A Special Provision for Writers in the Tax Law

By Gary A. Hensley, MBA, EA

It may be (and usually is) months or years before a writer, author or illustrator has something published and they are compensated for that work.  We generally associate sales as the acid-test for “being” in business.  But is a sale legally 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.”

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).

Special 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 IRC.   IRC section 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photographers, and artists” to deduct currently business expenses incurred in working on manuscripts that may or may not be published.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).

Congress and the courts have recognized some of the unique challenges involved in artistic endeavors and have responded with special legal relief.   IRC section 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 section 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

In addition, 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. You may need to share this information with your tax preparer.

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Featured Article in “The Write Life” January 2014 edition

My article “Be A Professional Writer–All Year Long” is featured in the January 2014 newsletter of The Write Life.

View the article here and sign up for your free subscription to this informative newsletter.

Article in the 2014 edition of Christian Writer’s Market Guide

The just-released 2014 edition of Christian Writer’s Market Guide contains my article “Nailing Down Your Professional Status” starting on page 186.

The guide is an excellent resource and I am very pleased that one of my articles was selected for inclusion.  Great way to start the new year!

 

Who Pays Federal Taxes?

The top 1% of all filers paid about 35% of all federal income taxes in 2011, the most recent year IRS has analyzed.  Filers need to have adjusted gross income (AGI) of at least $388,905 to qualify for the top 1% of earners.

The highest 5% paid 56.5% of total income tax.  They each had AGI of at least $167,728.

The top 10% of filers, those with AGIs of $120,136 or more, bore 68.3% of the total tax burden.

The bottom 50% of filers paid 2.9% of the total tax burden.

2014 Optional Standard Mileage Rates

The Internal Revenue Service today issued the 2014 optional standard mileage rates used to calculate the deductible costs of operating an automobile for business, charitable, medical or moving purposes.

Beginning on Jan. 1, 2014, the standard mileage rates for the use of a car (also vans, pickups or panel trucks) will be:

  • 56 cents per mile for business miles driven
  • 23.5 cents per mile driven for medical or moving purposes
  • 14 cents per mile driven in service of charitable organizations

Lower Your Taxes! Build Your Retirement!

The One-Participant 401(k) Plan

By Gary A. Hensley, MBA, EA

Small business (self-employed) owners have an incentive to establish a 401(k) plan instead of an IRA-based plan to increase their retirement savings thanks to the Economic Growth and Tax Relief Reconciliation Act of 2001 (EGTRRA), Public Law No. 107-16.  This article will focus on the rules for a one-participant plan that covers a self-employed individual (filing a Schedule C as part of their Form 1040) who has no employees.[i]

EGTRRA opened up the options for small business owners by increasing the allowable percentage of elective salary deferrals to qualified plans from 25% of compensation to 100% of compensation and by changing the effect of elective salary deferrals on the overall contribution limits for qualified plans.  A one-participant 401(k) plan cannot be established if the business has any eligible employees other than the business owners and their spouses.[ii]

For self-employed individuals, compensation is defined as net earnings from self-employment after deducting 50% of the self-employment tax and the employer contribution to the plan for the self-employed individual.[iii]  Just for clarity, in the case of a Schedule C sole proprietor, you are both the employer and the employee for the purpose of figuring your maximum 401(k) contribution.

As the employer, you can make up to a 25% contribution.  As the employee, you can make elective deferrals up to $17,500.  If you are age 50 or older, the catch-up provision raises this limit to $23,000.

Maximizing Plan Contributions

Let’s review an example of how this works:  Sarah, age 48, a successful mystery writer for several years, has a net business profit, in 2013, of $70,000.

Net business profit                              $70,000

SE tax deduction[iv]                            –   4,945                                                            Adjusted net profit                                $65,055

Employer contribution:

$65,055 x 0.20[v]                                   $13,011

Employee contribution:

Salary deferral (max)                             17,500

< 50 years old

Maximum contribution                           $30,511

Amazing!  Sarah’s profit of $70,000 will be reduced by one-half of her self-employment tax, $4,945 (entered on Form 1040, page 1, line 27) and by her employer/employee 401(k) contributions of $30,511 (entered on Form 1040, page 1, line 28).  This takes her business profit of $70,000 down to $34,544– more than a 50% reduction!  Her adjusted gross income (AGI) will be $34,544 (assuming no other income) and she will have $30,511 growing tax-deferred in her retirement account.

