Transcripts

 

John Caton CPA: Taxes and the Writer: When Does the IRS Take YOU Seriously (and other matters)! 10/23/03



Legend:
Questions from the Audience are presented in red.
Answers by the Speaker are in black.
The Moderator's comments are in blue.

Mary Rosenblum

Hello, all!

 

Welcome to our Professional Connection Live interview!

 

Every other week, I bring you a two-hour live visit with a professional connected to the craft of writing.

 

John Caton,a CPA, and my accountant, has been in public accounting since 1970. He is currently the senior partner in a firm that serves nearly 1000 clients, including writers and performing artists. If you are a writer in the eyes of the IRS, then you can deduct certain expenses, and need to keep appropriate records.

 

He keeps me on good terms with the IRS, and I have learned.

 

a lot from John over the years. I'm TERRIBLE about money matters and I need him!

 

Tonight he's willing to help you out with those basic questions we all have!

 

Welcome, John!

John Caton, CPA

Hi everyone.

Mary Rosenblum

I appreciate your coming tonight, John.

 

I know you're busy. Is there any time of year that ISN"T busy for a CPA?

John Caton, CPA

I am glad to be here. I hope I can be of some help. Now that I am past the last major deadline, things are a little easier.

Mary Rosenblum

We're glad to have you! I think we need to begin with the very basic

 

question that every writer faces.

 

No matter what our own criteria for 'when I am really a writer?’…

 

When does the IRS consider someone a professional writer rather than a hobby writer?

John Caton, CPA

This is a classic question. Unfortunately it is not a short answer.

 

The first few years of any business are usually the roughest. Some kinds of activities are virtually never questioned by the IRS, such as a store front retail operation. But when it comes to activities that are a little out of the ordinary, they fall back to Code Section 183.

 

This IRC states there is a presumption that if an activity has profits for any three years out of a consecutive five years, it is a business. (It used to be 2 out of 5 years) Otherwise, the burden of proof that an activity is engaged in for profit is on the taxpayer.

 

What this means is you have to be acting like a business in order to be treated as one. The consequences are that your expenses can only be deducted to the extent of your income. Just because you have income does not mean you are a business.

 

How do you act like a business you ask? First, let me give you an example. Situation is a couple who is running a stock car on a local track. There are substantial losses for more than three years and the IRS has become curious (audit).

 

We provided documents that showed they were contenders for prize money, the efforts to obtain sponsors, parts dealing, and a log of their activities. All were elements of being in the industry. One element by itself would not be enough to win the case, which we did.

 

The code does not say you must be profitable, just that you must be doing everything you can to be. Now, how does this translate to being a professional writer.

 

The most important thing you can do is to keep records of all your activities. I know how creative people like to do that kind of thing, but the burden of proof is on you and it is the only way to protect your backside. Remember, when you stick your head in the sand, you still leave important parts of your anatomy at great risk.

 

You must write and submit for publishing. Just writing for yourself, your friends, your own publication, will not be enough. You must try to get it published. Every submittal and rejection must be kept as evidence you are trying to produce income. The more the merrier.

 

One short story a year will not win the day. Proof of trying to improve your craft through workshops, working with a mentor, having or trying to find an agent adds to your body of proof.

 

Buying and/or reading books to study other writer’s styles will not carry much weight since that is an activity that can be considered non-business. There is possibility of a deduction if you can establish a direct connection to something you have produced.

 

Having a business card and letterhead helps, but is only a little piece compared to other activities. A registered business name or license, like you can do in Washington, could also help.

 

Maintain a journal of your activities with an estimate of the amount of time you put in each day. This establishes how much time in a year you have put into your business and helps to record those intangibles like contacts for an agent.

 

There is a test in another part of the code that uses 500 hours as a minimum for being active in a business. There is nothing in the hobby rules that address this, but it is a guide and can add to the argument of being serious about your business.

 

I won an audit that went to tax court because the client kept such a journal. He also wrote a two page business plan every January outlining what he had learned from the prior year activities and what he was going to do to become profitable the coming year.

