“The Tax Man Cometh” with John Caton

                                           Thursday, July 29, 2004

Mel is Mel Boring, moderator of this chat with John Caton and web editor of the ICL site.

John is John Caton, a Certified Public Accountant with Caton, Day & Company, CPAs, PC.  In his practice John specializes in income tax, and also in serving people who work in the arts.  John Caton understands us writers’ particular recordkeeping and taxpaying needs.  He is simply the best person to ask any questions about the records we writers need to keep, and how to handle our income tax return for minimum tax payment and maximum allowable deductions.  John Caton speaks the language of writers, having many of them as clients.  We sent John questions submitted in advance; and tonight he will also answer questions from people in the chat room.

Green shows the user names of the people and their questions asked of John Caton.

 

Mel: Thank you for coming out tonight to chat with us in the ICL Chat Room. Our guest, John Caton, is neither a writer nor an editor, BUT he is the main person you want to hear from about the dilemmas of April 15th, that "fearsome holiday." If you have read John Caton's previous interview with Mary Rosemblum at our sister site of the Long Ridge Writers, you know you are in for a problem-solving evening. I know about John's busy days at his office because I've talked with him on the phone, yet found him to be an open and welcoming person. I really appreciate your coming to our chat room tonight, and the taxtime-relieving answers and tips I know we're going to get from you. WELCOME, John Caton, to our ICL Chat Room!

John: Thanks, Mel, I appreciate being asked.

Mel: John, did you at any time in your youth decide to become an accountant?

John: Actually, I had not even considered it. While I was in college, my Physics and Chemistry professors suggested I look in some other directions if I wished to continue using numbers. I never blew up anything, but I did have my own lab bench to myself.

Mel: HA! It occurs to me to ask now, have you done any creative writing?

John: I have to admit I have done some scene writing, but nothing serious. It does take a bit of time to do it right

Mel: You're right--and in your scene writing we can see "roots" of writing! To many writers, their writing is just a hobby, John, but to us here tonight, it is a business. What is the difference, as far as our taxes go, between a hobby and a business?

John: I thought you would never ask. It is probably the most important question that is dealt with tonight. 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 Internal Revenue Code 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, so there is an audit.

We provided documents that showed they were contenders for prize money, their 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 may not 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 submission 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 state, 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 it helps to record those intangibles like contacts for an agent.

There is a test in another part of the code that uses 500 hours 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 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.)

Mel: BE long winded, John, it’s a good wind for us writers.  So, to satisfy the code, just basically, we have to show SOME kind of profit--income more than outgo—every three out of five years, and be working on our writing for 500 hours a year??

John: That is the ideal. Reality can change that. The reason for the journal and other records is show your intent to be profitable.

KM asked: You have recommended elsewhere that we have a business plan to be part of what proves we are a business. What exactly is in a business plan?

John: This can be a long answer, but I will try to do a Reader's Digest version. A business plan can be a very formal document if you are putting it together for some financial institution. Since you are doing this for yourself, the IRS is not going to expect to see anything so formal. It is nothing more than putting down on paper what your objectives are and how you think you will reach them, and most importantly, how much income you can expect to make.

For instance, you could say you plan to write one novel and twelve short stories during the coming year and note how that this can be done by writing X number of hours a day. You then indicate how often and to where these will be submitted for publication. If you need to do research for these stories, that should also be included. A realistic expectation as to time lines between submission, publication, and payment would be helpful.

You should also include a look back to the prior year analyzing what your goals were, what you accomplished, and a critique of how you are going change the coming year due to what you have learned. There must be a clear indication that you have an expectation of making more money than it costs you to produce your stories. Obviously, the longer you are in the business, the more detailed and knowledgeable the annual plan will be. Don't worry if it seems less than perfect the first time through.

KM also asked: Any other key things we should address in a business plan?

John: It is difficult to give specifics since every situation is different. The basic elements of a plan include an analysis of what you have to work with, what you are trying to achieve, and how you are going to get there. Plans in following years should look back at the prior years’ goals and analyze what went right or wrong and what you learned from it.

KM asked this question, too: Do you have a recommendation for a book with good examples for making a business plan?

John: I have not found a book that gives examples for artists. Most libraries carry books on business plans as a reference.

Mel: Maybe a good book for one of US to write!

MS e-mailed to ask: Can we really count all the expenses of our submissions and rejections as tax deductible?

