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:
-
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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