Assuming she is single, her standard deduction and personal exemption will drop AGI down another $10,000 leaving her just $24,544 of taxable income.  Her final income tax due?  $3,235 on a $70,000 profit.  Now, for the icing on the cake. If she had been 50 years old or older, in 2013, she could have added another $5,500 to her elective deferral (using the catch-up provision), dropping her taxable income down to $19,044 and her income tax to $2,410.  Had Sarah set up a SEP IRA plan, instead of a 401(k), her allowed retirement deduction would have been limited to $13,011.

The 401(k) plan needs to be in writing and set up no later than December 31st for calendar year taxpayers; however, the employer contribution, does not have to be made until the return due date (4/15/2014) or the extended due date (10/15/2014) if you file an extension for your Form 1040.   You can set up the 401(k) plan through a bank, credit union, insurance company or a mutual fund.  The paperwork is minimal and your annual administrative fee should be quite reasonable.

Be aware that your elective salary deferral maximum for 2013 is $17,500 ($23,000 if age 50 or older) across all active plans you participate in.  So, if you work for an employer and participate in a 401(k), 403(b), or similar plan, you must subtract the contributions you made to that plan from the $17,500 ($23,000 if age 50 or older) to determine how much is left to use in your self-employed retirement plan.  The total of employer and employee contributions cannot exceed $51,000 per employee in 2013.

The one-participant 401(k) plan provides an excellent opportunity for sole proprietors (and others) to reduce their tax bill while funding their retirement.   It’s not too late to set up your plan for 2013.  Compile your income and expense amounts at the end of November to determine this year’s profit or loss.  If you have a tidy profit, consider this strategy to bring it and your tax bill down.


[i] Self-employed, under EGTRRA, has a wider meaning than reviewed here.  The term self-employed generally includes sole proprietors, partners, and members of limited liability companies (LLCs) taxed as partnerships.  A single-member LLC, that has not elected “corporate” status, is treated as a “disregarded entity” or sole proprietorship and files a Schedule C as part of their Form 1040.  Thus, this article would pertain to such single-member LLCs.

[ii] A one-participant 401(k) is also called a Solo-k, a Solo-401(k), a Uni-k, or a Single-k.  The term itself is a misnomer because the plan may cover more than one person.  Participation is limited to a married couple who own an incorporated or unincorporated business, or the partners in a business partnership and their spouses.  Benefits cannot be provided to anyone else.

[iii] Because this is a circular computation, an equation is used to determine the allowable employer contribution rate:  the stated plan contribution rate is expressed as a decimal and then divided by the total of 1 plus the stated plan contribution rate.  For example, a 25% stated contribution rate becomes 20% (0.25 / 1.25)

[iv] [$70,000 x 0.9235 x 0.153) = $9,890 x ½ = $4,945

[v] Based on a 25% employer contribution [0.25 / (1 + 0.25)]

Take the Free Out of Freelance Writing

My brother, Dr. Dennis E. Hensley, put forward this advice recently in the May/June 2013 issue of Advanced Christian Writer (pages 3-4). He states:  “Outsiders to our profession think writing is fast and easy, that we have all the time in the world, and that seeing our names in print is enough payment to woo us in.  Lawyers, accountants, life coaches, psychiatrists, and fitness trainers charge for their advice and services.  The most frequent question I hear in response to this situation is, ‘But how much should I charge?’” This is where I would like to insert my own answer to this question.  Back in October 2012, I wrote a blog on this site titled “Writers: Stop Losing Money—Use This Fee Formula.”  Check it out.  In the blog, I outline a four-step process on how you should set your fees.  The formula can also be used to determine the absolute minimum fee (breakeven) if you are aggressively trying to break into a new market.  The formula covers the direct expenses of the specific assignment, the indirect costs of operating your business, your target profit percentage and the associated taxes that will be due on the assignment profit. Dr. Hensley further advises that you “match the market.  If you price your writing services too low, potential clients will wonder why your bid doesn’t match the bids of the other two writers he contacted.  Thus, you should check websites and ad brochures to find out what your competition is charging.  Naturally, there are such considerations as your level of education, experience, and previous client references.  But assuming most things are comparable, you should ask for what the market will sustain. “Don’t sell yourself short.  Writing is hard work, so you deserve proper compensation.  Move from freelance to moderately-priced-lance to outright-expensive-lance.”

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Dr. Dennis E. Hensley is the author of more than 50 published books.  His newest book, Jesus in the 9 to 5, will be released on October 18th