Searchlight, Nevada

When unhappy with his press release, Ralph rewrote it and sent changes to Northwest. When dissatisfied with Northwest’s marketing, he wrote demanding that they comply with the terms of their agreement.

By letter dated January 22, 1996, Northwest’s account executive told Ralph that 6,800 copies of Searchlight, Nevada had been ordered and shipped. It didn’t say who placed the orders or where they shipped them, but said that another 2,500 copies had been ordered by the chain Books A Million. Northwest promised royalty statements in about three weeks.

On his 1996 Form 1040, Ralph reported $2,600 in gross royalties from his writing activity.

In late 1993, after signing with Northwest for Searchlight, Nevada, Ralph began researching Nevada Nights, San Joaquin Dawn. He wanted to document the difficulties that women face when attempting a break from prostitution. “The story’s never been done before to any degree of authenticity,” he said, explaining that he thought it was commercially viable.

Ralph, however, had learned that rooms at brothels were equipped with listening devices. Therefore he met prostitutes at other locations on “out calls,” paying by credit card. In 1994, during January, February, April, May, June, and July, he spent from one to six days a month in Nevada on “out calls.” He successfully encouraged ten prostitutes to leave their profession. As of his trial, he hadn’t finished Nevada Nights, San Joaquin Dawn.

Some time after signing with Northwest on Searchlight, Nevada, Ralph submitted the 450-page Lightning at Dawn. He thought that Northwest only required a joint venture payment for first novels, and so if Northwest agreed to publish Lightning at Dawn, he’d not have to pay anything. He also tried marketing Boys and Girls Together, but stopped when he was told that there was no need or market for that type of short stories at the time.

Making the Deal and Working It

Ralph and Northwest reached an agreement for publication of Searchlight, Nevada on October 13, 1993. This agreement had Ralph paying Northwest $4,375 to publish ten thousand copies. Northwest’s marketing director wrote Ralph confirming receipt of Ralph’s money and described it as a “joint-venture payment.” The company’s operations officer explained via letter that Ralph’s payment represented about a fourth of production and marketing costs for ten thousand copies.

The agreement required Northwest to give a hundred “free” copies to Ralph and two hundred to major bookstores and book reviewers, to sell 2,500 copies through its “test market program,” and to sell the remaining books in the retail marketplace.

Ralph was to get forty percent of the retail amount of each book sold through the test market program and a royalty of fifteen percent of the retail price of remaining books sold to bookstores and wholesalers.

Northwest was expected to pay royalties January 31^st and July 31^st each year along with interest for late payments. It would do a certain amount of sales promotion, advertising, and publicity. It was to have exclusive rights to the book.

Northwest representatives told Ralph that his book would probably earn him at least $20,000 in royalties.

Northwest published and released the 131-page Searchlight, Nevada in December 1995 with a retail price of $7.95. The book went on sale at Barnes & Noble Booksellers in Boynton Beach, Florida, and Falls Church, Virginia, and at Super Crown Books, store #106. People could also acquire it in Bailey’s Crossroads, Virginia, by special order through Borders Books and Music.

Prior to its release, Ralph worked in all stages of publication. In 1994, having reviewed its galley proofs, he asked about adding two chapters. By letter at the end of February 1995, he suggested cover designs and attached pictures, showing how he thought characters on the cover should look. He promised to provide any additional assistance he could, saying that he realized the cover design equaled the storyline in importance. It didn’t matter if the story was good if readers failed to buy it. Optimistic about the joint venture, he believed they’d have a “hot seller” and sell over 100,000 copies.

Ralph gave Northwest’s public relations department mailing lists and telephone numbers of bookstores, newspapers, magazines, and radio and motion picture companies. On his own, he mailed about sixty complimentary copies of the book along with individualized letters to bookstores, newspapers, magazines, and hotels. He worked with Northwest’s marketing expert to get it stocked with distributors and to set up book signings at major bookstores.

The Adventures of Two Men Who . . .

Ralph resolved to write a story about the adventures of two men who travel across the country to patronize Nevada brothels, where such establishments are—ahem—legal. In early 1993, Ralph drafted an 18,000-word basic storyline. He submitted his draft along with Lightning at Dawn and Boys and Girls Together in June for copyright protection. Ostensibly to make the story realistic and to develop characters with fidelity, Ralph visited numerous legal brothels in Nevada as a “customer.”

