For anyone who follows my blog, it’s no secret I spent a former life in accounting. I worked for sixteen years in corporate finance and was studying to become a CPA (that’s a certified public accountant for the non-numbers types) when my writing career took off. I left my accounting job to write full-time, but it seemed wasteful to squander all that learning. I kept studying and sitting for the exams (fun!!) and in the spring of 2018 I received my Minnesota CPA license. Immediately I knew what to do with it.
As an author I’ve met so many talented and successful writers who have little concept of tax planning for their businesses, and that’s where I come in. Welcome to #TaxAdviceforWriters, because suspense belongs in your writing, not in your taxes.
Note that the assumptions and advice given in this blog series are intended for freelance and self-employed writers. (Quick self-check. Do you receive a W-2 or a 1099 for your writing income? W-2 = employee. Stop reading and click here to be redirected to amazing Amber Liu K-pop. 1099 = self-employed. Carry on.)
Our first part in the series focuses on the primary essential ingredient for paying taxes—income. If you don’t earn income from your writing, there’s nothing for the government to tax. If you’ve earned income (aka a tax base), the government may be owed a portion of that in income tax.
Let’s take a closer look at that income. The first and most important question for many writers is whether they have business income or hobby income. For tax purposes, a business is an activity performed primarily in order to generate profit. A hobby is an activity performed largely for purposes other than profit. Depending on the character of the income, it’s treated differently on your tax return.
|Type of Income||Location Reported||Expenses Deductible|
This table reflects a big change embedded in the Tax Cuts and Jobs Act (TCJA) recently passed by Congress. Prior to 2018, certain hobby expenses were allowed as an itemized deduction, but TCJA repealed that deduction until 2026. Now hobby income must be reported as “Other Income” on the new Schedule 1 for the 1040, and no expenses are allowed. So, if you earned $2,000 selling jewelry on Etsy and paid $1,700 for your jewelry supplies, you have to report the entire $2,000 and are not entitled to deduct any of the $1,700 it cost to make the jewelry. The only comfort here for hobby writers is that our basic cost of goods tends to be low. Business income, on the other hand, is reported on the Schedule C form where both expenses and losses are allowed.
So which income is your income? Business or hobby? The IRS provides both a general rule and a set of nine factors that are used to determine whether an activity is considered profit seeking.
An activity is considered “profit-seeking” if the activity shows a profit in at least 3 of the previous 5 tax years.
Did you read it twice? Are you panicking now? Stop. Breathe. The Tax Court has long recognized that new businesses take time to become profitable, and artists often have an even greater challenge in becoming financially successful. The Court explains: “Many artists have to struggle throughout their careers. This does not mean that serious artists do not intend to profit from their activities. It only means that their lot is a difficult one.” Waitzkin, 63 T.C.M. 2740 (1992). Your answer to the general rule test simply creates a presumption, and that presumption will govern how an audit of your tax return would proceed.
Profitability Test Met
The activity is presumed to be profit seeking and the IRS bears the burden of proving otherwise.
Profitability Test NOT Met
The activity is presumed to be a hobby and the taxpayer bears the burden of proving otherwise.
Let’s say you’re audited by the IRS and your writing business has only been profitable for two of the last seven years. They claim, based on the general rule, that your writing income is actually a hobby and move to disallow all the expenses you’ve claimed. The burden of proof is up to you, so how do you prove that despite these losses, your writing is a profit seeking enterprise?
The Regulations consider nine factors in determining whether an activity should be classified as profit seeking. Before we look at them, bear in mind that not all nine factors apply equally in every case and there is no formula to determine how the evidence will be interpreted by a judge. But we can, and will, look at prior Tax Court opinions to see how these have played out for other artists.
Nine Factors for Determining Profit Seeking vs. Hobby Income
- Whether the activity is conducted in a business-like manner.
- The expertise of the taxpayers or their advisors.
- The time and effort expended.
- The expectation that the assets of the activity will appreciate in value.
- The taxpayer’s previous success in conducting similar activities.
- The history of income or losses from the activity.
- The amount of occasional profits.
- The financial status of the taxpayer / consideration of other income sources
- The elements of personal pleasure or recreation in the activity.
These factors are intended to address every possible income producing activity in the United States from florists to personal shoppers to carpenters. Let’s look at each factor individually as it may apply to a freelance author.
1. Whether the activity is conducted in a business-like manner.
This factor can have enormous impact on the Tax Court’s decision in determining whether your writing is a business or a hobby. Do you approach your writing methodically, with the goal of earning income by gearing your work to a specific market? Freelance writers aren’t expected to have full blown charters, policy manuals, or administrative departments, but every business should create and follow a plan. For more guidance on creating a business plan and conducting your writing career in a business-like manner, check out the post Treating Your Profession as a Professional.
