Don’t muck things up

John R. McCarthy —I’ll call him Johnny—retired from Rocketdyne, Inc. He’d worked as a scientist and engineer for 35 years writing technical and scientific proposals. Thereafter, he still worked, but was self-employed, utilizing his prior experience.


On various Schedules C, Johnny listed his “principal business or profession” as writing, investing, job shopping, art, engineering, science, consulting, teaching, photography, and research. (A bit unfocused, eh?) Johnny stuck some royalties, interest income, and lecture fees characterized as business income on the Schedule C pertaining to writing. Despite asserting that he used those resources to pay for writing expenses, such income didn’t derive from any writing he had done. Johnny should have reported these royalties and fees as “other income” and the interest income on the interest-income line on his tax return.

The court said that Johnny’s expenses which truly related to writing couldn’t offset such income which didn’t come from writing. Everything Johnny did made it look like he was confused and undecided. To use a cliché, Johnny was a jack of all trades and a master of none. The expenses he listed on various Schedules C related to his writing activity all right. Writing was the only activity he really engaged in with regularity. Concluding that he should have reported everything on a single Schedule C pertaining only to writing, I’ll bet you’re not surprised to hear that the court concluded that he lacked a profit motive. He hadn’t generated any writing revenue. While aspects of his activity were managed in a businesslike manner, Johnny couldn’t explain how he expected to recoup his substantial losses. A sound, focused business plan and accurate and complete financial and non-financial records could have helped—both in making his business profitable and in convincing the IRS he had a “profit motive.”

Don’t muck things up. Forget trying to disguise income from other sources as income for expression activities. That’d be crazy. Keep records—business and non-business—that present operations clearly, completely, and succinctly. Remember the bard’s advice: brevity is the soul of wit. Mind your debits and credits if you use them. If not, don’t scrimp on accuracy, meticulousness, and using the data germane to and used in conjunction with a vibrant, viable and compelling business plan. Make it crystal clear that you have a plan to succeed as a writer—that your goals show that you plan to be as successful as J. K. Rowling or Dave Barry. If you’re convincing enough, you’ll never have to worry about convincing the IRS that you’ll recoup your losses.


Non-financial records should include databases of contacts, customers, and consultants, along with their pertinent information. If you’re a writer, you should keep track of the hours of your writing, researching, and editing. You should have a database to show details about your submissions, including the title of the work, where you submitted it, the date, follow-ups, responses, sales, etc.
One further thing: keep your expression activity records separate from personal records and other business records. Have separate expression activity credit cards, debit cards, checking and savings accounts, and accounts at your favorite vendors. If you have more than a single proprietorship, don’t ever intermingle them. Doing so may subject you to ridicule.

. . . plan well and follow your plan . . .

To start a business, you need a business plan. A resource for the essential elements of a business plan can be found online at the United States Small Business Administration. Also, you might want to check for business planning ideas from writers' sites online .


A great business plan and the IRC (Internal Revenue Code) have something in common. Like a great classic, every time you reread it you find something new. This is not because, like a great classic, your business plan is timeless, but because it’s dynamic. It’s a work in process, a series of actions, changes, or functions bringing about a result. Plan on it.

Just remember, Congress plans. It plans on some people and businesses paying taxes—but not everybody. It takes intricate legislative planning to allow certain contributing constituents of political parties to avoid taxation, but not others. Often when the public discovers hidden taxes, Congress’s solution is not necessarily to do away with the concealed taxes, but to hide them better. In similar fashion, you have to plan well and follow your plan to show that you are in business to make money, whether or not you have made money yet or not.

Is My Expression Activity a Trade or Business?

Guess what? Federal income tax law and related regulations don’t define what “trade or business” means. Surprised? You shouldn’t be. I told you there was plenty of mystery in taxation. Ambiguity, it seems, is intentional. Some wit compared an income tax return to a girdle. You put the wrong figure in it and you can get pinched.


Tests to check if a trade or business exists stem mostly from court opinions (primarily from the United States Tax Court or from appeals made from those decisions ). Courts have developed two key definitional elements, one for “profit motive” and the other relating to the “scope” of the activities.

Finding out the motive is a key element in figuring out a mystery, right? A trade or business doesn’t exist unless a taxpayer “enters into and carries on” an activity with a good faith intention to make a profit or in the belief that a profit can be made from the activity. Money is the motive—bottom-line profit. That means you have cash left after all expenses are paid. Faith that an activity will generate a profit doesn’t need to be reasonable. However, simply hoping and wishing it will be profitable absent specific plans suggests that you lack good faith.

Remember the cold-fusion fiasco? The notion that oodles of cheap atomic energy could be produced cheaply and “coldly”? Too good to be true, right? Well, one Burnet Outten, Jr.—I’ll call him Bernie—representing himself without an attorney, took his tax controversy concerning cold fusion and graces relative to it to the U.S. Tax Court in 1984.

Bernie seemed a bit “unusual.”

He didn’t file federal tax returns from 1972 to 1979, for one thing. He had an interest in Western Metal Products Company (Western), a manufacturing concern. Besides manufacturing, according to Bernie, Western conducted atomic energy research. Yet Bernie was the only company participant in such research. Ostensibly, an experiment in 1951 resulted in nuclear fusion. Bernie, however, didn’t “realize” that nuclear fusion had occurred in 1951 until 1961, while doing further research. Bernie purported that Western repeated the 1951 experiment in 1971. Neither Bernie nor Western ever patented any such process.