I can hear cogs in your mind working. If you’re like most, you’re saying, “Never mind telling me about deducting traveling expenses for going to Vietnam to obtain motorcycle pictures for a picture book.” A more vital question is: could Ralph deduct those costs? Well, we’ll see.

Ralph wrote in his journal. Note that, to Ralph’s credit, he kept a non-financial contemporaneous record. He wrote about his personal experiences at these—excuse me—whorehouses. He chronicled which bordellos he visited, the dates and even, sometimes, the hours.

Ralph’s notes described prostitutes he met and the amounts of lucre he paid. For each journal entry, Ralph wrote about these visits, about what happens at cathouses (Like people don’t know?). For instance, Ralph described selecting his strumpets, the “house rules,” negotiating prices for a gal’s time, their discourse—yes, discourse, not some other course—and the ladies’ clothing. He included personal information on his courtesans, including age, physical characteristics, place of residence, religion, ethnicity, education, and names and ages of offspring.

Ralph’s journal indicates that, at some point during said encounters, he told the demimonde he was writing a book about Nevada’s bordellos. He wanted to use them as characters.

The journal shows that during 1993 Ralph spent about three days a month—except in February, May, and December—meeting prostitutes at brothels. Using materials so gathered, he produced Searchlight, Nevada.

Anxious to sell his work, Ralph consulted the 1993 Writer’s Market. There he read about Northwest Publishing, Inc. Northwest’s entry stated that it published hardcover, trade paperback, and mass market originals and reprints, between forty and fifty titles a year on seven to eight hundred queries and five hundred manuscripts a year. Some eighty-five percent of said manuscripts came from first-time authors and ninety-five percent came from unagented writers. Northwest said that it paid a ten to fifteen percent royalty on retail price, publishing books four months after acceptance of submitted manuscripts.

Some of the Facts

Ralph, like me, had worked for the Treasury Department, although he didn’t work for the IRS, which is an agency within Treasury. His work as a budget analyst followed his graduation from the University of Maryland with a bachelor’s degree in marketing and advertising, augmented by twenty-four credit hours of English, journalism, and speech.

He retired from Treasury in January 1997 with 35 years of service. Part of his job (one of six critical elements) required him to “write budget justifications, procedures, and other written material by applying professional-level writing ability to create high-quality written work.” (Certainly Ralph wouldn’t have had the subject matter to write much of a thriller, but maybe he had a sense of humor. It was a bureaucracy, after all.)

Just before Ralph retired, his manager rated Ralph’s performance “outstanding” in this “writing” element. “Outstanding” exceeded “excellent” under this system. Go figure.

Anyway, in Ralph’s employment, “excellent” meant writing budget justifications, statistical reports, procedures, guidelines, and other written materials clearly, concisely, and correctly. It included:

•      Using excellent grammar and spelling.

•      Communicating ideas effectively, especially narratives.

•      Presenting ideas clearly so recipients asked few follow-up questions.

•      Structuring paragraphs and sentences correctly.

•      Working independently in drafting material and seeking guidance only when goals changed.

•      Recipients receiving well and acting upon the written budget justifications.

•      Doing only one revision per finished product.

Our man Ralph did even better than all of that since he received “outstanding” ratings. It was like getting an “A” plus-plus, I guess.

Ralph’s office staff, mostly accountants, used Ralph to do their writing. He contributed to a comprehensive agency-wide report in which agencies evaluated internal control and accounting systems. He edited the in-house newsletter of Treasury. So Ralph brought writing skill and experience to the table.

In 1992, about two years before he was eligible to retire, Ralph started writing outside his Treasury job. Fearful of retirement, he told the IRS and the court that he had hoped to make writing a second career. His first book-length manuscript of fiction was Lightning at Dawn. Later that year he wrote a collection of short stories called Boys and Girls Together. Before marketing these manuscripts for publication, he had an idea for another book.

Now what I’m about to tell you may seem incongruent for a bureaucrat like Ralph who worked for Treasury with a bunch of accountants writing staid budget proposals. He was at least fifty-five years old, maybe older.