John: Yes. As long as you can maintain that you are or are trying to be a professional writer, you can deduct all your direct costs and some indirect costs on Schedule C of Form 1040.

MS also asked: Can we really make deductions for telephone expenses and coffee for a phone interview we do for a nonfiction article?

John: Telephone expenses are deductible, but with some limitations. A phone line and accessories that are used 100% for business are 100% deductible. Cell phones can qualify. A home line is not deductible except for identifiable long distance charges (including those little taxes) and any accessories like an extension, answering machine or add-ons like call waiting. I should add that there are court cases denying deductions for the basic expenses of a home phone. It is only the extra costs that are allowed.

Expenses incurred to do research are deductible. This includes your costs to acquire the materials as well as travel costs to get them. Most people forget to keep track of their mileage when doing research, let alone going to the office supply store. That Starbucks you buy someone while interviewing them is an entertainment expense, unless you are writing about the coffee. If you are just buying for yourself while interviewing on the telephone, I am afraid that would be considered personal and non-deductible.

Someone else asked this basic and practical question: How do we classify ourselves as a writer on the IRS form--which number code do we use?

John: Professional writers report using NAICS code 711510 in box B of Schedule C, Form 1040.

Mel: Thanks, John, your answers are VERY practical and detailed! Here’s a question from one of our many Canadian friends:

paige: Hi John, I am Canadian. Recently I was asked to provide an ITIN number. I applied for and received one from the U.S. IRS. I have sold several pieces of literary work to U.S. publications and was asked only to provide a completed form W-8BEN to receive U.S. tax exemption. Why do I require an ITIN number for some companies and not others?

John: The highest probability is that some companies don't know to ask.

Mel: Here's some messaged appreciation for you, John:

catlady: Thanks, John. Your business plan answer was very helpful!

Wee Willie Winkie: When do you start keeping books for your writing career—while you are still trying to get published or after?

John: There is no time like the present. As long as you are making every reasonable effort to make a profit from writing and can demonstrate that intent and the extent of your efforts through your records, you can have deductible expenses even if there is no income. Of course, this can only go on for a couple of years before they begin to wonder if it is really a hobby.

Wee Willie Winkie: Besides payment and debt, what else do you include for headings in your bookkeeping? Example: writing supplies, traveling expenses, etc.

John: There is no penalty for having too many categories of expenses. The tax form calls for a lot of detail. Travel expenses has other subclasses such as lodging, meals, and transportation. Communication costs such as part of your internet connection, telephone, and postage can be separated. As a tax preparer, I have found it easier to combine accounts or classifications than to split them out. Oh yes, if you must use a "miscellaneous" account, keep it very small. The IRS really does not like them.

Wee Willie Winkie: What do you do when you run a second business (day care)? Do you file separately for each business?

John: When you have more than one business that are dissimilar in nature, you include a separate Schedule C for each one. The net income or losses are combined to calculate the self-employment tax and income tax.

Mel: You answered a Canadian earlier, John. Doda from Scotland e-mailed to ask if there would be relevant accounting information for her tonight, or would it be mostly US-based information. Is there by chance anything at all you could tell her about her Scottish Income Taxes, John?

John: Unfortunately, I believe what I have to say has primary relevance to US taxes. Although I have had some exposure to UK Inland Revenue issues, they have not involved anyone self-employed…yet. However, I suspect there is a common approach to who is in a business and who is in a hobby there.

Mel: Faith and begorra—thanks, John!

catlady: If we are considered a hobbyist, but making money, not profit, but money, at what point do we report it as income?

John: The rules say that all your income is reportable even if it is from a hobby. The difference is that a business can take deductions in excess of the income while a hobby cannot.

Mel: So, if I understand it, do we report income AS SOON AS it exceeds expenses? Or can we take a loss (for two years) if expenses are more?

John: Not really. You are supposed to show your income when it is received. They don't care if you report all your expenses or not. If they determine that you are really a hobby, they can go back in time and deny the losses you have claimed. I have not seen them do that, but they can. There is a safe harbor for two years where your expenses can exceed income and they will not make any adjustments. There is a regulation that allows them to do that, but they can still go retroactive if they feel there never was any intent to make a profit.

Mel: A clear-cut answer—thank you!