 

There is a very hazy line between being an interest or even an expensive hobby and being a business. The business of writing is hazier than most. You win this type of argument through the preponderance of evidence. (I will try not to be so long winded with other answers.)

Mary Rosenblum

That is incredibly clear, John, thank you very much! And for those of you frantically taking notes, remember that I will post the transcript of this session in Surviving and Thriving: Transcripts after the interview. You can read it or even copy it for your own information!

 

John, this brings up an issue for the nonfiction writer

 

who might spend a lot of time on the phone setting up interviews, verifying information, and conducting interviews.

 

Would it be prudent to keep a detailed phone diary then...especially if using the house phone?

John Caton, CPA

Using your home phone for business allows some deductions, but not everything.

 

The basic charge is never deductible, but extra expenses such as an extension into your office or call forwarding used for

 

business can be. Long distance charges and associated taxes on business accounts do count as well.

mbvoelker

What if you bought a calling card specifically for business use?

John Caton, CPA

As long as it is used only for business, it should work.

Mary Rosenblum

Would it be wise to list the long distance calls

 

such as calls to my agent for example, or my editor in New York who stays on the phone for an hour!!!?

John Caton, CPA

The easiest way to deal with that is to note the call on your monthly phone bill and show a total that is business related.

 

Then, if you have a business bank account, write a separate check for that portion. Do not forget, that phone bill is not part of

 

your business records and should be kept like any other business record.

senicynt

Hi John.... Thanks for coming. Mary must have bribed you with an autographed edition of one of her books :-) How do you split your home office from the rest of your house? My computer desk is in a corner of the dining room and besides writing, it is used for other things. If it is part of a larger, non-office room, should I just forget about it as a deductible office space?

John Caton, CPA

A home office can produce a deduction through Form 8829. The square footage of the space used 100% for business as a percentage of the total square footage available is applied to the interest, taxes, insurance, utilities, repairs, etc,

 

and deducted against business income through Form 1040, Schedule C. For instance, a 10 X 12 room in a 1200 square foot house would mean that 10% of the housing expenses would be a business expense.

 

The rules, require that if you claim a home office, then you have to depreciate that portion of the cost of the house, not including land cost, over 39 years. There are tables with the instructions for the 8829 to help.

 

When you sell the house, you will have to recapture the depreciation claimed as ordinary income, but it is no longer required to convert that portion of the capital gain on the sale to taxable income like we used to.

 

Home office deductions have become a useful tax deduction again. In your situation, it sounds like you would not pass the 100% use test.

Mary Rosenblum

I also use a portion of the main living space in my downstairs, but there is nothing in it for anyone

 

to do! No TV, no couch/sofa bed. Just a monitor, printer, and LOTS of ms!

 

And reference-filled book shelves. John lets me call it an office.

senicynt

I probably would not pass the 100% use test. This house is also on a reservation and probably different rules apply. the land can't be sold, etc.

John Caton, CPA

The key to it being an "office" is that it is not used for anything except writing related activities. Actually, being on a reservation should have no effect.

chatty lady

I bought a computer, printer and all the supplies needed when I retired my typewriter to make my writing faster etc. Is that deductible as a writing, business expense? I save ALL receipts.

John Caton, CPA

As long as these items are used for the business, it should be all right. Do remember, that items with a longer useful life than one year has to be depreciated.

 

I will give you the short version of what could be a long answer. Any long lived assets, such as computers, printers, desks, chairs, file cabinets, fax machines, etc. are to be depreciated over 5-7 years. There is a Form 4562 and a set of tables to work with here.

 

There is a Code Section 179 that allows you to take a full deduction as long as it does not create a loss for the business. There is also a bonus depreciation that is allowed of up to 50% of the purchase price that does not have that limitation.

 

A full explanation of how this is done would take too long. Suffice it to say the IRS has a publication that will tell you more than will want to know. The other choice is to have someone else prepare your tax return for you.