Bernie believed that the world was created by cold fusion. He seized upon the alleged religious significance of the creation of the world by such process. His legal briefs contained extensive arguments about scientific experimentation and religious freedom. They explored history from Thomas Jefferson to Ronald Reagan and from the Bible to reports of the Atomic Energy Commission.

Over the years Bernie often attempted to inform scientists and government officials of his miraculous “discovery,” asserting that it was never duplicated. Some commentators expressed polite interest; others found it . . . well, a joke.

Neither Bernie nor Western received any filthy lucre, let alone profit, from said nuclear fusion “process.” No income relative to it was reported. Western’s income, if any, came only from manufacturing. Nonetheless, by 1978 Western established a $50,000,000 book value for this fusion “process.” On 1977 through 1979 tax returns, Western listed net operating losses of $100,000, $10,000,000, and $5,000,000, respectively. The preparer of the return described these losses as a “write-off of capitalized research work.” Bernie concluded that a grace was justified because government officials ignored him and his “discovery.” It was strange. Sort of like the President of the United States releasing his tax returns which listed the economy as a liability and write-off.

During the audit Bernie listed various actual expenditures—small amounts—that he made during the years involved. He gave the list to IRS. These included mostly expenses for his home office and for his move. IRS attorneys acknowledged that the expenditures were made by Bernie, but scoffed at them falling within any acceptable grace. The Tax Court concurred, saying that Western faced “a multitude of obstacles.” The court focused on just one: profit motive. It said that no income was generated nor was any likely to ever be generated from the fusion activity.

Well, let’s face it. Bernie’s circumstances were “singular.” His mistakes cost him more taxes. He was like a conservative president deducting right-to-lifers as dependency exemptions, accepting his election as a gift, and trying to write off the losses in Iraq. Nonetheless, something can be learned from Bernie’s case. As a man of religion once said, “If you make a mistake, all is not lost. You can always be used as a bad example.” So let’s use Bernie’s case as a bad example. It can teach us what not to do. I’ll summarize some points below and expand upon them in chapters to follow.

First and foremost, figure out how to make money from your expression activity. Have a profit. Bernie didn’t make any money from cold fusion. Make a written plan setting forth how you plan to make a profit from your expression activity. Follow it. If it doesn’t make money, change your plan so you think it will after the change. Keep following the plan and revamping until you make money or decide you can’t make money. If it comes to that, your expression activity becomes increasingly difficult to sell as a trade or business. Eventually, it becomes almost impossible to convince the cynics at IRS.

Second, keep complete and accurate records, both of a financial nature (you know, dollars and cents, checkbooks, receipts, debits and credits, etc.) and non-financial records (like submission databases, contracts, business plans, correspondence with agents, diaries or journals, etc.). From the opinion of the Tax Court in Outten v. Commissioner, it doesn’t appear that Bernie kept very good records of his activities, does it?

Make certain that your expression activity has substance. Don’t be naïve like Bernie was by boasting it hadn’t been duplicated when duplication was the very thing that may have given it some scientific credence. Know the ins and outs of your activity and know how to communicate them.

Another thing; don’t try to hide your expression activity results for tax purposes within some other, perhaps more viable enterprise on your tax return. For instance, it looks as if Bernie tried to make his cold fusion activity transparent by burying it in the Western partnership operations. If you write fiction part time and work as a lawyer most of the time, don’t bury the profit-and-loss statement of your fiction-writing activity within the profit-and-loss of your law practice. Doing so makes you look like a cheat and a ditz. Don’t do it. It’s not savvy. They are separate activities, for pity’s sake.

To be or not to be; that’s the question. To be a trade or business there has to be enough business activity and profit objective. Get them and you’re home free. Such are measured objectively . . . well, that’s what the laws and courts say, anyway. Tax shelters, for example, often have neither sufficient business activity nor profit objective. Many therefore receive no graces. To be certain, a trade or business can exist with no profits in the early years (and sometimes none are earned for many years and yet a court approves), provided there’s a prospective profit sufficient to cover the losses. You don’t have to expect that profits from your expression activity will come immediately or within a short time, but your aim to profit must be genuine. If challenged, you have to be able to persuade the IRS or a court. If you’ve stacked up $100,000 or more of losses over multiple years, you have to be able to convince the IRS (and if not the IRS, then a judge) that your expression activity will earn enough not only to make an annual profit but to recoup your prior losses.

Blood From A Turnip

Our prospective Vietnam traveler, Doug, who was mentioned in prior postings, works as an administrator for wages (“W-2” income ). His employer pays him what’s left over after withholding federal employment and withholding taxes, among other amounts. Law requires his employer to withhold and pay over taxes on behalf of Doug. Almost everyone is acquainted with working for wages and has complained about withholdings. It’s not that the government doesn’t trust us, but it’s a pay-as-you-go system. And of course, they don’t trust you.


So Doug has income. The critical question now, though, is whether Doug’s prospective costs in traveling to Vietnam to get pictures to use in a potential picture book relate to activities that generate his wages. The answer is no, the two activities don’t relate. At most his wage income facilitates Doug’s going, but that’s all. There’s no link between his administrative job and his potential trip to gather photographs. Any income related to a picture book is only speculative.

