John Caton CPA: Writers and Taxes 1/11/07

Mary Rosenblum

Hello all!

Welcome to our Professional Connection live interview...the first of the new year!

I hope you're all enjoying the mild winter. Ours just reverted to normal Brrr.

I invited John Caton, my accountant, here tonight because all new writers wonder just how to handle taxes.

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 more than 1000 clients, including writers, musicians, 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.

Since I don't have the expertise to answer the tax questions I get, I called in the expert!  And now for a paid announcement by our Internal Revenue Service.  Since John is offering advice about tax matters, he is required to post this disclaimer put out in Circular 230 by the IRS…in essence it means; just because he said this, it is not a defense in tax court.   Here it is:

IRS Circular 230 Disclaimer: To ensure compliance with IRS Circular 230, any U.S. federal tax advice provided in this communication is not intended or written to be used, and it cannot be used by the recipient or any other taxpayer (i) for the purpose of avoiding tax penalties that may be imposed on the recipient or any other taxpayer, or (ii) in promoting, marketing or recommending to another party a partnership or other entity, investment plan, arrangement or other transaction addressed herein.

So,  now that we have THAT out of the way, John, our tax expert...and the man who keeps me on good terms with the IRS...welcome!

John Caton, CPA

Thanks Mary, It is always a pleasure

Mary Rosenblum

I won't tell anyone that I had to promise to get my tax infor in good time in order to get you to come here this time of year!

Ah, I see we've already received The Burning Question. So let's get right to it!

ashton

Welcome, John! When are you considered a writer in the eyes of the IRS?

Mary Rosenblum

Saves me having to ask it! J

John Caton, CPA

Okay, I have a bit of long answer so it will be a bit of read

Mary Rosenblum

We're patient.

John Caton, CPA

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 more than minimal profits for any three years out of a consecutive five years, it is a business. Otherwise, the burden of proof that an activity is engaged in for profit is on the taxpayer.

What this means is you have act like a business in order to be treated as one. If they decide you are really a hobby, then your expenses can only be deducted to the extent of your income. Just having some income does not mean you are automatically a business.

Let me give you a real life example of how you act like a business. 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).

They had documents that showed they were contenders for race prize money, the efforts to obtain sponsors, and parts dealing. All activities were elements of being in the industry. They also kept a log or journal of their activities and had a business plan. One element by itself is not enough to win the case, which we did.

The code does not say you must be profitable, just that you must be doing whatever a prudent person would do to get there. Now, as to how this translates to being a professional writer.

The most important thing you can do is to keep a record of all your activities. That means a log or a journal of some kind.

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 a 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 what you do relating to writing each day with an estimate of the amount of time you put in. This establishes how much time in a year you have put into your business and helps to record those intangible activities like contacting a prospective agent.

There is a test in another part of the code that considers 500 hours in a year as a minimum for being active in a business. There is nothing in the hobby rules that addresses 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 prior year activities and what he was going to do to in the coming year to become profitable.

There is a very hazy line between being an interesting hobby and being a business. The business of writing is hazier than most. You win this type of argument through the preponderance of evidence. You have to dazzle them with your brilliance.

Mary Rosenblum

Bless you, John, here is one of the best arguments for getting rejection slips that I have ever seen!

Actually I still keep that submission/rejection log as well as records of my calls/conversations with agents, publicists, and the like.

hauckston

Adding to that question, would you please insert the Canadian version, also?"

Mary Rosenblum

Can you help with the Canadian rules at all?

John Caton, CPA

I am afraid I am not well versed in all the Canadian rules. But my experience is that most of them are pretty close to the same.

Mary Rosenblum

It seems to me that the real key here is the record keeping. Saying 'I write' is not enough.

robastor

Does all of what you said about being a writer pertain to being a musician as well?

John Caton, CPA

When you are in a profession most people do not understand, you have a much higher burden of proof.

It pretty well applies to any of the arts.

jewel

I am wondering if I have to file separately or can I file jointly with my husband?

