Rick's Writing Was for Business

Rick, the writer, did have a viable business, according to the Tax Court; his writing activity was not a hobby.

What made the United States Tax Court conclude that he was in the business of writing?

First off, the court believed Rick conducted aspects of his writing in a businesslike way. He hired agents to help him negotiate prices for the sale of his screenplays.

He had a long history as writer, with publishing credits and success in the endeavor. Because he had worked in the field for such a long time, he had numerous contacts. Furthermore, he devoted a lot of time and energy to writing.

One of the biggest factors, though, had to be that he didn't have any income from many other sources to speak of. This meant that he and his wife didn't derive a great deal of tax benefit by claiming the loss he incurred.

The court also recognized that writing has a precarious nature, especially as relates to the entertainment industry.

Now, how did Rick fare in deducting the expenses he said were for writing?

Rick the Writer

Maybe I've mentioned this case before. If so, I'm going to mention it again. It came out in 1999, about ten years ago now. It is a United States Tax Court case, TC Memo 1999-163 involving Rick and Ruth Richards. The Richards represented themselves before the court. IRS audited them and determined a deficiency for the year 1994, some sixteen years ago now. The deficiency that the IRS alleged was $1,328 and they asserted that the Richards had not exercised ordinary business care and prudence by alleging a penalty in the amount of $266.

Rick was a writer. He deducted a business loss relative to his writing activities. The IRS said his writing activities didn't constitute a trade or business, but comprised a hobby. For this post, I will handle that issue. Other issues will come in subsequent posts.

The Richards lived in Palm Springs, California.

Among expenses Rick claimed relative to his writing were the following:

Typewriter (ribbons and repairs)	$198
Stationery, desk and office supplies	940
Registry	680
Copies	370
Research books, magazines & trade publications	760
Must-see movies, stage plays, country and gospel concerts	1,140
Travel trailer maintenance, supplies and repairs	2,480
Research trip to Alaska	3,296
Research trip to Mexico	1,319
Miscellaneous (primarily travel expenses)	3,120
TV sets, the VCR & videotapes	569
Audio tape-recording & copying equipment plus studio time fees	560
Fax messages and responses	115
Shipping costs	1,189
Office preparation	180
Long-distance calls	1,114
Cash telephone calls	240
Total	18,684

 

The Richards were both in activities that were challenged by the IRS as hobbies, so it is difficult to set forth exactly what expenses were Rick then what expenses were his wife's. She was an actress. Their combined losses relative to their respective activities of writing and acting were something like the following for the years preceding and succeeding the year that was before the court:

Year	Income	Expenses	Profit/(loss)
1991	---	$28,307	($28,307)
1992	---	29,103	(29,103)
1993	---	30,616	(30,616)
1995	---	---	(24,278)
1996	$814	30,877	(30,063)

 

The Richards did have income from their activities from 1991 to 1993 but reported it with their wages. The income amounts were nominal in comparison to the expenses they claimed.

Rick's first job as a writer came in 1940 when he wrote stage material for Bob Crosby's band. It was intended to be funny and included lyrics, parodies, and original songs. He also ended up working for various publishers in New York. During one period of time he served in the military. In the 1950s, Rick started writing short stories. He lived in Pennsylvania and wrote 88 short stories has sold 39 of them. He also started writing novels.

The Richards actually married sometime in the early 1960s and that is when they moved to Palm Springs. Rick continued writing novels at first but soon put that aside to work in the blooming and more-lucrative entertainment business. He obtained contracts with various comedians and met producers through them. As a freelancer, he ended up writing situation comedies, and he was able to sell his work doing sitcoms throughout the 1960s and 1970s. Some of the familiar shows he wrote episodes for include The Lucy Show, The Odd Couple, Love American Style, The Addams Family, The Beverly Hillbillies, and Petticoat Junction. In 1974 he sold a screenplay to a Canadian company.

By the 1980s, Rick no longer found writing sitcoms that fun; the novelty had apparently worn off. He switched to ninety-minute television movies. However, the networks didn't cooperate and canceled their ninety-minute movies. So Rick switched too. He started writing screenplays for the two-hour timeslots the networks then wanted. In the 1980s and 1990s, he branched out, trying different things. Things start to slow down and fall apart. One project got scheduled for three different occasions but canceled at the last minute each time. Another time, Rick received an option payment of $1,500, but the company, Columbia Pictures, never exercised the option. Rick testified that various producers and directors and whatnot were interested in his work, but things just didn't work out. He tried to work out specific deals with specific individuals, around the problems and things got canceled or placed in abeyance.

