Authors and the Internal Revenue Code

by
Linda Lewis


Linda Lewis attended the University of Texas at Austin and Southern Methodist University Law School in Dallas. Linda has been an Assistant State's Attorney in Chicago, an Assistant D.A. in Philadelphia, and she currently litigates cases before the United States Tax Court, representing the Commissioner of Internal Revenue.

  1. Introduction

    1. The Internal Revenue Code of 1986 provides, "gross income means all income from whatever source derived, including (but not limited to) . . . royalties". I.R.C. § 61(a)(6).

    2. "Writer" is defined in the Internal Revenue Code (in the section exempting free-lance authors from the requirement of capitalizing expenses associated with producing property):

      The term "writer" means any individual if the personal efforts of such individual create (or may reasonably be expected to create) a literary manuscript . . . I.R.C. § 263A(h)(3)(A)

    3. When an author writes a book, the literary ideas embodied in the manuscript are property. Lewis v. Rothensies, 61 F.Supp. 862 (E.D. Pa. 1944), affd. per curiam 150 F.2d 959 (3d Cir. 1945). When she sells it in exchange for royalties, her interest in the contract by which the royalties are paid is also property in the nature of a chose in action. Reece v. Commissioner of Internal Revenue, 24 T.C. 187 (1955), affd. 233 F.2d 30 (1st Cir. 1956).

    4. Royalties paid on the commercial exploitation of a book are taxable to its author. Miedaner v. Commissioner, 81 T.C. 272 (1983).

    5. "Taxable income" means gross income minus the deductions allowed by the Internal Revenue Code. I.R.C. § 63(a).

    6. We are currently operating under the Internal Revenue Code of 1986, which eliminated many deductions, but which retained the basic rule that business expenses are deductible, but personal expenses are not.

    7. Like all basic rules, especially legislative ones, this one has exceptions. For example, personal mortgage interest is deductible.

  2. I.R.C. § 162. Business Expenses

    1. An expense a business expense if it is incurred while carrying on a trade or business. Section 162 allows an individual, corporation or partnership to deduct from gross income the ordinary and necessary expenses of carrying on a trade or business. However, a current deduction is not permitted for an expenditure required to be classified as a capital expense. In general, capital expenditures are amounts paid to acquire real or personal property or to permanently improve its value. A computer purchase is a capital expenditure, for example. (But see § 179.)

    2. The statute does not define "trade or business", and the question of whether or not a person is engaged in a trade or business is one of fact.

    3. "Trade or business" includes the arts, and the mere fact that an author has not yet produced a book does not preclude him from being in the business of writing for purposes of I.R.C. § 162.

    4. Generally, to be in a trade or business, a person has to be engaged in profit-making activities with the intent to make a profit.

    5. In addition to being incurred in a trade or business, an expense must be "ordinary and necessary". Examples of expense of an author which were considered to be ordinary and necessary by the United States Tax Court in the case Faura v. Commissioner of Internal Revenue, 73 T.C. 849 (1980):

      1. Office rent
      2. Mail
      3. Gifts, travel and entertainment
      4. Printing
      5. Telephone
      6. Supplies
      7. Answering service
      8. Post Office box rental
      9. Legal fees
      10. Subscriptions
      11. Water and power
      12. Gas
      13. Architectural fees
      14. Research
      15. Miscellaneous

    6. Section 162(a)(2) specifically provides that traveling expenses, including amounts expended for meals and lodging (other than amounts which are extravagant or lavish) while away from home in pursuit of a trade or business are deductible.

  3. "TRADE OR BUSINESS" Cases

    1. Wright v. Commissioner, 31 T.C. 1264 (1959), affd. 274 F.2d 883 (6th Cir. 1960).

      1. The taxpayers were an attorney and his wife who took a trip to Japan to visit their son, and continued the trip around the world. They wrote a daily diary of their experiences which they compiled in book form and unsuccessfully tried to publish. Both the Tax Court and the Sixth Circuit Court of Appeals held that the expenses of the trip and of producing the manuscript were not deductible as ordinary and necessary expenses of carrying on a trade or business.