Don’t be too surprised.

Tune in next time for a shock.

Venting Frustration by Turning the Tables

You know, there’s a plethora of wisecracks about tax auditors. For instance, one says that the Postal Service just recalled its newest stamps because they picture famous IRS agents on them. People couldn't figure out on which side to spit. Another witticism asks, “What do you call twenty-five IRS agents buried up to their chins in cement?”

“Inadequate cement.”

Venting frustration through humor makes sense. An additional way to vent is to turn the tables on a tax auditor with solid documentation of your hard work and preparation, enabling you to claim a few of the tax perks for self-employed persons. Of course, the ruling administration always claims that the IRS is simply liberating people—primarily, the working middle and lower classes—from fiscal burden.

A tax case involving a writing activity played out in Tax Court in Arlington, Virginia, the case of Ralph Louis Vitale, Jr.1 Let’s look at it relative to preparation and expertise. I don’t know if Mr. Vitale goes by Ralph or Louis or some other appellation among friends and acquaintances, but I’d like to call him Ralph. It seems such an improbable name for what his writing focused on after retirement. To me his last name, Vitale—reminding me of “vital” or “vitality”—seems more apropos. Anyway, the guy had verve, although some might say he was just libidinous. You be the judge.

Let me give you the facts in the next posting.

1 Ralph Louis Vitale, Jr. v. Commissioner, TC Memo. 1999-131 affirmed by unpublished opinion of the Fourth Circuit at 217 F.3d 843.

Silly Sarah

Consider Sarah Lesher, who had had a couple of appalling encounters with the IRS, partly because she didn’t adequately prepare.


From 1976 to 1980, Sarah worked for Yale as a research associate and computer programmer. When she learned of a publisher of travel guides in need of information for a revised edition of an African travel guide, she contacted the publisher and received information regarding the submission of articles.

Sarah traveled to Africa in October 1980 and then to Israel in January 1981. While in Israel, apparently to gather information for writing, the Weizmann Institute employed her as a computer programmer. During 1981 she bought a typewriter and wrote at least one draft of a fictional work based on her adventures while in Africa and Israel. She didn’t keep any type of business accounting records of her writing activities. Nope, Sarah thought she could get by without debits or credits or other financial or non-financial records.

My friend Doug, longing to deduct the costs of going to Vietnam to get photographs of unique motorcycle use to create a picture book, might want to pay attention to this case as an example of what not to do.

In September 1981, Sarah left Israel for Europe and then returned to the United States at the end of November. During 1981 she incurred a total of $9,847.13 in expenses connected with her travels. She deducted this amount on Schedule C of her 1981 Federal income tax return.

Again in 1982, Sarah traveled to Africa, possibly for writing materials, and there resumed working as a computer programmer. In April 1983, she returned to the United States where she continued her education and again worked as a computer programmer.

Sarah lacked experience writing any type of literary work prior to her trip. Further, she didn’t publish or sell anything she wrote with respect to her travels before her Tax Court trial. By then she still hadn’t engaged a literary agent to help her to publish. (It doesn’t appear that the Tax Court knows how difficult it is to get a literary agent.)

Silly Sarah didn’t ever show the court that she had traveled to Africa, Israel, and Europe to write, or that she had remained in Israel in 1981 to author works that could make money. The court said that Sarah used her fiction manuscript as a pretext to claim her travel as a tax deduction. Essentially, the court said that Sarah’s fiction was a fiction.

While Sarah introduced several hundred exhibits, including a copy of a draft of her novel—it makes one wonder how that impacted her copyright—correspondence and information concerning the accomplishments of her ancestors, friends, and acquaintances, her personal life, her activities for many years before and after the years in issue, and even the backgrounds of various authors, the court still said that Sarah used her draft novel as window-dressing to support claims for travel expense deductions.

“Preparation precedes power.” Remember that axiom. Prepare to be a better artisan and to address every IRS concern by studying your expression activity’s accepted business, economic, and scientific practices, or by consulting its experts.

Preparation and expertise.

An old story has a businessman boasting to his competitor, “Tax day is coming next week. Yep, good old April 15th—that particular day used to scare the pants off me. But you know what? I don't pay the tax man anymore. KPMG did my return this year. I'm getting a refund of $4 billion.”