Mary Rosenblum

Ha! I know MY limitations! Which is how I got to know John! :-

lmel

Are library memberships (for research access) deductible?

John Caton, CPA

Interesting question. A public library probably not. One that specializes in some way so that it is unique, I suspect would be accepted.

Mary Rosenblum

Here's a variation that you may not be able to answer, John, but I'll try.

 

If you live in a very rural area with a limited public library, and you pay for an urban library membership because the rural is insufficient...could you justify that if you are documenting research activities?

 

I know we have some very rural attendees here with marginal library systems.

John Caton, CPA

Hmmm. This is a creative group isn't it. As long as you can document your use as being primarily for business use, I would be willing to argue the point. This is where that journal I mentioned early helps.

roe

So as long as I keep good records of all my submissions, postage, etc. and rejections I can claim the cost of the Long Ridge writing course?

Mary Rosenblum

Ha! I knew that question would pop up! :-)

John Caton, CPA

Continuing education is normal for any profession. It would be possible to point at that as an element of your intent to make a profit as a writer.

Mary Rosenblum

But you'd have to convince the IRS that you were in the business of writing first, right?

senicynt

What about perishables -- paper, inkjet cartridges, laser printer supplies, postage, stamps, etc. How are those deducted?

John Caton, CPA

Yes, you still have to establish your intent with a preponderance of circumstantial evidence that you are trying to be profitable as a writer.

 

Normal office supplies are just part of doing business on daily basis. But let me go on about another aspect of that.

 

There is an Internal Revenue Code Section 263A that requires any business that produces something to capitalize the costs to produce what they create and deduct them as their items are sold. There is also a sub section that specifically excludes writers, photographers, and artists.

 

This means you get to deduct your business expenses as they are incurred instead of being required to wait until you sell something. However, if you self publish, the exclusion does not apply.

 

The costs associated with printing the book are capitalized as inventory and expensed as the books sell. For instance, you print 100 books for 500$ and sell 40 of them in the same year. You deduct 200$ currently and show as inventory 300$.

 

As you can, anytime you deal with the Internal Revenue Code, it can just get deeper and deeper...just like some other stuff I won’t mention.

lmel

What about mileage for treks for supplies (ie. paper, ink)?

John Caton, CPA

Auto usage is something a lot of people overlook when they are working from their home.

 

Once you are established as a business, all the mileage from your home to meet with your agent, go to the bank with all those royalty checks, do research, etc can as business mileage and is deductible at .36/mile.

 

As with any other business, you have to keep records of the business use. You need to keep a log of the business use with the mileage so you can show, if you need to, when and where you went.

 

Once again, a journal of your activities can be of great use. When you first start, the burden of proof is more difficult. Once you have been published several times and have had some literary recognition, it is not so hard a sell.

Mary Rosenblum

I keep a spiral notebook in my van and write down trip, purpose, date, and miles. Fourteen miles to the PO, 5.6 miles to the Office Depot...etc.

katherine

I use my computer for my writing, but my husband uses it too. Is this deductible?

John Caton, CPA

Katherine, what does he use it for? If it is for something other than business use, then you have to determine what percentage it is used and only claim that portion.

senicynt

How would we deduct writing conferences? Is the plane ticket, hotel and conference, food, etc deductible or just portions of it?

John Caton, CPA

Generally, you can claim all the expenses as long as you can show the business connection. You need to keep anything that shows the agenda or workshops and that shows you participated.

 

Travel expenses are an easy target for an auditor because most people do not keep enough to show the business use. You should be aware

 

that only half the meal costs create a deduction. You are not supposed to enjoy them you know.

Mary Rosenblum

Is it worth keeping a diary of business conducted? For example, if you speak to Dave Hartwell, editor of Tor, and he invites you to submit your novel, that is a business transaction is it not?

John Caton, CPA

One other thing, if your spouse goes with you, their presence has to have a direct connection with the business to be deductible. It can't just be to be supportive of what you do.

lizzy

What about coffee, lunch, and writers workshops?