On the other hand, suppose Doug has previously written other things and sold them or won prize money for his writing. Maybe he uses those revenues to fund his trip. Now we begin to see a closer connection. Maybe Doug pitches his picture book idea to an agent or editor and he gets positive feedback, and he has a contract, implied or otherwise. His writing is an activity, separate and apart from administrating for an employer, and has a closer connection to his prospective picture book-making activity. So now, assuming Doug finances his trip to Vietnam from revenues from his writing activities, is he home free in deducting those expenses?

One of the IRS auditors who sent many taxpayers my way to appeal his extreme exactions (and extractions) of more tax had a morbid sense of humor. He’d say, “Invariably my taxpayer will pick the thing up and turn it over. You know, trying to figure it out. It looks sort of like a misshapen hourglass, don’t you think? And instead of sand it has that dark-red, almost purple, viscous fluid in it. The thing just sits there on my desk, across from me and close to them, while I go through their bank statements, receipts, and canceled checks. Taxpayers become bored. ‘What’s this?’ they eventually say, picking it up.”

“And what do you tell them?”

“Blood from a turnip.”

As you can imagine, timid taxpayers don’t laugh at such morbidity. Nevertheless, those engaged in expressive activities like you need to know that hidden traps can humor sinister auditors when all you want to do is to deduct the costs of creating a book design or a picture book trip.

Grace? No, not that girl!

Faced with the immensity of the IRC --- the Internal Revenue Code---, it’s no wonder that tax consulting and preparation businesses thrive. Most productive people, especially those in business for themselves, rely on CPAs, enrolled agents, public accountants, attorneys, and other professional tax preparation businesses and firms (and some not-so-professional). Everybody knows what H&R Block and J.K. Harris firms do. Many have relied on firms like KPMG, perhaps to their everlasting chagrin.


The U.S. Legislature and the Administration, no matter what party runs the government, promise tax simplification. Without equivocating, they have “simplified” income taxes and related forms beyond understanding . . . especially for those unwilling or unable to spend time and attention—significant time and considerable attention. Where do you fit in relative to this scheme? Let me give some scope to Doug’s quandary—or yours. Our tax system is premised upon a simple notion: income. All income, from whatever source derived, is taxable (IRC §61 ). If you find money hidden in the workings of the old piano you plunked on as a girl when you visited Aunt Betty and that she bequeathed to you, such money is income to you. Not only is the money in the piano income, but so is the value of the piano. And if you trade your knowledge of graphic design to a friend, promising to help with a brochure in exchange for him moving your inherited piano, guess what? You’ve got it. The value of the exchange is income . . . to you and him. It’s the old cliché; they’ve got you coming and going.

“Whoa,” I hear you saying, “that doesn’t sound right. I don’t think my folks paid any tax when they inherited that money from Gramps.”

Well, that’s where “grace” comes into it—not your old girlfriend, Grace, but grace, the disposition to be generous or helpful; goodwill. No matter who’s running the government, they want to be seen as generous and helpful. To be seen that way, but not necessarily to be so, that is. So when there’s a hurricane and consequent flooding, elected officials wander out hoping to be seen as bighearted and taking control. (The judiciary is a little different; they want to be perceived as erudite, fair and just.) In any event, the legislature grants some generosities to be helpful with the tax system and the administration also puts its stamp on them, grudgingly or not. It’s often nothing more than a sophisticated exercise in social engineering. Grace is often granted to the rich and powerful, a special interest group, or to some “special” situation. It all must have some semblance of equity and fairness.

All income is taxable, but by grace allowances are made. One grace eliminates the value of that inherited piano from taxation. Freelancers like Doug or you or me have lots to consider. First, do we have any income? If not, it’s moot; it is, after all, an income tax. We don’t need graces with no income. But if we have income, it’s important to consider its source. Why? Well, the graces generally relate back to the source of the income. That piano’s value is not taxable because lawmakers decided inheritances wouldn’t be taxed.

How about the money hidden in that piano? What does its taxation depend upon? I hope you’re saying, “Whether or not the legislature granted a grace.” Well, in this case there is no grace. The windfall is taxable.

Dizziness, Nausea, Regurgitation, and Loss of Consciousness

The novice, new to a sustained expression activity, is reminiscent of the neophyte writer who enters an IRS taxpayer service site to get help with a federal tax question. In the foyer she sees a small sign: “Tax Help.” Above it is a much larger poster with myriads of arrows pointing in every conceivable direction. However, there’s no clue where any of the arrows go. Two other separate arrows on separate signs are clearly marked: “Audits” and “Collections.” Clearly they don’t involve “Tax Help” and also don’t point where anyone wants to go.


In this blog, I’ll make it clear where the crucial arrows go and how best to avoid or prepare for ones clearly labeled pointing toward audits and collections.

Now, a crucial question for you: do you have a business plan for your expression activity? If you want results, you must plan. A plan allows you to look ahead, allocate your wherewithal, concentrate on key points, and prepare for problems and opportunities. Planning is vital for operating a business, whether you’re just starting up, getting a new loan, or making or soliciting a new investment. Plans facilitate optimal growth and development.

If, at this stage, you’re still trying to figure out if you’re a writer, if you’re still just focused on that first novella, a third sculpture, or perhaps only your second book design, then by all means now is possibly not the time to read this book. On the other hand, if you begin to see the glimmer of possibilities of succeeding as an artisan of expression and getting significant tax benefits as you start up, then stay tuned.

Some wit coined a term, intaxication, used to describe the stupefaction caused by the Internal Revenue Code (or IRC, as it’s known in the profession—otherwise referred to by some snooty attorneys who look down on it as Title 26 of the United States Code ).

