Sunday, October 13, 2013

What do you mean that's taxable!

Before we delve into the tax consequences of earning income from your writing as a hobby, let’s first discuss what the IRS (and statutorily backed by Congress) identifies as income.

Per IRS Publication 525, Taxable and Nontaxable Income, income is defined as that which is received, “…in the form of money, property, or services.”  Furthermore that income is generally taxed if it is “constructively” available to the taxpayer whether it is in the taxpayer’s possession or not.  Moreover, this applies to all income received worldwide and not just in the US or its territories.  Additionally, all income is subject to taxation unless specifically excluded by law or IRS ruling as identified in IRS Publication 525.

So, let’s look at some examples of different types of income that you have the potential of receiving as a writer.

In the previous blog one of the scenarios illustrated a situation where Ima Writer helps her dear friend, Ima Small Business Owner, produce her first newsletter.  Her friend doesn’t have much money so she offers Ima Writer some of her product instead.  This is technically considered a bartering transaction and, at a minimum, is subject to income tax.  Ima Writer constructively received product in exchange for a service of producing a newsletter and must include the value of that product on her individual or business tax return.  Her friend must also reflect the transaction on her individual or business tax return and we’ll come back to that in a later blog as we progress in Ima Writer’s journey.

If Ima Writer’s friend had paid her a small amount of money instead, say less than the going rate for a freelancer’s fees to produce a newsletter, then that money would still be considered income but because it was less than the going rate it would tend to classify Ima Writer as a hobbyist because she didn’t intend to make a profit and the low payment supports this – for the most part.  Still, she must pay income taxes on the money received and we’ll discuss this further when we walk through how this shows up on IMA Writer’s federal income tax return as a hobby.

Let’s say that instead of product Ima Writer’s friend offered to advertise her writing services to other businesses via her store and the newsletter.  This is now an exchange of services and again subject to the federal tax rules.  The trick here is figuring out the Fair Market Value (FMV) of the services and how to report the income on a federal tax return.

In another example, Ima Writer decides to send off a manuscript to a publisher and receives an offer of publication and accepts.  She receives an advance and eventually royalties on the publication of her first novel.  This is considered constructive income.  It’s important to note that the term royalty means something different in the IRS code than it does in the publishing business but there is at least one example when these actually mean the same thing in both arenas and that will be discussed in the future.

Stepping away from the world of writing for a moment, and in an attempt to further illustrate the concept of income as something other than actual money, let’s examine a more familiar situation where two people exchange services.  Two parents decide to exchange watching each other’s children while they run errands, go on social outings, attend classes, etc.  You get the idea.  It’s not difficult to figure out what the going rate for a “babysitter” is.  Just look it up on the internet for your area or try to find someone who will provide child care in your home or theirs. While no money actually changes hands this is a bartering transaction and the exchange of services is a taxable transaction.  Whether or not it has an impact on either person’s tax return depends on the rest of their tax and financial profile, which is something a tax professional can determine.

Regardless of how the income is categorized and how it is reflected on Ima Writer’s tax return, Ima Writer needs to keep detailed records on all income and expense transactions.  Yes, you guessed it, we will be covering record keeping in detail throughout this blog.

So, I hope you’re not getting motion sickness on this windy and bending road of the business side of writing.  Hang in there it will make sense eventually and remember that it’s important to consult a tax professional if you have any questions regarding your specific tax situation and how your writing endeavors do or do not have an impact.

Next time we will run some numbers on the impact of hobby income and expenses on Ima Writer’s federal tax return.  In the meantime, here’s a research assignment:

-          Access the IRS website at www.irs.gov
-          Review and/or download IRS Form 1040 Schedule A and the Form 1040 Schedule A instructions
-          Review and/or download IRS Publications 529 and 535
-          Pay particular attention to hobby income and expenses and the 2%-of-adjusted-gross-income limit.

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