Mary Rosenblum

And taking agents out to lunch? Is it a straightforward 50%?

 

But workshops might be continuing education, yes?

John Caton, CPA

Writers workshops should not be any problem. Buying your agent's lunch, coffee, or whatever that is legal should also be fully deductible. Coffee or lunch for yourself when it is not an over night trip would be thrown out by an agent.

 

Meeting with other writers for coffee would be problematic. If it is regular get together, it could be argued. Then it would depend on the agent whether they bought it or not.

 

In any case, any food or entertainment costs are adjusted down by 50% on the tax return. Again, you are just not supposed to enjoy yourself.

 

A workshop fee would be continuing education.

Mary Rosenblum

So if you're going to a one day conference, pack a lunch!

speckledorf

How about child care for us parents of small children?

John Caton, CPA

Child care would be difficult to claim as a business expense. However, as a self-employed person, it may be possible to get a child care credit. There are few other conditions, but it is possible.

Mary Rosenblum

Would it make a difference if the writer was a single parent, John?

John Caton, CPA

Actually, it might be easier since one of the key rules is that the expense is incurred so the taxpayer could work and make taxable income.

Mary Rosenblum

Well, that's logical at least!

senicynt

:-) Can I make my children employees?

Mary Rosenblum

Actually, I've been trying to bribe my kids to copy edit for me for years! I'm terrible at it! LOL

 

Maybe I should offer 'em a contract.

John Caton, CPA

Hmmm! This is a creative crowd. For someone who is self-employed and reporting their income on Schedule C, it is possible. They have to be under 16 and you have to keep a good record(there is that song again) of what they do that supports your business.

 

I have clients who have auto shops where their kids helps clean up and put away inventory and it has worked fine. I am not sure what they would do for writer other than not to interrupt.

Mary Rosenblum

That's worth paying for! LOL.

elisabetam

Sorry for being late..maybe this was already asked..I’m NOT going to do my own taxes this year, what do I need to bring with me to a CPA?

Mary Rosenblum

Good question, Elisabetam!

John Caton, CPA

What you need to bring depends on how good a record keeper you are. Most accountants do not want to see a bag full of receipts.

 

If you maintain a separate bank account and some form of ledger, it would be a good start. Let me just add something I wrote up earlier.

 

There are many ways to maintain your financial records. The biggest trick is just to be organized. The simplest way to have a separate business bank account and related check register.

 

You could use spreadsheets to tabulate the income and expenses by source and type of expense. There are check register programs like Quicken and MYOB that can be used to record everything.

 

If you are comfortable with some form of accounting, then you could use programs like Quick Books or Peachtree. Your method of record keeping is dependent on your current skills and willingness to learn something new.

 

Whichever way you go, you need to have an organized filing system where you can find the receipts for expenses and sources of income for each year. A desk drawer or a corner in the closet just won’t do it.

elisabetam

Would they rather see an itemized list of what receipts I have?

John Caton, CPA

That would be very helpful. Your list should be separated into the various kinds of expenses i.e. office supplies, computer items, travel expenses, research expenses, and so on.

Mary Rosenblum

Let's see...think about how long it would take to ADD those receipts...multiply by a CPA's hourly rate... :-) I have an adding machine!

 

Actually, I'd like to mention here that every year, John sends me an extensive questionnaire...showing me what expenses I claimed last year

Mary Rosenblum

with a space for this year's value. Which helps non money minded head in a novel plot me immensely!

John Caton, CPA

I should point out that Mary does a fine job of it.

Mary Rosenblum

You're not looking over in my shoulder in my dining room in January, John. My dogs go hang out in the barn!

paja

Please give advice about setting up a program like Quicken for business.

John Caton, CPA

Quicken is an okay program. Keep in mind I am an accountant and a little pretentious when it comes to those kinds of things. The most important thing is that you have accounted for all you expenses, whether paid by check or cash.

 

Quicken does have the ability to set up multiple accounts to keep your business expenses separate from your personal expenses.