In the Fall of 2005, I worked every day with the IRC at my side—my version published in 2004 contained 9,390 pages—and five volumes of similarly sized Treasury Regulations, necessary to explain the IRC. That’s over 54,000 pages alone, none of it what could be described with a straight face as a “good read.” Not only that, but the text in the IRC volume was fifty-fifty size-eight and size-six fonts.


Immediately across the hall from my office resided a vast library of books containing further explications, opinions, and tangential laws related to the IRC, bless its little (and I mean tiny) heart.

A friend told me when she was small and her mom took her to the town library, she dreamed of reading every single book in it. Only the most sick-of-soul person dreams of reading all the volumes in that tax library situated across from my former office. Such would result in inebriant effects: dizziness, nausea, regurgitation, and loss of consciousness. I confess I’ve suffered the effects myself.

Don’t be naïve like the anxious taxpayer who was visited by a revenue agent. The agent completed her audit and presented a proposal for a lot more taxes. It seems the taxpayer had claimed costs of a vacation trip for his entire family to Hawaii, arguing that he needed to personally experience snorkeling in order to achieve realism in his television drama Nowhere to Be Found. The agent evangelized as she watched the taxpayer’s eyes and mouth widen as he reviewed her proposal for more taxes and penalties. “You know, Mr. Taxpayer, it’s a great privilege to live and work in the USA,” she said. “Citizens have an obligation to pay their fair share. And we really expect you to pay with a smile.”


“Thank God,” said the taxpayer with a guffaw. “I thought you’d want cash.”

This blog will try to give you answers, the statistics, the possibilities, the strategies. Not only that, but I hope it will entertain you too, relieve your worry, and banish your anxiety by teaching you the best strategies for managing your freelancing business as you express yourself—making the process literally less taxing. Sit back and relax when the IRS calls. Change the IRS acronym from Internal Revenue Service (or as many taxpayers call it, the Infernal Revenue Service) to: I’m Really Sorry, IRS . . . but I don’t owe those taxes.

What Does It All Mean?

Such questions as were posed in yesterday's posting characterized the cases of myriad taxpayers who appeared before me during my career as what was once stiltedly called an “appellate conferee.” That title gave way to the simpler “appeals officer.” But what didn’t grow simpler during my career was the Internal Revenue Code. It has grown thicker in every conceivable dimension.


Well, while you’re thinking about Doug’s chances, think about this. On March 3, 2005, Peter Jennings wrapped up the night’s newscast by saying, “Finally here this evening, one very large tax bill. The government says it has never seen anything like it before. Walter Anderson, a multimillionaire businessman, appeared in a Washington, D.C. court today, accused of failing to pay more than $200 million in taxes. The government alleges that Mr. Anderson used several elaborate schemes to hide his considerable income. It's a lot of money.” Anyway, that’s $200,000,000 smackers of taxes, indeed a lot of money. Any normal person would ask himself: with government going after the likes of Walter Anderson and getting that large a return on their investment in resources, why would IRS operatives even care if Doug deducts the measly costs of his trip to Vietnam to get pictures depicting oversized loads on motorcycles?

On August 29, 2005, the IRS reported that the accounting firm KPMG LLP (KPMG) had admitted to criminal wrongdoing and agreed to pay $456 million in fines, restitution, and penalties as part of an agreement to defer prosecution of the firm. In addition to the agreement, nine individuals—including six former KPMG partners and the former deputy chairman of the firm—were headed for criminal prosecution in relation to the multibillion-dollar criminal tax fraud conspiracy. The fraud per the IRS and Justice Department related to the design, marketing, and implementation of fraudulent tax shelters.

Again, does it make any sense to worry about the IRS devoting resources to Doug’s crummy little Vietnam trip? Even if—shame on him—he takes his family with him and deducts their costs, too? Why should the IRS care about Doug when it can get the kind of return they have on KPMG? Or the return they possibly got on KPMG’s clients, who claimed billions of dollars in tax benefits from the fraudulent tax schemes and all owed the tax back plus interest and penalties? We’re talking about billions of dollars. What’s the risk to little old Doug of the IRS throwing its resources after him for deducting one lousy trip to Vietnam? Not much? A lot? Somewhere in the middle? And if the IRS does go after Doug, what’s the risk to him that the IRS will prevail? How much will it cost Doug? Does he risk serving jail time? And what about monetary fines or penalties? Is he at risk? What about his reputation? He is, after all, an aspiring author on the possible precipice of great things. Could the publicity help him?

All good questions. Many things for Doug to think about, to learn, to consider and ponder before he puts the costs of that trip on his profit-and-loss statement on a Schedule C and attaches it to his Form 1040, exposing it to the potential ravages of a dreaded IRS agent or auditor. And maybe, just maybe, those answers and many, many more important ones like them, both for Doug and for you, are just as important as finding a perfect simile or eliminating an unnecessary gerund, finishing the last chapter of your novel, entering that disquieting contrapposto or portrait in an art contest, or acquiring an agent to sell your work or a gallery to display your sculptures.

What does it mean to carry on the freelancing of expression in a businesslike manner? How does a person maintain a complete and accurate set of books? How important is it to consult advisors and have expertise? How much time and effort does a person need to expend in the actual conduct of freelancing? Does anybody care? Questions. Many pertinent and probing questions for every freelancer of expression.