Hope Marston: When you do programs without charging, such as for the local Head Start or some other organization you deem worthy of your time, is there any legitimate way to note that on your income tax forms? Is there some spot that would take care of "in kind" services?

John: Let's see, good news first or bad news? The bad news is that the tax code sets the value or "tax basis" of our time at zero. That's why all of our wages are fully taxable. I am sorry to tell you that our time spent in charitable activities, even if using our professional skills, is not deductible. Believe me, I wish it were different. Unfortunately, all we get from our time for charity or community service is a good warm feeling of being good citizens. But good for you for being involved in your community.

The good news is that, at least, your out-of-pocket expenses are deductible. It is arguable that they are business “promotional” expenses depending on the circumstances and the recognition you get. They are at the very least charitable deductions, your expenses.

Mel: Here is another e-mailed question, similar but with further details:

DS: I am a fulltime freelance writer and have filed taxes as such for the past 5 years. I also do some pro bono work—writing copy for my local park system, campaign materials for a school levy, PR materials for a not-for-profit bike club, and a kid's writing seminar in a local elementary school. Can I deduct this from my taxes as a charitable contribution, and if so how? (I assume I'd figure the amount of time spent at my regular hourly rate, right?) Where on the tax forms would I claim that?

John: Unfortunately, it is the same answer. Our time, no matter how valuable, cannot produce a deduction when given away, even for the best of reasons.

Mel: Sad, but TRUE, I'm afraid, from my experience also.

massite: Are writing contest fees considered deductions?

John: Interesting question. If you can establish that your are in the business of writing and the contest has either a cash prize or enough prestige, I suspect it would be an acceptable expense.

catlady: So, let's say I make this year, have no other income, but my spouse does, I add it to our income. Do magazines then give me a 1099 (Isn't that the regular employee form?) Then I would include that instead of a W2?

John: If you receive a Form 1099 for a fee for a story, you would report that on Schedule C of Form 1040. Then you can show your expenses to offset the income on the same form. That is form used by anyone who is self-employed. If you have no other expenses, you can add it to the other income line on the 1040. A bit of a warning though, it could still be subject to the self-employment tax.

caq: Couldn't DS (who asked the questions a moment ago about pro bono work deductions) accept the amount in payment and then give it back to the people the pro bono work was for as a donation, and then deduct it as charitable donation?

John: Oh yes. Yes, but the income is reportable and may be subject to the self-employment tax, while DS only gets an itemized deduction, assuming it is enough to itemize. In most circumstances, it works out better to not have the income. The best you can get is a break even on it.

caq: Do writers have to pay out quarterly estimates for income tax installments as I did when I was self-employed doing desktop publishing?

John: The answer is yes. There is no difference in the rules. Frankly, being a writer who has to worry about estimated taxes is good place to be.

massite: If one wins writing contests or scholarships are they still considered a hobbyist?

John: Yes. A hobbyist can still have income which is subject to tax. Scholarships might be excludable depending on the situation.

massite: Scholarships won through writing, are they reported as income?

John: It depends on whether the scholarship is a prize or if the writing is just to qualify. There are some variables here that I would need to know to give a definitive answer.

caq: How do you go about estimating what your taxes will be if you have no idea how much you will make? I always overestimated when I did the desktop publishing.

John: I have been in this business 34 years. Estimating future income has always been more of a SWAG than anything else. You know what a SWAG is? A Scientific Wild Ass Guess!

caq: Is there any way around the quarterly payments? Are they quarterly or month-wise? You pay before you have even made the money.

John: Predicting income is difficult, but it is better to overestimate than to be under. Too many penalties. The basic rule for estimated taxes is to have as much tax paid in throughout the year as your prior year tax. Technically, you are supposed have at least 90% paid in. The 100% of prior tax is just a safe harbor to avoid penalty. You can owe another $100,000 as long as you meet the safe harbor. The payments can be in form of "quarterly" payments or withholding from wages of a spouse.

Mel: Here's an excellent basic question:

caq: I am thinking that those who have not done the quarterly payments may not know what they are and when they are paid, so for them, could you explain it?

John: Everyone is to prepay their taxes either through withholding from wages or by making periodic estimated deposits. The deposits are to be made by or on April 15, June 15, Sept 15, and Jan 15 of the next year. Now if you notice that these are not exactly even “quarters,” you are right. There are two 3-month quarters, 1 two-month quarter, and a four-month quarter. Don't ask me why.