Mary Rosenblum

I'll mention my receipt filing system here, since I'm the quintessential 'can't be bothered to write it down now' type. I have an accordion file folder with many pockets. Receipt for office supplies goes here,

 

receipt for research books there,

 

dues for professional organizations here...and so forth. I add it all up when I get my questionnaire. Which is when the dogs leave town.

 

Messy, but more or less organized. Spread sheets intimidate me! :-)

 

(John is rolling his eyes...bet you!)

John Caton, CPA

Oh, but accountants love them. I guess we are a little strange.

Mary Rosenblum

Strange but necessary! Here are a couple of related questions, John.

senicynt

LOL... what if we are ambitious and prolific and send things out all over but are not accepted? Do we still qualify as a business or will the IRS say to develop a hobby that isn't a money hole? :-)

chatty lady

Is it true that a business can show a loss for up to three years (earn nothing) and still claim the same type of deductions?

John Caton, CPA

The tax code says you must have a profit motive. It does not say you must be profitable. Code Section 183 says, if you are profitable for three out of five consecutive years, you are presumed to have a profit motive and pass the test.

 

It was 2 of 5 years once, but they changed it. Once you have had three years of losses, then the burden of proof that you have a profit motive is on you.

 

There is a form you can send to the IRS that requests an extension for that test, but it is a little like telling them to "audit me". This is way I emphasized earlier the need to document every effort.

 

A short war story. A client had a business where he rented out sailboats. He had losses for seven years. He was audited every other year after the third year. We won our case each year because he kept

 

his journal, had a business plan, and was able to show he spent at least 800 hours a year in managing the business. He also had a separate sailboat for personal use. That didn't stop him from 'testing' the other larger boats though.

Mary Rosenblum

Good for your sail boat client! Good records MATTER! It occurs to me that a new issue is the self published or Print on Demand writer. While the IRS may be willing to believe that a writer is serious whose books are regularly out from a New York publisher

 

they may be LESS willing to take a writer seriously who self publishes, and may demand more proof of 'business'. Just a guess!

John Caton, CPA

Oh yes, this one went to tax court once, and the IRS settled out of court at no net loss to the client...except for fees of course.

 

A self publisher does have other issues to over come. They must be able to show how they can be profitable through the volume of what they print and how it is distributed.

Mary Rosenblum

Ouch. That is going to get sticky, unless the author is out there really publishing and promoting their work!

 

Something to keep in mind, if you publish with a house like iUniverse.

John Caton, CPA

A self publisher also has to deal with inventory values and costs of sales. They do have it more difficult.

lmel

What about claiming expenses for a trip (biking), intending it as the basis for a travel piece?

Mary Rosenblum

And is it different if the editor has requested the piece, rather than simply planning to write one on spec?

John Caton, CPA

I read a case a few months ago that would fit this to a T. It was a spec piece that did not sell. The tax court held against the taxpayer because he could not establish that he had a reasonable expectation to make the sale.

 

If he had been an established writer in the field of writing biking pieces or even general travel articles, he might have won. As it was, he had not sold anything before.

 

If it had been a commissioned piece or there was a written request to fall back on, it might have worked.

Mary Rosenblum

So this is a place where a track record in publishing does matter!

 

And for those without a track record

 

save that email or snail mail request or at least document the phone call!

John Caton, CPA

Once again, a journal of your activities and your attempts to be profitable matters.

chatty lady

What if your publisher is in Canada and promotes the book there, are tax laws the same in that case?

Mary Rosenblum

Or in France, she says, thinking of the euro's she's gonna receive for a story!

John Caton, CPA

Since you are located in the US, it will probably not matter. There is a tax treaty between the US and Canada, so you should be all right. France may be another matter. I will have to check out the treaty and see if they withhold on royalties.

Mary Rosenblum

Hey, at least they paid me for this work!!!

lmel

Any pointers on finding a CPA specializing in artists?