The Aspiring Writer or Artisan or Freelancer

Every month—more or less—aspiring writers escape. They flee marital and parental responsibilities, leaving kids, parents, spouses, significant others, and even debilitated relatives behind for a few hours, maybe even escaping work by taking leave, or excusing themselves from a social obligation. All of this they do in order to go to a nearby bookstore, a library, a community center, or someone’s home to meet with peers in writing leagues, critiquing groups, associations, and organizations . . . so driven because they enjoy conveying themselves in words. They want to share and refine their expression.


If you are one such writer, this blog might be for you. If not, it’s probably not, unless you’re an artisan equally devoted to your medium.

This blog is for writers and artisans of expression, the plodding, diligent, have-to-be writers and artists of every ilk: fiction or nonfiction, sculpting or painting, technical or escapism, poetry or journalism, photography or graphic design. Yet it’s not for writers and artisans now supporting themselves entirely through their writing or artistry.

Some who get out in this manner to such meetings or to a show or exhibit each month more or less are published, or their works are shown or represented, and, possibly, they are “known.” Some are earning their entire support or supplementing their major sources of income by writing or by selling their talent or artwork. However, most attending such types of meetings are wannabes: they want to be published, they want to be exhibited, they want to be paid, and they want to be successful. They want to profit.

Amongst the tens of thousands of these wannabes are thousands on the cusp of moving from wannabe to winner. Or perhaps they’ve been a winner and fallen off the podium but are back on the cusp of winning. This blog is written for those on the cusp. It will help teach them strategies to succeed and, in doing so, make their expression activities less taxing. It will show how to avoid an assessment from the IRS, claiming your activity is a hobby. It will show you how to mitigate mistakes in operations that may get you in trouble with the IRS.

Office in the Home

Most writers I know plan to do their writing, at least most of it, at home. So I guess if you consider your writing activity a business, the temptation is to deduct every household expense you can conceive of as a business expense. After all, you work at home.

But you need to be careful and be aware of the rules. Remember, tax law distinguishes between what is personal and what is business. Generally, rent, mortgage payments, repairs on a residence and the like are not deductible. They are considered personal living expenses. You have to have some place to live. In tax administration such expenses are usually personal.

In order to get a business deduction for the use of your home you must use part of it (1) exclusively and regularly as your principal place of business, as a place to meet or deal with patients, clients or customers in the normal course of your business, or in connection with your trade or business where there is a separate structure not attached to the home; or (2) on a regular basis for certain storage use such as inventory or product samples, as rental property, or as a home daycare facility.

Now, the assumption is that you're working as a proprietor, not as an employee of someone else. If you are an employee who receives a W-2, in order for you to claim a deduction relative to the use of your home you must be able to prove, in addition to the other things mentioned above and talked about below, that the use of your home is for the convenience of your employer and that the portion of the home so used is not rented by the employer.

Now let's talk about all of that. First, exclusivity. Note that. It means entirely. It means you don't use it for anything else. Supposedly, you don't eat there, cook there, or do your wash there. You write there. Now, I know there's going to be someone out there who is a freelance writer who specializes in writing articles about cooking and producing cookbooks or some such thing. And they are saying, what about me? My writing about cooking and producing cookbooks entails more than just putting words down on a piece of paper or in a computer. Okay. I can buy that. But it's more likely that you use whatever area you use for cooking as an adjunct to your writing also for personal purposes. Where do you cook your meals that you consume? Or that your family consumes? The more you look for exceptions to what "exclusive" means in this way, the more lack of clarity it has as to "exclusivity" and the more chance you have of having it questioned.

Regular use means that you use the area for your writing on a regular basis, not incidentally or occasionally. Regular versus incidental and occasional. That's the test; only regular use qualifies.

 

Gabriel the Comedian

In February, the United States Tax Court issued an opinion in the case of Gabriel J. Loup. Agents or auditors of the Internal Revenue Service had determined that Mr. Loup owed more taxes for his 2003 federal income tax return than he had reported or paid. The dispute revolved around his entitlement to claimed business expense deductions. IRS said he couldn't deduct expenses he had wanted to. Gabriel represented himself before the court; he didn't hire an attorney to represent him.

You have to be careful of the judge you get. In this case, Gabriel drew a judge named Wherry. Now, that has to give you pause and make you wary, doesn't it? Some might say it should be enough to let the case go and not argue it. Anyway, I suppose Gabriel didn't know he would draw that judge and decided to proceede anyway. Afterall, Gabriel aspired to a profession in comedy.

Yeah, Gabriel wanted to be a standup comedian and actor. He had some experience to tell the court about. As a matter of fact, in October 2002, he had signed a contract with the Morgan Agency for a one-year period. The agency would act as Gabriel's agent for some television commercials. Gabriel also had a regular job. He was licensed as an intensive care unit nurse and worked as a pharmaceutical company representative.

Gabriel said he became a member of the 9 Layer Dipz, a sketch comedy group, in 2002 or earlier. The group, 9 Layer Dipz, wrote, produced, and directed its own comedy shows.

On his tax return for 2003, Gabriel claimed deductions on Schedule A that totaled $16,704, $12,811 of which were listed as "job expenses and most other miscellaneous deductions" which actually represented $13,761 of expenditures limited by two percent of Gab's reported adjusted gross income for the year. He detailed the expenses on an attachment, a Form 2106-EZ, used for deducting unreimbursed employee business expenses. He also stapled an explanry statement to his return.