Preparation and expertise. Let’s get a little more know-how under our belts, and not the type that the businessman boasts about in the gag. Too many taxpayers rely on complicated schemes without real substance and pay large fees to promoters to get tax relief when their own honest effort could give them the breaks they seek. Relevant income tax regulations say in their technical, cumbersome, and boring way that:

Preparation for the activity [in our case, an expression activity,] by extensive study of its accepted business, economic, and scientific practices, or consultation 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.

In other words, hit the books and ask the experts. Study a range of experts, covering all aspects of your niche in expression. Implement what the sages say it takes to succeed in your expressive nook. If an expert advised you to try something and it didn’t work, do more study and consulting and try another sage’s idea or one of your own. Make things happen.

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.

Richard Stasewich (I’ll call him Richie) of Chicago attended Northern Illinois University between 1971 and 1977, majoring in art and minoring in accounting. Richie didn’t graduate. By 1978 he was registered as a CPA and by 1983 Illinois had licensed him as a public accountant. Between 1978 and 1984 Richie worked in various positions utilizing his accounting background.

From 1992 to 1995 Richie operated both his accounting and artistic activities out of the building where he worked and lived. Beginning in 1984, he treated his artist and accounting activities as sole proprietorships for Federal income tax purposes. He reported net profits and losses for his two separate Schedule C activities as follows:

Richie’s income from artist activities without expenses for 1992 to 1995 was only $770, $320, $266, and $357, respectively. Needless to say, he didn’t support himself from this expression activity, and his accounting-activity income came in handy for his sustenance. Not only did he support himself with such work, but he kept good financial records and was able to show the IRS substantiation for all of the expenses he claimed on his returns.

Richie had a Certificate of Registration from Illinois that permitted him to engage in business, selling tangible personal property at retail. He filed state sales and use tax returns and completed Forms W-2 for the art students he employed.

What Richie didn’t keep were records of a budget or financial projections for his artist activity, or records of costs he might incur in attempting to develop his artist activity. That is, he didn’t plan well.

At trial Richie explained that before 1992 he had decided to create a commercially viable product from nude drawings. He tried fashion illustrations and spent a lot of money on materials and props, but never secured a large client and never earned anything from it. Around 1992, his artist activities changed from nude drawings and fashion illustrations to portraitures and installation art displays. For $1,200, he placed two advertisements in his local newspaper to solicit work as a commissioned artist of portraits. He painted two portraitures between 1992 and 1995 that generated about $850 in revenue. From 1992 to 1995 he created four displays of installation art consisting of peppers, dolls, pumpkins, and cucumbers. These he displayed in front of his residence. The exhibition of dolls received media attention, was the subject of two newspaper articles in 1994, and was mentioned in another newspaper article in 1995. (I guess journalists passed on reporting about the exhibitions of peppers, pumpkins, and cucumbers.)

Richie's income from the installation displays totaled a measly $88.04 . . . of donations.

The IRS audited Richie first for 1988-1991. The dispute ended up in the Tax Court, where he lost. This didn’t deter Richie from claiming his expression activity losses from 1992-1995 and again taking the matter to court. We'll talk more about this in the next posting, too.

Planning to Exploit the Graces

John (see Ellsworth v. Commissioner, 21 T.C.M. 145, 150-51 (1962)) was 65 years old and had a plan. The attendant facts showed it’d take him 15 years to generate a profit. Yet the Tax Court said that a trade or business existed in his case because his purpose in “carrying on the activity” was to profit.


America was founded to avoid high taxation, right? Today avoiding high income taxes takes planning to exploit all of the graces. So it should be no surprise that you need to plan relative to your own expression activity. Remember, experience isn’t necessarily a requirement for having a trade or business. But a good plan is. So to answer further the question, “Is my expression activity a trade or business?” let’s look at the process of planning next.

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.

Another Doctor Claims His Wife's Horse Losses

Wednesday, the Tax Court issued an opinion in a case involving another doctor whose income supported his wife's horsey losses that the IRS said were hobby losses. See the Phemister case to read about it. The case also covers innocent spouse, failure-to-file, and negligence penalty issues.