2. The expertise of the taxpayers or their advisors.
Your expertise as a writer can be demonstrated in multiple ways. A bachelor’s or master’s degree is evidence of an advanced education in the field. Teaching classes or workshops also signals a publicly acknowledged level of expertise. If your work has won awards or been recognized for excellence, this is a testament to your skill. Even blurbs and reviews can offer evidence of peer and industry recognition of your expertise.
As for the expertise of your ‘advisors,’ this can mean agents, editors, publicists, mentors, or anyone in a position to help advance your career.
3. The time and effort expended.
This is a fairly straightforward factor and will be considered in relation to all the others. You won’t need to produce time sheets for the Court, but should be able to testify to the average amount of time devoted to your writing career. Bear in mind that this “time and effort expended” is not limited to writing or revising new work, but includes all the other necessary and often tedious activities like marketing, maintaining websites, social media outreach, event planning, attending conferences to expand your network, updating your business plan (see factor #1!), and of course tracking your expenses and paying your taxes.
4. The expectation that the assets of the activity will appreciate in value.
This factor is simply the assumption that your work and your time will become worth more as your career grows. It can be demonstrated to the court through the execution of your business plan and/or by a history of earnings growth. Did you make $50 for an article of 1,000 words early in your career and earn $200 for a similar length article recently? Have your rates for teaching workshops increased? Obviously you’ll need to rely on a good record keeping system in order to use historical evidence for this factor.
5. The taxpayer’s previous success in conducting similar activities.
This factor is built on the idea that a track record of success in other business ventures may indicate you have the skills and determination needed to succeed in your current activity. (Example: Someone who previously managed a coffee shop may have more success opening their own franchise than a person with no experience in the industry.) This factor may have limited relevance for freelance writers, but if you can show a history of being recognized or being offered payment for your writing before you turned it into a business, it may sway this factor in your favor.
6. The history of income or losses from the activity.
This is one of the factors where artists struggle the most, but as mentioned above the Court has ruled “a history of losses is less persuasive in the art field than it might be in other fields.” Churchman 68 T.C. 696. The Court often looks at what expenses contributed to create the losses, and whether those expenses were truly business related or personal (read: nondeductible.) We’ll take an in depth look at expenses and deductions later in this blog series.
7. The amount of occasional profits.
If you’ve made a profit through writing but the profits are minimal, it could indicate that the activity is more of a hobby than a genuine profit-seeking business. However, the Regulations acknowledge that “an opportunity to earn a substantial ultimate profit in a highly speculative venture is ordinarily sufficient to indicate that the activity is engaged in for profit even though losses or only occasional small profits are actually generated.” Section 1.183-2(b)(7), Income Tax Regs. They cite the example of an oil drilling venture where huge losses are incurred on the small chance that the taxpayer will strike oil and make a large profit. Not so different, perhaps, than working for years on the small chance that you may write a NYT bestseller.
8. The financial status of the taxpayer / consideration of other income sources.
In this factor the Court considers what other income you have. If you work a steady day job in accounting, for example, and continually use your writing losses to shield your W-2 earnings from income tax, the Court may be swayed to believe your writing is not primarily a profit seeking venture. The mere existence of a secondary income source doesn’t preclude your writing from being considered a for profit activity, though. The Court acknowledges that taxpayers may have multiple careers.
9. The elements of personal pleasure or recreation in the activity.
And finally, here’s the factor that outrages artists every time. The Regulations state that if a taxpayer enjoys doing an activity, it suggests they may engage in it for reasons other than making a profit. The temptation of course is to read this as: Since writing is all giggles and fun, it may not be a real business. Don’t be disheartened by ‘the recreation element,’ though. The Court has continually defended people who enjoy their work, sometimes to fantastic quotability as in Jackson v. Commissioner, 59 T.C. 312,317 (1973). “Suffering has never been made a prerequisite to deductibility.” Considered in this factor, too, are all the less pleasurable aspects of writing such as marketing, querying, maintaining records, researching markets and trends, emailing literally everyone, and rewriting that last section for the EIGHTEENTH TIME only to figure out how many times you used the word replete, what is wrong with you, you’re going to spend the next two hours doing a search and agonize over the context of each replacement until you are replete with loathing for this book that’s already two weeks overdue. The Tax Court, in short, welcomes your frustrations.
In Income, Part II, we’ll take a look at an actual Tax Court case to see how these factors are applied and considered for artists. Thanks for coming along with me on this #TaxAdviceforWriters blog series!
This material has been prepared for informational purposes only, and is not intended to provide, and should not be relied on for, tax, legal or accounting services. Presentation of the material does not create a tax-professional-client relationship. The material is provided on an “as is” basis and is accurate and true to the best of my knowledge, but no representation or warranties of any kind are given about the material, and there may be errors, inaccuracies or omissions.