Tax Facts: Is Your Writing A Business?

I had planned on continuing my articles on writing expenses, however, an issue arose that I thought was important enough to put that off and discuss whether you, as a free-lance writer, have a hobby or a business. I will continue the discussion on expenses in the coming weeks.

Hobby or Business?

Are you writing as a hobby or do you write to make a profit (also known in tax-law-language as an activity for profit/business)?

This question is very important in respect to your U.S. federal income tax return. Your answer determines where you report your income and expenses and whether or not you can claim your expenses now or later.

You need to make this decision before you prepare your income tax return claiming writing expenses.

The Internal Revenue Service (IRS) has very specific guidelines concerning whether an activity is for profit (a business) or is an activity not for profit (a hobby). The IRS presumes your business is an activity for profit if it makes a profit during three of the last five years. If your business does not make a profit during that time, it may still be considered an activity for profit depending on certain factors. If you are audited, you will be asked to provide information proving you are in the business of being a free-lance writer. I have reworded the general questions so they are applicable to writers.

1. How much time and effort do you spend writing?

This includes writing, researching, taking classes, reading “how-to” books, etc.  Do you spend enough time to make a profit?  (For example, a couple of hours every once in a while is probably not enough.)

2. Do you conduct your activity in a business-like manner?

Do you keep your receipts for your purchases?  Do you keep your business records separate from your personal?  If they are mixed, do you identify which purchases are for your business of being a free-lance writer?

3. Do you depend on the income for your livelihood?

Do you or your spouse have another job which pays for your living expenses?

4. Have you changed your method of operation to improve profitability?

Have you taken any classes, joined a writers group or association, or changed genre? What have you done to increase your ability to make a profit?

5. Do you have the knowledge needed to carry on the activity as a successful business?

Have you taken classes or workshops, entered contests, read “how-to” books by successful authors/editors? Have you attended a Small Business Tax Workshop?

6. Have you made a profit in a similar activity in the past?  Have you been successful in your past/present occupation?  Do you use some of the same skills?

7. Have you made a profit in some years from your writing?

Have you made some sales during the years even though you haven’t made a profit yet?  Are the sales increasing each year?

8. Did the losses occur during the start-up phase of your writing?

If you are ever audited, you will need to prepare a statement answering these questions in as great detail as you can in order to verify your claim that you are an activity for profit.  In addition, it might be helpful to include information concerning how many years it took for certain authors to sell a manuscript.  For example, I’ve seen certain authors say it took them 10 years to get published.

HOBBY

If your writing is a hobby, you report your income on Form 1040, line 21, Other income, and your expenses are deductible on Form 1040, Schedule A, Itemized Deductions, line 28, up to the amount of hobby income reported and subject to the 2% deductible limitation.

BUSINESS

If your writing is a business, you report your income and expenses on Form 1040, Schedule C.

The above links are to the 2010 forms since the 2011 forms have not been published at this time.

Do you consider yourself as a free-lance writer (aka business)?

Tax Facts for Writers: IRC 263A(h)

Why Do You As A Writer Need to Know About IRC 263A(h)?

Internal Revenue Code 263A(h). Capitalization Rules.  As a free-lance (self-employed) author/writer, you may be exempt from the capitalization rules. You can deduct the expenses of creating your manuscripts(s) on Form 1040, Schedule C, Profit or Loss From Business, if you meet the requirements of an activity-for-profit. You do not have to wait until you income from the sale of your manuscript(s) to claim these expenses.

What Does It Mean?

Under the capitalization rules, normally you may not claim expenses until you start receiving income from the sales of your products. Then you must spread the expenses over the life of the products being sold.

If you are a self-employed (free-lance) writer with the goal of earning a living and making a profit from your writing (a business), you may claim your writing expenses on your federal income tax return when the expenses occur. You do not have to wait until you are earning income from writing to claim your writing expenses.

How Does This Benefit You?

You report your business-related expenses on Form 1040, Schedule C, Profit or Loss From Business. Even if you have no income from writing. This results in a loss. This loss is carried from Schedule C to Form 1040, line 12, as a negative number. This loss is subtracted from all your other income (or spouse’s income) causing your gross income to be less. When gross income is less, then your taxable income is less and you pay less income taxes.

Drawback?

When you sell your book and receive royalties, you will not have these expenses to decrease your income. Therefore, you may pay higher income taxes and self-employment taxes on this income in the year you receive it. Self-employment taxes are the equivalent of social security taxes for self-employed individuals.