his activities was crucial to his victory.  I have lectured and written repeatedly about the need to document all your “business” activities.  Although he had a full-time job as a computer programmer, his documented activities as a musician provided the substantiation the Court required.

To be engaged in a trade or business within the meaning of Internal Revenue Code (IRC) section 162(a), an individual taxpayer must be involved in the activity with continuity, regularity, and the primary purpose of deriving a profit.  Deciding whether the taxpayer is carrying on a trade or business requires an examination of all of the facts in each case. A taxpayer must conduct the activity with the requisite profit motive or intent for the activity to be considered a trade or business. The taxpayer generally bears the burden of proving that the requisite profit objective existed.  The taxpayer’s profit objective must be actual and honest.  The pertinent regulations set forth a nonexhaustive list of factors that may be considered in deciding whether a profit objective exists.  For a list of these factors, refer to my earlier blog “Professional Writer or Hobbyist?”

The Tax Court reviewed the relevant factors and determined  the taxpayer’s musical activities qualified as a trade or business for purposes of IRC 162.    The Court stated:  “We have recognized that a taxpayer may engage in more than one trade or business at any one time.  It is also well settled that the term ‘trade or business’ includes the arts.”  In addition, “We have found that ‘a history of losses is less persuasive in the art field than it might be in other fields’, as economic success in the arts frequently takes longer to achieve than success in other fields [Churchman v. Commissioner, 68 T.C. at 701-702].”

This case makes clear that documenting all your efforts and activities en route to a profitable business as a writer, author or illustrator will be the key to deducting your annual losses until that is achieved.

Self-Employed Business Losses and the Profit-Presumption Rule

The question of whether an activity, such as freelance writing, is a hobby or a business arises when losses are incurred. Early business losses in any endeavor are not really all that unusual; however, that does not mean you shouldn’t be prepared to substantiate “your numbers” during an IRS field audit.

Normally, your self-employed business losses will be challenged as part of an IRS field (person-to-person) audit after a one-year significant loss or losses for two or three consecutive years.  To successfully sustain your losses:

  • You will have to prove that you are engaged in the activity to make a profit (“profit intent”), supported with a viable business plan [read my post “Professional Writer or Hobbyist?”], or
  • You may be able to take advantage of a “profit presumption” election to defer an IRS business/hobby determination until after you have completed the first five years in business.

Presumption of Profit-Seeking Motive

You are presumed to be engaged in an activity for profit if you can show a profit in at least three of the last five years, including the current year.  The presumption does not mean that losses will be allowed; the IRS may try to rebut the presumption. You would then have to prove a profit motive as outlined in “Professional Writer or Hobbyist?”

Profit Presumption Election Postpones Determination

If you have losses in the first few years of an activity and the IRS tries to disallow them as hobby losses, you have this option:  You may make an election on Form 5213 to postpone the determination of whether the above profit presumption applies.

The postponement is until after the end of the fourth taxable year following the first year of the activity.  For example, if you enter a freelance writing activity in 2012, you can elect to postpone the profit motive determination until after the end of 2016.  Then, if you have realized profits in at least three of the five years (2012-2016), the profit presumption applies.

When you make the election on Form 5213, you agree to waive the statute of limitations for all activity-related items in the taxable years involved.  The waiver generally gives the IRS an additional two years after the filing due date for the last year in the presumption period to issue deficiencies related to the activity.

To make this election, you must file Form 5213 within three years of the due date of the return for the year you started the activity.  If before the end of this three-year period you receive a deficiency notice from the IRS disallowing a loss from the activity and you have not yet made the election, you can still do so within 60 days of receiving the notice.  These election rules apply to individuals, partnerships, and S corporations.

Professional Writer or Hobbyist?

IRS Criteria

By Gary A. Hensley

There is more to writing than the study of the craft itself.  Most of you reading this have attended writers’ seminars, read books and numerous articles, visted Web sites, and attended college writing programs to learn the fundamentals (and perhaps even a few secrets) of professional writing.  It’s a good start, but it’s not the whole story for the aspiring professional writer.