The first thing that should be noted is that Gabriel's tax return preparer put these expenses on the Schedule A and then detailed them on the Form 2106-EZ erroneously; they should have gone on a Schedule C. The preparer, it appears, didn't know what he was doing.

During the trial, Gabriel and the IRS argued about whether his activity relative to comedy was a hobby or not. Of course the IRS said it was a hobby and Gabriel said it most certainly wasn't. Most of the evidence Gabriel submitted was intended to prove that the activity wasn't a hobby, but most of the evidence he had also postdated the year at issue, 2003. Eventually, IRS gave up on the hobby issue, conceding it, and argued that Gabriel wasn't in a business yet as a comedian so he couldn't deduct the expenses. It basically said that Gabriel had only done his comedian routines sporadically up to the end of that year and, therefore, it wasn't a going concern. It said he failed to substantiate the expenses and said many of them were personal and not business expenses.

Gabriel provided four advertisements for 9 Layer Dipz but none of them indicated which year they pertained to. Some of them did provide the day and month of a performace but not the year. Gabriel said at least one of them pertained to 2003, but the advertisement itself said it was going to happen on a particular day, a Wednesday or some such, and that particular day on that particular month in 2003 was not a Wednesday. Ah oh! Also, it became apparent that Gabriel had created a log that didn't coincide with anything else and appeared to be made up. Double ah oh!

The evidence indicated that all of Gabriel's performances with 9 Layer Dipz occurred in 2004 not 2003. Even the contract Gabriel had entered into in 2003 was not helpful because it didn't establish that he had ever performed as a comedian or actor in 2003. The court concluded Gabriel had not demonstrated active involvement in acting or comedy in 2003.

Gabriel lost his case because he didn't have his facts straight, didn't have his evidence properly lined up, wasn't entirely prepared, didn't have a business plan, and probably another few dozen reasons that could be listed. Preparation precedes power. If you're not prepared, don't expect to have any power to persuade a revenue agent or a tax auditor, or, for that matter, the United States Tax Court over agains what an agent of the IRS says.

HOW MANY YEARS

Many writers who have written for quite a while but haven't had much success at making a profit ask me how long they have before they must make a profit. Most of them have heard of the presumptive rule that if you make a profit a couple of years out of five you're home free. Almost everybody that's a novice misunderstands the presumptive rule. They seem to believe that it's an absolute rule. That unless you make a profit two of five years, you're out of luck. But it's not. It says nothing about how long you have to make a profit to have a valid profit motive. There is no absolute rule to that effect. The presumptive rule just says that if you have a profit two of five years, IRS will assume you have a profit motive.

So how long do you have? Far be it from me to say with exactitude. That is not the nature of taxation or of law, for that matter.

John Ellsworth had losses for thirteen years. Big losses. They ranged from over $21,000 to over $74,000. They probably averaged around $55,000 per year. He wasn't a writer, though. He was a cattle breeder. And it wasn't as though he didn't have revenue from his activity. Beginning with the third year, he had substantial gross profit. It's just that his operating expenses above and beyond the costs of purchasing cattle exceeded his gross profit.

Another crucial factor in Ellsworth's case is that he was getting back into cattle breeding after having been successful in it in his earlier life. He was quite old --- I believe 65 --- when he entered into this thirteen-year stint of substantial losses. The court was convinced that it takes about 10 to 15 years to develop a breeding herd with the superior strain and of substantial commercial value. They were satisfied that Ellsworth devoted sufficient time and effort to the enterprise to conclude that it wasn't some lark. You don't do all that work --- even though he employed 12 full-time employees to do all of the heavy lifting --- as a hobby.

How many years does it take? Your guess is as good as mine. It all depends. It depends on whether you can convince the court of three things:

• You conducted your activity in a businesslike way
  
• You had sufficient expertise in your activity and worked at gaining more expertise
  
• You worked at your activity regularly and sufficiently

SCHEDULE C

It's a crazy world. Tell your granddaughter about sleeping beauty and she asks if sleeping beauty had a trust. "Can she avoid death taxes?" she wants to know. And your grandson, he is no better. When you mention a like-kind exchange he knows you're not talking about some transformation, like Clark Kent into Superman. He wants to see the two properties.

Taxes pervade our lives. Income taxes have been with us since they were initiated to pay for the Civil War. Ever since then, they've been utilized for all kinds of wars and social situations. They aren't going away anytime soon. The basic structure has stayed consistent over time and no matter how often people, including the best of our statesmen, suggest a different tack to take with respect to taxation --- whether it's value-added taxes or some other scheme --- the fundamental foundation remains in place.
All income is taxable from whatever source derived. It is called gross income. The only way you get out of being taxed on income is if there is some legislative grace that has been enacted to do so. And I guess that is gross.

If you are in a trade or business --- or you think you are --- the part of the tax return that should interest you is Schedule C. You ought to become acquainted with it.

MAKE THINGS HAPPEN

Businessmen have been known to boast that they don't pay any taxes because they utilize an aggressive taxman that takes advantage of every loophole known to mankind. One joke had an individual saying that he didn't pay taxes anymore, that KPMG did his tax return, and he was getting a $4 billion tax refund. Well, we know what happened with KPMG, don't we?

If you want to utilize the graces granted you under the Internal Revenue Code, it's a good idea to prepare and to become an expert or to consultant someone who is. Too many taxpayers rely on complicated schemes that don't have real substance. They often pay large fees to promoters thinking that they can get tax relief when their own honest effort could have given them the breaks they sought and paid for.

