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.
Simple, right?
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 |
Business | Schedule C | Yes |
Hobby | Schedule 1 | No |
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 Prior to 2018, certain hobby expenses were allowed as an itemized deduction, but TCJA repealed that deduction until 2026.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.
General Rule:
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.
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.