Mel: So EVERYone pays their taxes ahead of time, either through withholding or with ETPs, it sounds like.

John: That is the rule.

realityczech: Can I deduct the mileage to and from a Writing Critique Group meeting? Do I need exact odometer readings or just the round trip value times the number of trips? If meetings are held at a restaurant at mealtime and food is involved, are those expenses deductible?

John: Mileage to workshops is deductible. I found in audits that reasonable estimates based on good records like an appointment book is acceptable. The meal is generally not deductible unless it is business meeting like with your agent. A casual meeting of writers who talk shop may not pass muster.

tkat_2: How much money does a writer have to earn before they can claim it on their tax return? For instance, does the amount of time a person spends on the computer researching or writing count like paper and ink for the computer?

John: The tax code says that all your income is taxable unless another part of the code says it isn't. Any payment you receive for writing is reportable. There is no rule that says anything below this amount of income does not have to be reported. In fact, it is best if there is some income reported to support your claim that you are in the business of writing. The time you spend writing or researching is not deductible. Keeping a log of the time you spend on the process does help when arguing with the IRS. One distinction between being a hobby and a business is how much time you put into it and what you do with that time.

Mel: Here is what I THINK is a legitimate writer's deduction, John, which may be helpful to some, which I only learned about late in my career. When I TRAVEL to research, I keep mileage for expenses, and take food expenses if I have to be away from home, and parking expenses, as well. I have to make a 300-mile round trip to the BEST library in Iowa here, and I keep close figures on all expenditures for those trips.

John: Don't forget the lodging expenses. You can also take expense such as laundry if incurred on a business trip overnight.

Mel: GOOD suggestions, thanks!

caq: Sounds like writers don't get the "lunch expenses" other business people so often use, is my observation.

John: Actually, the so called business lunch is overrated. They have to show in their records that business was conducted in order for the lunch or other entertainment to be deductible. As writers, you can do the same. It is just a little harder because of the nature of your business.

pathway: What does a new writer need to be aware of regarding taxes?

John: The best advice for someone starting in the business is to learn to be a record keeper. I know that is a little like herding cats, but I haven't lost an audit yet when the client has kept good records.

isabella: Is there a book you can recommend that covers basic tax laws and other pertinent information?

John: I am afraid there are no simple books out there. There have been some attempts such as Taxes for Dummies 2004, but there is no way to simplify something that Congress has worked so hard to...well, never mind the editorial thought.

Paulette Koon: While taking a writing course from the Institute of Children's Literature, I have purchased oodles of books for present and future reference, along with a used laptop to aid me in writing. Can I write any of this off as a tax deduction even though I am not planning on taking the credits given for the course in writing for children?

John: Reference materials, continuing education expenses, travel costs for the education, and equipment are all deductible. Travel expenses such as mileage, parking fees, lodging, and meals are included, although described as what they are and not as education expenses. The meals are deductible only if you are away over night for a course. The equipment has to go through the process of the depreciation rules (Be sure to have aspirin nearby if you are doing you own tax return!), but you can get a deduction for it. I will give you a 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 100% of the cost as long as it does not create a loss for the business. There is also a bonus depreciation that is allows 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 you will ever want to know. The other choice is to have someone else prepare your tax return for you.

Paulette Koon: When we start sending manuscripts off to the publishers, are the supplies, postage, and etc. tax deductible?

John: Costs for submitting manuscripts and for preparing them are all part of your costs for being in the business.

Paulette Koon: Can you suggest anything ELSE that we might overlook as a legitimate tax deduction for writers?

John: We have already touched on most of the basic items. The most important thing is the record keeping. Once you have started, you should open a separate bank account to help with the record keeping. Using a separate charge card is also advisable. Creativity is not limited to your writing. Aaron Elkins, who writes mysteries, sets his locales in various places of the world. Traveling to those sites and keeping a journal of notes for the book which are incorporated as a plot element makes for an interesting argument for deducting the entire trip.

Mel: Great tips, John!

caq: If you are at a book signing, the only expense would be travel, not the time, correct?

John: Correct!

oma: Is it best to file a joint return or individual return?

John: Usually, it is best to file jointly. The tax rates and limitations on some deductibles when filing as "married filing separate" are not good. There can be reasons to file separate, but none of them would apply here."

realityczech: At what point are we required to begin making the estimated quarterly tax contributions? IF a writer is paid for the first time by a magazine in August, say, do they need to pay the quarterly amount by September 15th? Is it possible to lump any/all payments together and pay one time on April 15th?