John Caton, CPA

You can file jointly. The self-employment income is reported on a Schedule C and SE which attaches and is included with the rest of the Form 1040

sailor

Last year was the first year I used Schedule C for my writing. I sold one article for and carried forward losses (for computer and furniture) of about ,000. This year, I my writing income was No further losses, but still carrying forward some old ones. I've documented all my submissions, rejections, acceptances, and time spent. Is the IRS likely to be suspicious?

John Caton, CPA

They have no reason yet to be suspicious. The rule is you are considered to be a business if you have net income for 3 out of the previous 5 years. The first two years are generally not a problem if there are losses, so if one of them shows a profit you are okay. I am concerned about the reference to "carrying foreward a loss". Generally, any losses apply to each year separately.

robastor

Could a regularly written blog page be considered the same as a journal?

Mary Rosenblum

What do you think about this, John?

John Caton, CPA

Af the Blog. That should qualify as a journal if it is specific enough. But, I would keep a hard copy somewhere. The IRS is not proactive in looking for proof.

Mary Rosenblum

Here's clarification on those losses from Sailor:

sailor

I used Turbo Tax. The losses were Section 79.

John Caton, CPA

Oh Okay. Section 179 deductions are allowable only to the point of breaking even. They cannot be used to create a loss.

dim writer

What is a loss?

Mary Rosenblum

Time for basic definitions, here. J

John Caton, CPA

A writer that has never experienced a loss. How interesting. A loss occurs when your expenses exceed your income. Most beginning businesses are in that position. When you are self-employed, any loss from the business is deducted against other income when it goes from Schedule C to the front of the Form 1040.

Mary Rosenblum

Some selling writers have been in that situation, Mary mutters.

robastor

To file my taxes, would it be a good idea to print everything out? Blogs, webpages, press releases; anything at all dealing with writing and music?

John Caton, CPA

I would not bother sending any of those with the tax return. They will most likely not only not read it, but throw it out. You need the back up only when you get audited. Preparing for the audit when you do the tax return is the most successful way to protect yourself. So keep those hard copy records.

jewel

How do you deduct the course costs from LRW?

Mary Rosenblum

I get asked this a lot.

If you're filing as a writer, is this deductible?

John Caton, CPA

If you are already writing and submitting, then you can deduct the cost as continuing education. If you are just getting started and have not submitted anything it is likely the IRS will treat it initial education for a profession and not allow a deduction. Just like a Bachelors degree is never deductible as it is considered basic education. Once you have joined the profession, the same course work can be considered furthering your ability to be profitable.

drake

Missed this one. I have done 2 courses from LRW, and do not believe the first was deducted. Can I go back this year and do it?

John Caton, CPA

You can go back two years and amend a tax return to get a refund. You use a Form 1040X.

Mary Rosenblum

As long as we're on this subject, Destiny8 had a question in the auditorium but couldn't get it up here. S(he) wondered if attending the forums and interviews here could be logged in as hours advancing the business.

John Caton, CPA

Absolutely! This is also a form of continuing education. You are learning more about the business side of being a writer. I have a client that had a business of renting out sail boats. We were able to have his time attending boat shows included as being active in a business.

Mary Rosenblum

There you go folks. Now you have reasons to submit and reasons to show up here. Make a note of your time here tonight!

drake

Isn't logging hours difficult though?

Mary Rosenblum

Do you have any suggestions for the best method to impress the auditor?

I have to admit that keeping logs can be a pain. But I have won many audits, including one that was taken to Tax Court, because the client keep an excellent log of all his business related activities.

Mary Rosenblum

I have a couple of questions about self publishing. More and more people are doing this.

info

What if a author self publishes through a Print On Demand publisher? Is that enough for the IRS if you publish that way in addition to submitting to regular publishing houses?

John Caton, CPA

By itself, going through a Print On Demand publisher will not win the day. There are a lot of hobbyists that are doing that. It is the preponderance of evidence that wins. So doing it all is what counts. Of course, if you sell enough self-published material, it might work. There is no clear cut measure.

drake

Last year I paid a subsidy press to publish a book and it is now in process. Would I be able to deduct any of that?