      2. The Tax Court noted that businesses had been defined as "that which occupies the time, attention, and labor of men for the purpose of livelihood or profit," and said, "Some continuous or repeated activity in the literary field, coupled with a reasonable expectation of making a profit, would be more convincing of an intent to engage in writing as a business or profession, than does the isolated effort made by these taxpayers, even though it may have been with the hope of making a profit."

      3. The Tax Court concluded, "The cost of a trip such as this, undertaken by petitioners for purely personal reasons, cannot be turned into and deducted as a business expense merely by writing in a diary en route with a mere hope (unjustified) that it might be published and bring in some income. To allow the deduction of such expenditures to two people who have never been engaged in the business of writing and have no intention of attempting to earn a livelihood in the future in such business would be an invitation to many taxpayers to convert pleasure trips into business trips at the expense of the revenue."

    2. Lamont v. Commissioner, 339 F.2d 377 (2d Cir. 1964).

      1. The expenses incurred by the taxpayer, who was a wealthy man with an independent income from investments, in publishing books and pamphlets principally on topics of philosophy, civil liberties, and international affairs, were not deductible under section 162.

      2. The taxpayer was prominent in the intellectual and academic world and had written many books and pamphlets. He conducted his professional activities in a business-like manner, paying careful attention to the keeping of books and records, trying to minimize expenditures, and maintaining an office at his residence for his writing activities.

      3. He suffered continual losses from his writing, realizing a profit only twice in the twelve years preceding the taxable year 1957. He had a profit of $254.38 in 1946 and of $1,500.31 in 1957.

      4. "Although continuity and efficiency of operation are criteria which would tend to support the existence of a trade or business, we cannot agree with the taxpayer's contention in the instant case. The totality of circumstances surrounding Lamont's background, his interest in the wide dissemination of his ideas, his activities and financial status justifies the conclusion of the Tax Court that a profit motive was lacking."

    3. Stern v. Commissioner, 71-1 USTC 9375 (D.C.C.D. Calif. 1971)

      1. The taxpayer had been engaged in the business of writing since 1926. He had authored numerous newspaper stories, magazine articles, and screenplays, and had frequently been compensated for his writings.

      2. The expenses claimed by the taxpayer as a deduction were incurred while researching, writing and arranging material for a book on D.W. Griffith. The taxpayer lived in Los Angeles and traveled to New York City where the papers of D.W. Griffith were located.

      3. The expenses were ordinary and necessary expenses of carrying on the taxpayer's business of a writer and were deductible under I.R.C. § 162(a).

    4. Gestrich v. Commissioner, 74 T.C. 525 (1980).

      1. The Tax Court held that the petitioner was in the trade or business of being an author. He wrote scripts, advertisements, and worked on a book. All his works during the taxable years before the court were unfinished and/or unpublished through at least the time of trial.

      2. "We believe that petitioner was engaged in the trade or business of being an author during the taxable years before us. He clearly spent a significant portion of his time working on his book and other materials. While petitioner has been paid for his works in years past, he earned no income from the sale of his works during the taxable years before us. Nonetheless, the petitioner was attempting to get his book published and was, therefore, holding himself out for the sale of goods or services. We conclude, on the record before us, that petitioner was in the trade or business of being an author during the taxable years before us."

    5. E. Synder v. United States, 674 F.2d 1359 (10th Cir. 1982).

      1. The taxpayer was a practicing attorney. In 1972 he began work on a book of photographs of the Colorado high country. He expected to publish and sell the finished product. He devoted about 30 hours a week to taking pictures. He kept detailed records of technical data regarding his photographs. He sent letters to publishers soliciting their interest in his book. Six or eight publishers expressed an interest, but none offered to buy or publish his book.

      2. The District Court judge concluded that the taxpayer was not engaged in the trade or business of producing a book, but he did not make formal findings of fact and conclusions of law. He stated that the taxpayer did hope to make a profit.

      3. The Court of Appeals said that the profit motive finding supported a conclusion that the taxpayer was in the trade or business of producing a book, but that the trial court's findings of fact were not sufficient to guide the appellate court in rendering a proper decision. The case was remanded to the trial court for further factual findings.