Rick didn't have a regular agent. If he thought he had a deal to work through, he would hire an agent to discuss money with the executives of the movie industry. He said agents were able to get more money for his work.

Rick's mode of operation was to work on 4 to 6 different screenplays at a time, knowing that if he sold just one of them it would be quite lucrative. In 1993 or 1994 he pitched an idea about a screenplay to an agent with Creative Artists Agency. The agent thought highly of the idea and indicated he would try to market it. Rick got busy and wrote the screenplay, but by the time he went to trial it had not been sold.

Sometimes Rick wrote lyrics for country and gospel songs. He didn't write the melodies and so most of his experiences writing lyrics were collaborative. In order to facilitate his lyric writing, he traveled to numerous country and gospel concerts. However, he never sold the song.

So that's pretty much the facts the court said it dealt with in deciding whether or not Rick had a viable trade or business as a writer.

So what do you think? Did he have the requisite continuity of activity and the profit motive?

IRS Strategic Plan

Contrary to what may be intuitive, IRS has a strategic plan. It is a plan that ran from 2005 to 2009. You can read it online, at IRS.gov. If you can't sleep, I recommend it. The nice thing about the plan is that it expires this year which means there will be a new one. Of course, the IRS can plan all it wants to do this or that, and just like anything else, if it doesn't have the funds to carry out the plan it is all for naught. The same is true of any government agency and it can have profound effects upon any number of things, witness the financial meltdown due to the government's failure to adequately fund agencies that oversee the financial markets.

Anyway, the strategic plan of the IRS will contain a message from the Commissioner of Internal Revenue Service, a statement of the agency's vision and mission. It will give some sense of the organization structure in charts and whatnot. It will then spin its perception of the factors that affect its achievement of its vision and link the strategic plan to the budget and its ability to perform. It will name key partners in achieving strategic goals of the agency.

Among goals listed there, you will find that IRS intended during that timeframe to improve its taxpayer service, it intended to enhance enforcement of the tax law, and it intended to modernize the IRS through its people, processes and technology. If you're interested in any of that gobbledygook you can read it there on the IRS website. Like I said, it is probably all good for sleep inducement. But you might be interested nonetheless and get something useful out of reading it. I doubt it, but maybe you'll want to give it a shot.

Bank Deposits Analysis

If a taxpayer fails to file a return, there are several things IRS can do to get around that. If the taxpayer is employed, it gathers the employers W-2s and 1099s and utilizes them to construct what a return would look like. Say, however, the taxpayer is self-employed --- maybe he operates a bookstore or some other retail outlet. What does the IRS do then? Well, if the taxpayer kept checking and savings accounts, IRS might utilize those accounts to reconstruct his income from the deposits in them.

A good example of IRS doing that is a case issued by the United States Tax Court today, the case of BLAKE HYUN SEO. You can view the case at http://www.ustaxcourt.gov/InOpTodays/Seo.TCM.WPD.pdf . I'm not certain how long that link will work, though, because the opinion will only be a "today's opinion" today. However, you can do a search any time using his name on the United States Tax Court webpage and find the case.

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.

 

Surprises

My oldest son brought a gal home tonight for us to meet, a friend he met way back in grade school and hasn't seen for years. The young lady now lives in Boston where she works in real estate as a broker. She says times are rough in real estate right now, not a surprise to me, but fortunately she said her office handles a lot of rentals that apparently keeps her in the black.

My boy had told her about my tax book for writers and artisans. (He might be impressed." He wanted me to show her a copy, so I did and she ended up taking it with her to read. Her degree is in German and music. She aspires to opera but has had to settle for a more practical occupation. She related how difficult it was for her to fill out online her 1040 this year and how not having properly estimated and paid in estimated payments of taxes in advance had been a shock to her.

I guess it's better to be shocked than to have paid nothing and owed nothing in taxes, for that would suggest not much if anything was made. But still, it is always a good idea, almost a necessity, to keep a running account of where you are profit-wise. That way, you don't get surprised and you can change your mode of operation if you need to. It also means that you're doing a fairly decent job of keeping records.

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.