John Caton, CPA

This gets a qualified yes. If you are paying to have it printed, you are now a publisher as well as a writer. You can deduct the costs that relate to the books sold. You have to keep track of all your expenses for publishing If you have 100 books printed and you sell 40, you can deduct 200$.  The rest of the cost is part of your inventory and can be deducted when it is either sold or discarded.

ashton

So you just make note of the time you are here and the IRS will believe you? I mean, there's no real proof... but gosh, am I HAPPY to learn attending these forums is a form of continuing my education in their eyes cause I love it here! Cool! Do something you love and get credit for it.

Mary Rosenblum

And Destiny8 has a suggestion.

destiny8

Get a DayTimer -- Log all time daily, total monthly, easy.

John Caton, CPA

Nowhere is the Internal Revenue Code does it say you can not enjoy your work.  Do keep in mind that they have seen a lot of fiction in their own right. Your log or journal has be supported by proof of your activities.

drake

So I can deduct the money from last year? Sorry – I’m a bit thick as the book has just been layout approved and hasn't been printed yet but will be soon.

John Caton, CPA

If the money was to print something, it is deducted when you sell the books. If it is for other services such as advising you in some way, it is deductible when you pay it.

gail

My better-half and I are currently working jointly (on-spec) on non-fiction writing that sells best with photos. My guy takes most of the photos, while I do the written work. He works outside the home and, other than writing freelance, I do not have "outside" employment. Is it okay for me to claim the (as-yet) infrequent photography sales as my own income, or does my guy need to claim this as other income?

John Caton, CPA

This is a little touchy, but if the photo sales connect to your writing, you should be able to claim the income on your own Schedule C. The expenses do have to be paid by you to get the deduction.  Otherwise, he has a business of his own and should report on his own Schedule C

robastor

Filing for the first time as a writer/musician, which form do I use?

John Caton, CPA

As a self-employed, you use Schedule C and Schedule SE to report your income and expenses. The Schedule SE is used to calculate your self-employment tax. Self-Employment tax is Social Security and Medicare for the Self Employed.  The SE tax is calculated on your net (after expenses) income. The rate is 15.3%.

robastor

Should I save all expense receipts with those hard copies of pages? Don't send copies with the tax return?

John Caton, CPA

I would save receipts as well. They are your proof of your expenses. Do not send any to the IRS as it will not matter at that point.

info

What about things such as paper, pens/pencils, memory sticks or other data storage devices? Beings they are a part of my writing ventures, would I be able to deduct them as business related?

John Caton, CPA

Certainly! Any direct expense is allowable as long as it is primarily used for the business.

robastor

If I'm using the Internet as my primary tool to sell and promote myself, is the monthly charge something I can deduct?

John Caton, CPA

As long as your primary use is for the business, yes. I would suggest not taking the entire amount as there may be some personal use involved and the IRS likes to see people take that into consideration.

Do not forgot about other expenses like research costs and travel expenses.

Mary Rosenblum

Speaking of travel expenses:

gail

I aspire do some travel-writing. What, if any, travel expenses could I deduct, and is that dependant upon whether or not the article sells?

John Caton, CPA

Travel expenses are interesting and like walking a tight rope. If you can connect the travel with your work, it is deductible. Aaron Elkins writes mysteries located through the Northwest and the world. Since the locale plays an important part of the story (it is obvious he has been to the various locations), then I have no doubt he has deducted his costs.

The costs of anyone accompanying him would most likely not pass the same test. It does not matter if the article sells as long as you can prove you did everything possible to sell it.

newbewriter

If I have a web site and pay monthly fees are they deductible?

John Caton, CPA

If the web site is about you as a writer and is a method to promote yourself and your work, then it should be deducible. I did have to caution a client when he told me he was trying to expose himself on the Internet. There are some limits.

destiny8

I photograph for NF articles. Submit just the best. What Xf film and processing cost is deductible?

John Caton, CPA

As long as all you shoot is to be considered for submission, then you should be able to take it all.

Mary Rosenblum

I think we'd better open the 'home office' can of worms here. J

dim writer

If you have a home office, can you deduct anything on that?