The income tax regulations say in technical, cumbersome, and boring language:

Preparation for the activity [writing] by extensive study of its accepted business, economic, and scientific practices, or consultation with those with those who are expert therein, may indicate that the taxpayer has a profit motive where the taxpayer carries on the activity in accordance with such practices.

So if you want benefits, hit the books and consult the experts. Not only an expert but perhaps a range of experts, covering all of the aspects of your niche. Then implement what the sages say that it takes to succeed in your writing nook. If one of the experts advises you to try something that doesn't work, study some more and consult further and try another sage's idea

You've got to make things happen!

SEDGWICK SLICK

Being a smart aleck with the IRS won't work out quite like it did for Mr. Sedgwick Slick, the phantom of folklore. Sedgwick, a handsome young man, appeared for his IRS audit with his buddy, Barney. Introductions proceeded. Alears introduced herself as the auditor.

After reviewing Sedgwick's records and considering information received from an informant, Alears confronted the good-looking Sedgwick. "Hmmm... Mr. Slick, I'm sorry, but it's plain to me that you're living well beyond the income you've reported on your return. Looks to me like you owe at least four grand in additional taxes for the income you have omitted."

Sedgwick answered, "Please, call me Sedgwick. Gambling's my game. I never lose when I make a bet. Let's say I had a good year."

Alears gave Sedgwick a skeptical stare.

"I see you doubt me," said Sedgwick. "I'll show you, if you want."

Alears asked, "What's on your mind?" She was, after all, an auditor, curious and inquisitive by nature.

Sedgwick smiled broadly at Barney, and then told Alears, "I'll wager 2,000 bucks against what you say that I owe that I can bite my own eye."

Alears wondered what the catch was, but said, "That's not possible. You're on." If she lost, she could adjust her report even though it wouldn't be right.

Sedgwick Slick removed a glass eye, slipped it into his mouth, and parted his lips, revealing the eyeball resting between his teeth.

Alears swore under her breath.

"Double or nothing?" Sedgwick said. "I'll bet I can do the same thing with my other eye."

Clearly, Sedgwick Slick wasn't blind. Alears needed to get out of this predicament. "You're on," she said, deciding that such a feat was impossible.

Sedgwick popped the artificial eye back into its socket. Then he removed a set of dentures, taking them in both of his hands, and manipulating them to nibble at his seeing eye.

Alears almost swallowed her own tongue. Now she was in real trouble. This whole thing had put her job at risk, and she felt horrible about her ethical lapses. She felt sick to her stomach.

"Okay, okay," Sedgwick said. "I see that I've upset you. I didn't want to do that. I'll go double or nothing with you again. This time I'll bet you $1,000 I can stand here" --- he slapped her desktop --- "and take a whiz into your waste paper basket over there by the door and never get a drop anywhere in between."

Alears had no idea what to do. She analyzed the situation as only an IRS auditor could. Her job was at risk. This crook was about to get away without paying his taxes. And there was no way on earth Sedgwick Slick could pull this one off.

"Okay," she said. At the very worst, she figured, if someone noticed the spectacle she could claim Sedgwick Slick was entirely insane. People audited by the IRS often acted in very strange and crazy ways.

So Sedgwick jumped onto her desk, quickly aimed, and let loose. He utterly missed, getting it all over. Sedgwick grinned.

Alears smiled, too. Thank goodness, she thought. Then she noticed Sedgwick's friend, Barney. He had turned green and looked ready to vomit.

"You okay?" Alears asked.

"No," Barney said. "Before we got here, I made a bet with Sedge. He bet me $20,000 that he could take a tinkle on your desk and you'd be happy about it!"

ALEARS AGOG

Alears Agog is a creation of my fantasy. I used her in my tax book, Making Expression Less Taxing, a Freelancer's Tax Resource. She is what is known as a tax auditor at the Internal Revenue Service. Now, I'm not certain that's the terminology they still use for tax auditors today, because I've been retired for a couple of years.

I was with the Internal Revenue Service for over thirty years, and that is the terminology we used those years for people who audited individuals and small businesses in the offices of the Internal Revenue Service as opposed to audits conducted at taxpayers' places of business or residence. (The people who did the field audits were called revenue agents.)

Of course, during the term of George W. Bush, a lot of traditions went by the wayside.

I worked for a few years as a tax auditor myself, from about 1974 to 1979.

I chose Alears's name for a particular reason. Successful tax auditors are incredible listeners. They listen to what taxpayers say to them and take voluminous notes. They are all ears. Their ears are open, agog! I know that agog usually pertains to vision. Eyes, not ears, are usually said to be agog. Isn't that correct? Maybe not. In any event, agog means eager. A good tax auditor is eager. The auditor is full of keen anticipation. Why?

I guess there are a few reasons. They are trained to catch mistakes and errors. Isn't it fun to find out the mistakes of others and be able to do something about it? Well, for many people there is. Beyond that, they are always looking for crooks. There is a sense of self-righteousness and the same level of enthusiasm law enforcement workers often have in catching criminals. Perhaps, for some there is a degree of maliciousness in their machinations. However, my experience is that most tax auditors are simply conscientious workers trying to do the best work they can for their employer with a keen sense that they are civil servants.