John: It is possible to wait until April 15, but if you do not pass the 90% of tax on deposit test or 100% of prior year tax on deposit, then there could be an underpayment of estimate penalty.

Mel: Here is a good and practical tip from cup.

cup: I use QUICKEN to keep records. Easy to learn and use. I can set up all the categories I want. At tax time I just take my printout to our tax consultant.

John: Quicken would work for your situation since there is no need to track specific assets from year to year, but it doesn't work for other kinds of businesses.

caq: If I ride along on one of my husband's business trips and do some writing during that time, can I deduct my food if I do research at the place we are going to, their library, etc.?

John: The food would be deductible only if you are away overnight. Otherwise, it is considered a personal expense. The primary purpose of the trip does have to be for the research, at least your part of it does.

catlady: Regarding coffee or a meal as a deduction. You said if it is with your agent, but what if it you are interviewing someone over coffee or a meal?

John: If you are interviewing someone for material for an article, then it could be considered an entertainment expense.

realityczech: When can we deduct a writing course? In the year we paid for it only? Upon completion/graduation? Once we have started writing as a business?

John: This is not an easy question. Generally, education to prepare you for a profession is not deductible. For instance, my college tuition was not deductible. However, you are in a business that does not have education requirements other than to be able to read, write, and think. If you have already started writing and submitting, I believe the tuition for such a course would constitute continuing education and be deductible. Oh yes, it is deductible only in the year it is paid since you are a cash-basis tax payer.

shirlanne: Do you have to depreciate a computer, say under $2000?

John: Yes, but there are ways to accelerate the deduction through code section 179 or the use of the new bonus depreciation rules.

caq: Just a point, I may be wrong, but if you deduct computers, printers, phones, home space, don't they have to be used solely for your writing and nothing else? If that is true, wouldn't it be wise to have your own internet connection?

John: True, in order to get a deduction, the equipment has to be used virtually 100% for business use. They do allow some minimum use for personal purposes, but it has to be pretty limited. A separate internet connection is ideal.

Mel: One last short question:

massite: Is there a listing of deductions for writers somewhere?

John: I once saw a publication put out by the IRS, but right now I cannot recall the number.

Mel: They could search the IRS site for it at: http://www.irs.gov.

John: I have a question for everyone else. How do you write for hours and not have your hands fall off at the wrist?

Mel: Ha, GOOD question for us, John! I guess writers assume any of our guests types daily, so I hadn’t thought about the fact that you probably don’t type much in your business.  I might suggest a voice activation program if you do end up typing a lot. J  Who knows, perhaps you might’ve caught the writing bug here!

John Caton, the time has swifted along, and we are at the end of our chat. Thank you so MUCH for the often-confusing things you've explained so easily, and for the tax tips you have treated us with this evening. We appreciate your taking time to be with us today. And I wonder—

except for your busy tax times—could we get you to come back another time someday and help us again with that taxing April 15th?

John: I would be happy to come back. If anyone has questions later, Mel could just forward them to me and I will get back to you.

Mel: That is VERY gracious of you, John, thank you!

I want to make clear the DATE of our next Guest Chat, with Katherine Paterson. It will be on THURSDAY, AUGUST 12, rather than the day before that, as previously announced. On August 12, Katherine Paterson will be coming to chat with us in what I know will be a very rewarding talk for children's writers. Katherine has won the Newbery Medal TWICE, and with very worthy books you'll want to read if you haven't already: Bridge to Terabithia in 1978, and Jacob Have I Loved in 1981. Katherine's The Great Gilly Hopkins (my favorite!) was also a Newbery Medal Honor Book in 1979. So we welcome you back two weeks from tonight to chat with this immensely talented children's writer, who is also very kindly and personable lady.

Mel: John Caton, thank you again so much for being with us tonight. I know that I, for one, am going to rest much easier around next April 15th because of all the suggestions and tips you have given us. We wish you well in your business, and may next April 15 be "less taxing" for you in your business as well!

pathway: Thank you.

tkat_2: Thank you for coming. It was a pleasure.

massite: Thanks for the info.

John: You are all very welcome.

Mel: Goodnight, Everywriter!