John Caton, CPA

A home office can be deducted if it is used 100% for business use. The expenses that apply are rent, mortgage interest, property taxes, insurance, utilities, repairs and maintenance. The square footage of the office as a percentage of the total space available is applied to get the deductible amount.

Mary Rosenblum

But that means it can't have a daybed, and that extra chest of drawers in it, right?

John Caton, CPA

The 100% test is the one that most people fail. A kitchen table doesn't work. A separate room usually works as long as it is not used for anything else.

Auto usage is another deduction that can yield great benefits.

You must keep a log of your use including what the trip was for and the mileage. The easy deduction is using the mileage at  $ 0.44 per mile for 2006 and for 2007. Since your place of business is likely to be your home, any time you leave to go to the post office, or (hopefully) the bank, or to attend a  conference or workshop, do research or anything else where the principle reason for the trip relates to the business will count. The record keeping is a must.

Mary Rosenblum

Isn't there now a medical deduction, too?

Mary Rosenblum

for auto use I mean?

John Caton, CPA

There is a provision for a medical deduction for mileage. I believe it is now at $0.18 per mile. Not much.

Mary Rosenblum

Rob asked this question right after you commented on the photo expenses being deductible if the photos were submitted for publication.

robastor

Would the same apply to making a music video?

John Caton, CPA

I can not say I have seen that done, but the principle is the same. You produce something for sale, the cost is deductible . The only problem I see here is that the IRS would likely treat it the same as feature length movies and consider your costs as inventory and let you deduct it only when sold or discarded.

robastor

Does the expense of hiring a promoter fall into the deduction guidelines you've talked about?

John Caton, CPA

Yes it does. If you are paying them a fee for services, then it is a current expense and deductible.

robastor

So, a video used for music promotion falls outside the deductions, correct?

John Caton, CPA

So much depends on what is being produced. If it is a promotional item where all it does is to try and sell something, them it is a current deduction. If it is a music video that is to showcase the music and is available for sale such as any you see on TV, then it becomes inventory. This is assuming you are trying to sell multiple copies of the video. As you can see, there is a fine line here.

gail

This may sound frivolous, but....if I wanted to attend a conference, I would need some "professional-looking" attire. Would that cost be deductible if I used the attire only for professional events?

Mary Rosenblum

Now here's an interesting question!

John Caton, CPA

Unfortunately, the only clothing that is deductible are uniforms. Anything that can be considered normal street wear, is not accepted.

A court case involved a woman who managed a high fashion house in New York City. She was required to buy and wear the type of clothes they sold. She deducted $5,000 as a business related expense because she did not normally wear that type of clothing except on the job.

She lost the case because she could have worn the clothes anywhere and no one would have known where she was employed or what she did.

Mary Rosenblum

Whew. Boy would I have kicked myself....

sailor

I know someone who claimed depreciation on his house because of his home office. Can't that come back to haunt you if you sell the house later on, such as increasing the capital gains?

John Caton, CPA

Good thought! But it is an old rule now. Congress, in one of their many "fixes" of the code, changed the rule a few years ago to where the business portion of the house does not come back to bite you...

too hard anyway. Any depreciation claimed does get recaptured in the sale and generate taxable income. The appreciation on the business portion is now considered to still be personal residence appreciation and likely to fit within the or exclusion.

sailor

Re penalties, isn't it true that the IRS considers an improper deduction as a "slap on the wrist" violation, but they get really irate if they find you not reporting income? I know penalties apply either way, but hiding income can get you into tax court.

John Caton, CPA

They are on a ''quest" to catch under reporters of income. In either case, if the amount of adjustment is too much or if they consider the error to be an intentional act to disregard the rules, they can add some pretty hefty penalties.

It is not likely you would go to tax court unless you fought the penalty that far.  A basic rule of tax planning: Pigs get fat, Hogs get slaughtered.

jewel

I am a full time RVer writing about RVing and I am writing about this. Can travel expenses be deducted, such as RV park costs, because I will be mentioning them?

John Caton, CPA

As a full timer, your tax home is your RV. So the only expenses that would be allowable would be those over and above your normal costs. Of course, you do have a home office issue. The problem is there likely not enough room to have a space dedicated 100% to business. It is possible though.

gail

From a "recovering" (Canadian) accountant, I've just got to say, I LOVE your sense of humour! Nice surprise (considering some of the extremely dry accounting conferences/seminars I attended.)