Every taxpayer who claims tax benefits against their income must consider what their chances of being audited are. Why is that? Because not every claim you might make as a taxpayer comes clearly within the terms

Let me give an illustration. I spoke at a writers' workshop sometime ago. One of the blooming authors there asked me if he could deduct the books he purchased to read for both research and/or to make himself more proficient as a writer, following the admonitions of many experts on writing that he should read a lot. In other words, not all of the books that he had purchased were on writing or directly related to research for a project he might be working on. They might be just the normal books, magazines, and newspapers that anybody else might read just because they were popular

Could he deduct their costs? What do you think?

If he got audited, a good auditor like Alears Agog probably would question his deduction of some or all of those purchases. They're a couple of reasons, but the main one probably would be that the law doesn't allow an individual to deduct personal living expenses. It does allow a taxpayer to deduct ordinary and necessary business expenses. There is a good argument for saying the cost of the books is a personal expense and a good argument for saying the cost of the books is an ordinary and necessary business expense. There is ambiguity.

The subject writer's situation differs from somebody that works as the proprietor of a restaurant when it comes to deducting the costs of books. There is less ambiguity with respect to the restaurant operator and if such individual attempts to deduct the cost of his John Grisham books he or she will probably fail if audited. On the other hand, if a writer deducts deduct the cost of his books written by John Grisham he or she may well succeed. Or fail.

THE BORING ACCOUNTANT

Accountants and CPAs are often characterized as misers. A better word for them is perhaps frugal. But there're stories. For example, there's the story about the refreshment stand at the beach

A customer walks up and orders a cold one at the refreshment stand. The vendor working there asks if the customer wants to try a new brew made locally, saying it'll only cost him a buck instead of the usual three bucks for a cold one. So the customer looks around and notices several people with the new brew, except for one guy who it appears has only a glass of water, no ice, not even a lemon-slice. The taste-testers seem all happy and contented with their refreshment, while the guy with the water seems quite dour.

So the new customer decides to try out the new brew, and he really likes it, and he goes back for another one. As he stands there waiting he asks the vendor, "Do you know what's up with that guy over there? He seems so sullen, and I notice he doesn't have one of these new brews like everybody else does."

The vendor smiles and shakes his head. "That Skippy Flint. He's a CPA --- actually does my taxes for me --- and he has a reputation as a great accountant. You get audited by the IRS, you want to Skippy Flint with you. But he knows that at five I offer these new brews for free for an hour, and so he's waiting until then."

While it's definitely a stereotype to characterize CPAs and accountants like the story does --- I've known some of these types to be very exciting individuals, like Sid who rode his bike across the United States from coast to coast or David in Idaho who grew marijuana in his house --- it is probably a good idea to try in your writing or artistic endeavor to utilize great care in keeping your books and records and being thrifty.

WHAT IS A PROFIT MOTIVE

The term "trade" and the term "business" are very important to writers and artisans who want to benefit relative to their income taxes. Nonetheless, the terms "trade" and "business" are undefined in Title 26 of the United States Code, otherwise known as the Internal Revenue Code. There is also no definition given in the federal regulations, an explanatory adjunct to the Internal Revenue Code. Hence, any definitions that apply have arisen in the context of court decisions. The courts have developed a couple of definitional elements. The one relates to the writers' or artisans' profit motive. The other relates to the scope of activities. I mentioned in the previous posting the notion that activities have to be on-going in order for there to be a business or trade. Additionally, there has to be a profit motive.

What is a profit motive? Plain and simple: you do your writing work or artistry because you want to make money. However, the courts have decided it isn't enough to subjectively say you want to make money to satisfy their eventual conclusion that you have the necessary motive. Just saying it doesn't cut it with them. You have to enter into the activity with the good-faith intention of making a profit. You have to believe that a profit can be made from your writing or artistry. Reasonableness has nothing to do with it. A mere hope will not cut it, though. The hope has to be accompanied with specific plans of how you are going to make money. Otherwise the writers' and artisans' assertion is not believable.

Is that all crystal clear? I know it isn't. Next time, I'll illustrate it further by telling you about the taxpayer who claimed he had created a cold fusion system that would solve all of our energy problems.

CARRYING ON

To "carry on" is to continue doing, pursuing, or operating, according to my Merriam Webster dictionary. That is the way it is used in the phrase "carrying on a trade or business." As writers and artisans, if we want the grace that allows us to deduct our expenses relative to such activity, even if they result in a loss, we must make certain that we are carrying on our writing or our artistry.

"Carrying on" can also have a negative connotation. When I used to work for the government it wasn't unusual for those I worked with to be "carrying on" about this or that. They were complaining, usually. I haven't been above and beyond "carrying on" in that vein myself.

For the purposes of writers and artisans and others who do freelancing, with respect to coming within the terms of the grace that allows you to deduct business expenses, to meet the "carrying on" test not a great deal is expected. Activity is the key. Sustained activity. If you travel to Las Vegas once or twice a year hoping to make money gambling, that won't meet the "carrying on" criteria --- for a number of reasons, one of which is that you are not carrying on the activity in a sustained manner. You are not continuing to do, pursue, or operate.

A Hierarchy of Importance

There is a hierarchy of importance in the words and phrases quoted in the last posting. The meanings of "carrying on" and "trade or business" are more important than the meaning of "ordinary and necessary" because they have broader impact. As writers and artisans doing freelancing and worried about taxation and minimizing taxes, it is important to know the hierarchy. Next time we will talk about what it means to carry on.

So for now, at ease and carry on. Sayonara.