In addition to developing your writing expertise, you must be aware of and follow the rules regarding your writing business. The headlines and television networks have been filled with stories about undocumented workers in the United States.  Are you an undocumented writer (defined as a writer who falls willingly or unwittingly into the IRS category of a person who writes only as a hobby)?

What’s the difference?  Who cares?  You should, if you are truly serious about establishing professional writer status both in print and before the IRS.  Remember that all income received from your writing efforts is taxable income, whether you consider yourself a professional or operate as an on-again, off-again sporadic writer.

The benefit of professional status is on the expense (or deduction) side of the ledger.  The professional writer can deduct all reasonable and ordinary business expenses (Internal Revenue Code Sec. 162) incurred during the year (even if this results in a business loss).  The writer who functions at the hobby level can deduct only expenses up to the amount of income received that year from writing activities, and those expenses can be taken only on Schedule A as itemized deductions.  If the hobbyist does not itemize deductions on Schedule A (but takes a standard deduction), the deductions are worthless.  But (and you knew this was coming), all income received from writing (even as a hobby) goes on page one of Form 1040 (as Other Income) and becomes part of adjusted gross income (AGI) subject to income tax.  Thus, the best-case scenario for a writer deemed to be functioning as a hobbyist (and not as a business) is breadeven (no profit and no loss), assuming he or she uses Schedule A.

The professional writer, on the other hand, uses Schedule C to report income and expenses, which assures that deductions and expenses will be used to reduce writing income and will result in net income or net loss (expenses exceed income) before that amount moves over to page one of Form 1040.  Schedule C is used by sole proprietors (an unincorporated business) and is attached to the annual Form 1040.

Most people, including new entrants to professional writing, don’t start a business or profession with the intent (a key factor used by the IRS to determine your status as a professional or hobbyist) of perpetually incurring annual losses.  But it is hardly unusual not to “throw losses” in the early years in any new business.  Thus, for the beginning professional writer, these losses, coupled with a healthy dose of sweat equity, are actually his or her capital (financial) investment (not in the strict accounting principles sense but by looking at substance over form) needed to launch a long-term profitable business.

Professional writers, using Schedule C, will use the cash basis of accounting.  This means they will recognize (report all) sales or fees when they are actually received, and they will deduct related expenses when they are actually paid.  Receivables (money earned but not yet received) are not recognized until received. Payables (expenses incurred but not paid yet) are not deducted until actually paid.

Internal Revenue Code (IRC) Section 183 covers activities not engaged in for profit.  Remember, income from any activity is taxable whether or not the activity is engaged in for profit.  As explained earlier, the provisions of IRC Section 183 limit the deductions related to an activity not engaged in for profit (in other words, a hobby).  A key consideration in deciding if your writing is a business or hobby is that the taxpayer begins and continues the activity with the intention of making a profit.

Treasury Regulation 1.183-2(b) contains nine relevant factors that are to be used to evaluate the profit motive of a business activity.  The factors are not all-inclusive.  No one factor is more important or more weighted. The nine relevant factors used to evaluate the profit motive of a business activity are:

  • Businesslike manner;
  • Expertise;
  • Time and effort devoted to the activity;
  • Expected appreciation;
  • Taxpayer’s success with other activities;
  • History of income and losses of the activity;
  • Amount of occasional profits earned, if any;
  • Financial status; and
  • Personal pleasure or recreation.

If your tax return is selected for examination by the IRS, these factors will be used (along with any other relevant information) to make a business or hobby determination.  By looking at these factors in advance, the professional writer will be able to discuss each one intelligently and provide documentation to support his or her professional status.

In the beginning, the professional writer should seriously consider a one- or two-hour appointment with a professional tax advisor to help set up financial books and records, a day planner for documentation of business activities, a business mileage log book, and documentation needed for travel and entertainment expenses.  This will be money well spent–and it’s deductible.

If nothing else, the successful professional writer is disciplined and tenacious.  These same attributes will serve the professional writer well on the business side of his or her enterprise.

Be a total professional.

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This article originally appeared in WRITERS’ Journal, March/April 2008, pp. 13-14.   This article may be cited with attribution and a reference to this website.