Mary Rosenblum

Take a bow, John!

John Caton, CPA

Thanks. I never try to take myself too seriously. Besides, life is too short.

Mary Rosenblum

This one sounds a bit complicated, John. To me anyway!

drake

My husband paid for my schooling and I haven't worked in nearly six years. He also paid for the subsidy publisher, we file jointly, how would we do this?

John Caton, CPA

Hmmmm, let me think a moment

First of all, I am not sure where the schooling comes into this. As far as reporting for taxes, it is a joint tax return and it does not really matter who pays as long as the expense is business related. I assume you are already reporting as a self-employed writer, so the expense would show on your own Schedule C. If the expense is to print your book which you will be selling, then we are back to the inventory issue talked about earlier.

Mary Rosenblum

John, I did have a couple of questions I was sent by email. Let me pop them in here before you expire of finger-exhaustion!

This is  from Janelle: How, or do you, declare contest prizes you won if they aren't money? For example: a trip, or membership in a particular organization? It couldn't really be put on your 1040 as income.

John Caton, CPA

Prizes are considered income. A trip has a definite value and the contest operator is supposed to provide the winner with a Form 1099 to show the amount. It is supposed to be to you by Jan. 31. Membership in an organization may fall under the diminimus rules where the value is not more than $25 and would not be income. If it does not relate to a business, then the income is reported on the line for other income.

Mary Rosenblum

I have one final email question from Mary Kay here:

Does he have any suggestions how to document deductions and expenses since banks (or some, including mine, unfortunately!) now do not return cancelled checks?

Gee. My bank doesn't either.

John Caton, CPA

This Check 21 business is a real pain to accountants. I won't say where. It is a problem. Most banks will provide photo copies of checks with their statements. That would be the best you can do these days. Otherwise, it is a matter of maintaining a good check register and keep the bank statements that show the checks were cashed.

The receipts for the expenditure becomes even more important now. Those are the only record of what the expense is for. The IRS is aware of the problem and are trying to be more accepting of this limitation.

Mary Rosenblum

Or use a credit card? Isn't that an acceptable paper trail? If you keep your statements?

dim writer

Separate accounts? Home and business?

John Caton, CPA

A credit card is a good record of the payment. You must keep the statements as part of your financial records though. I am amazed at how many people throw them out as soon as they pay it. Yes. Thanks for bringing that up, dim. One of the best things to do when you are operating a small business is to keep the income and expenses separate. A separate bank account and credit card are a must. Otherwise, it is easy to get things mixed up. Besides. if you are a business, you have separate business accounts.

hauckston

In the future, banks are working on a system whereby you can go online and see an image of your check saved in their archives and the Canadian system will be ready for that phase in about six months... still working on it.

Mary Rosenblum

Actually my credit union has that.

You can see both sides of the check.

On last question and then I'll shut off the tap here! J

gail

I mainly use my business-account's debit-card for purchases, and keep the store receipt. However, debit slips fade quickly. Will the receipt, and the bank statement (which indicates the pertinent debit,) be sufficient if audited years later?

John Caton, CPA

Normally, audits occur within 6 to 18 months after the return is filed. So you shouldn't have to worry about years. Between the bank statement and receipt, you should be alright anyway.

Mary Rosenblum

John you have been great! Thank you so much for being so patient with us all.

tolkienlvr

Wow, this is a great forum! Super information! Thanks so much, John!

ashton

We sure appreciate you coming tonight, John. We've learned a lot.

hauckston

Thank you both, Mary and John... very informative.

Mary Rosenblum

It was a great forum!

Thank you SO much for coming and now I have to get my tax info in to you. :-)

dim writer

Thanks John.

John Caton, CPA

If there are more questions, they can be sent to Mary and forwarded to me. I can answer them by e-mail.

hauckston

thank you for sacrificing yourself for us Mary

Mary Rosenblum

LOL!

That's very generous of you, John.  Good night and have a good tax season!

And thank you all for coming.