John Caton, CPA

The only way I know of is to just call and ask. I am not aware of any place that keeps track of that kind of list. Blatant commercial comment: I do have clients all over the states, from Mass. to Louisiana , California etc.

Mary Rosenblum

I'll back up your blatant commercial comment. John is a meticulous and excellent accountant!

elisabetam

How about deducting the cost of school when it is to change profession? (Not continuing education for a previous profession)

John Caton, CPA

This is a horse of a different color. Basic tax rule, if you are getting the basic education to get the credentials for any new line of work, it is not deductible. In fact, even if you are taking classes that may fit with what your currently doing

 

and those classes will prepare you for another vocation, they can deny the deduction. This is where judicious planning comes to play. I could go on, but it would be a bit lengthy.

chatty lady

I hope this isn't a dumb question but what if you've been writing for a year and now it's tax time. You've never filed on this business before, no income from it yet, but good records. Do you think it might be better to wait until you have an income, then file that year?

John Caton, CPA

Basic rule--no such thing as a dumb question. Many new businesses do not have a profit in the first year. Writing is one where it is common to not even have any income at all. If you are sure you could look at an auditor face to face and say you intend to be profitable and can back it up with records that show you are acting like a business, then go for it.

elisabetam

If not Quicken, is there a program that you prefer?

John Caton, CPA

I do prefer programs that act more like a general ledger like Quick Books or Peachtree. That being said, Quicken is not a bad place to start until things start coming together. The biggest danger with Quicken is common problem of personal and business expenses getting intermingled. It is a little like cousins dating.

speckledorf

I plan on hiring a full-time housekeeper one of these days...keep house clean while I work....how would that be counted?

Mary Rosenblum

Ah, what a lovely dream! :-)

John Caton, CPA

That is a tough one. I suspect an IRS agent would view that as a personal expense. Even if it does free you to do more writing, it would not have a direct connection to you being a profitable business...

Mary Rosenblum

Nice try! :-)

John Caton, CPA

If there are children involved and the housekeeper is a nanny, there is the possibility of a child care credit. A word of warning, once you hire someone, you have become an employer and have to withhold taxes and pay employers payroll taxes.

Mary Rosenblum

A couple of final questions, John, and we'll let you go!

 

You have been a great help! Lizzy had to leave, but she wanted to know if a photo of her office was sufficient proof to an IRS agent

 

that it's an office and not a spare bedroom.

John Caton, CPA

Photos have helped in audits. She just has to be able to convince the auditor (heaven forbid) that it is her office and not someone else’s.

senicynt

Hmmm. I am an IT support technician by day. If I take a certification course, the MSCE, is that deductable? It furthers my training but is also a promotion to Information Systems Manager instead of Information Technology Technician. (I know --- off topic! :-) )

John Caton, CPA

You probably have a 50/50 chance on that one. It is within the same industry and just adds to the base of your existing knowledge, but management is a little different. I would probably take the deduction anyway.

chatty lady

This has been very enlightening and helpful and I wanted to say Thank You!

Mary Rosenblum

Well, John saves my sanity every year! And probably keeps me out of jail! LOL. John, thank you so much for coming!

 

Taxes just aren't something you think about at first, but that mindset of 'I am a pro and a business' is critical! Even after you sell.

lmel

This has been terrific, very helpful! Thanks.

senicynt

Thanks for coming John.... remember all us members of your discount accounting group plan! :-)

Mary Rosenblum

Laughing, Sen! :-) I get him first!

 

It has been helpful, and you really answered a lot of questions!

John Caton, CPA

It has been a pleasure. Thanks for asking me.

Mary Rosenblum

I hope you'll come back next year. This is the sort of topic that I'd like to bring up regularly here.

Mary Rosenblum

And I had some questions that we simply didn't have time for. Next time! We'll let you go, and again, thanks!

John Caton, CPA

I just hope my wrists recover by morning. I don't think I have typed this much in years. I would be happy to come back.

 

Good night.

Mary Rosenblum

Thanks for coming, John! Good night!

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