Wednesday, February 9, 2011

I’ve earned money writing - What do I do now?

There are ways in which hobby (or sporadic) income and expenses/deductions are treated differently than those of a business and there are ways in which they are treated the same. It's important to know the difference because Congress and the IRS do.

First, all income from a hobby (or sporadic activity) or a business is subject to taxation. BUT, just how much and how it is taxed will vary between the two tax structures.

Second, all expenses/deductions used in a hobby or business MUST be reasonable and necessary, but how they are treated in the calculation for taxable income -- and even some of the forms used -- is different.

Ima Hobbyist not only earned money writing for her friend's business but she also received a Form 1099-MISC. In a panic, she called her friend because she had never seen one of these before and wanted to know what it meant. Also, she hadn't realized that she had made as much money as the document indicated.

Her friend calmed her down and advised her to talk with a tax professional. Ima Hobbyist said that she didn't know how to even begin to choose one of those since her return had always been so easy to do in the past. Her friend gave her the name of her own accoutant and advised Ima Hobbyist to contact her.

The accountant explained that a 1099-MISC form was issued for a variety of reasons to include reporting to the IRS money tendered to independent contractors such as herself, and that these documents were required when the total amount of money tendered/recieved at one time, or over a given tax year, was $600 or more.

Perplexed, Ima Hobbyist queried as to what an independent contractor was and the accountant explained that this is someone who provides a service to someone else or to a business, and who is not an employee of that person or business. (More discussion forthcoming on this topic in a future Blog.)

It was clear that Ima Hobbyist had much to learn even though she felt she had earned very little money over the year. Armed with the advice of the accountant, Ima Hobbyist set out to have a better understanding of just what she had gotten herself into. So, she went to the IRS website (www.IRS.gov) and downloaded the following publications, forms and instructions for tax year 2010 per the accountant's advice:

Publication 17 - Your Federal Income Tax
Form 1040
Form 1040 Instructions
Schedule A
Schedule A Instructions
Form 1099-MISC
Form 1099-MISC Instructions

She also downloaded Form 1099-MISC and the instructions for tax year 2011 since they were also available.

Dear Writer - you too should download these publications, forms and schedules (you may even want to print out the forms and schedules - the instructions can be 100's of pages so watch out) - AND grab a calculator because we're going to run some numbers just so you can see where the money flows on Ima Hobbyist's federal tax return and how her income is taxed. We'll also see just how much of her hobby income is taxed and how it affects the rest of her federal tax return calculations.

Get ready to run some numbers and have some fun!

Wednesday, February 2, 2011

Are YOU Writing as a Hobby or a Business?

The most obvious question is what's the difference between writing as a hobby and writing as a business - and that is indeed what this first blog is about. But you also might ask - why even bother caring about the difference between the two? Well, the answer to the second question is that the IRS cares about the difference because Congress directed them to care about it.

The fact that you write or that you call yourself a writer (or author) is irrelevant as far as the IRS is concerned. What does matter is whether or not you earn taxable income from your writing or deduct expenses related to your writing from your taxable income. Either of these will impact on how much you do or do not pay towards your federal, state, and sometimes local income tax obligations.

The first place to start to determine if you, Dear Writer, are a hobby or a business is to examine how you are behaving as a writer. Notice the word behavior, a word that implies that you have at least some control over your writing journey, and indeed you do.

So, let's look at how a hobbyist writer behaves.

Scenario 1:
Ima Hobbyist loves to write but isn't interested in making money from her writing. She mostly writes for herself. She has dabbled in writing the Great American Novel (GAN) but that's just a dream right now. Maybe when her kids are grown she'll take it more seriously, but right now it's just for fun.

In this situation, Ima Hobbyist has no tax obligations because she has not received income nor has she deducted any writing expenses on her tax returns from her taxable income.

Scenario 2:
Ima Hobbyist's friends found out that she loves to write and one of those friends has a small business and needs the occasional brochure or newsletter written for her business. Ima Hobbyist agrees to her friend's proposal that she become her scribe. Ima Hobbyist knows that her friend is just breaking even on her business so charges her very little for her services.

In the above situation, Ima Hobbyist is still writing as a hobby because she's not charging the fair market value for her services and only occasionally provides written product for her friend. In the lingo of the tax code, Ima Hobbyist is not demonstrating an intent to make a profit - a critical element of behaving as a business, regardless the trade. However, she now has to claim the income on her tax return. She can also deduct her expenses but only as a hobby which has stricter limitations than a business. (Stay tuned for this discussion in a future Blog - I mean real soon.)

Scenario 3:
Ima Hobbyist continues to write for her friend's business but this time she exchanges her writing services for some of her friend's products.

In this situation, Ima Hobbyist is still writing as a hobby but is earning money from bartering and must report the fair market value on her tax return. A future Blog on the different types of income writers can earn, including bartering income is coming.

So, Dear Writer, consider the scenarios above and see if any of them apply to you.

Next we will discuss how income earned as a hobbyist affects your federal tax return.