      4. In Synder the IRS argued that an author cannot be in the trade or business of writing if he has not yet produced a book. The Court of Appeals found no support for this contention and believed, "as a policy matter, that such a position would have an unwarranted and undesirable chilling effect on budding authors who are serious in pursuing a writing career."

  4. I.R.C. § 183. "HOBBY LOSS"

    1. Section 183 provides that, subject to certain exceptions, no deduction will be allowed with respect to an activity unless the activity is engaged in for profit. Although most of the cases under § 183 involve farm losses (usually incurred by doctors, attorneys and other high-income taxpayers), its provisions affect actors, authors, artists and tax shelter investors, too.

    2. A reasonable expectation of profit is not required, but the facts and circumstances as opposed to the taxpayer's subjective intent, have to indicate that the taxpayer entered into the activity, or continued the activity, with the good-faith objective of making a profit.

    3. Presumption of profit intent: Section 183(d) provides for a presumption of profit intent if the gross income from the activity, for at least three taxable years out of five consecutive taxable years ending with the subject tax year, exceeds the deductions attributable to such activity.

    4. Factors used in making a determination of profit motive;

      1. Manner in which the taxpayer carries on the activity. Conducting the activity in a "businesslike manner", keeping accurate books and records, and operating the business in ways similar to profitable businesses of the same nature.

      2. Expertise of taxpayer or his advisors. Study of an activity's accepted business, economic, and scientific practices, and consultation with experts in the business are evidence of profit motive if the taxpayer follows the accepted practice and the advice of experts.

      3. Time and effort expended by the taxpayer in carrying on the activity. In the absence of substantial personal or recreational appeal, the taxpayer's devotion of large amounts of time to the activity, especially if he withdraws from another occupation to devote more time to the activity, tends to indicate a profit motive.

      4. Expectation that assets used in the business will appreciate in value. This factor permits finding a profit motive in speculative activities, such as real estate investment, where the investment will be operated at a loss, but the appreciation of the property may produce an overall profit.

      5. Success of taxpayer in carrying on other similar or dissimilar activities. The fact that a taxpayer has engaged in similar activities in the past and converted them from unprofitable to profitable enterprises may indicate that he is engaged in the present activity for profit. This factor has been extended to consider a taxpayer's success or failure in other, unrelated activities.

      6. Taxpayers' history of income or losses with respect to the activity. Initial start-up losses may not be important to a determination of profit motive, but sustained losses, if not explained by customary business risks, casualty losses, or depressed market conditions, may make it difficult to prove a profit motive. Loss deductions are sometimes allowed in spite of an extended loss period, but courts generally rule against taxpayers with relatively long periods of losses. This reflects the assumption that anyone willing to sustain losses of long duration or great amount must necessarily have little or no interest in profits. The length of the loss period can also vary depending upon the particular business.

        1. In Churchman v. Commissioner, 68 T.C. 696 (1977), a case involving an artist with a ten year history of losses, the court treated the lengthy loss period as less significant because of the lengthy period before "a struggling artist" can achieve sufficient "public acclaim" to generate a profit.

        2. In Sherman v. Commissioner, T.C. Memo. 1989-269, the court found that a taxpayer who had only sold one manuscript in seventeen years wasn't engaged in the activity for profit. During that time he only presented one manuscript for publication.

      7. Amount of occasional profits, if any, which are earned. Small occasional profits with large consistent losses, especially if the invested capital is large, point to the absence of a profit motive. On the other hand, substantial occasional profits or the possibility of a substantial ultimate profit, point to a profit motive despite small interim losses.

      8. Financial status of the taxpayer. The absence of substantial income or capital other than the business enterprise in question is a factor indicating a profit motive. Substantial income from other sources, especially if the losses from the questioned activity produce substantial tax benefits, tends to indicate the absence of a profit motive.

      9. Elements of personal pleasure or recreation. Personal motives are some indication that the activity is not undertaken for a profit, especially if recreational or personal elements are present. However, "A business will not be turned into a hobby merely because the owner finds it pleasurable; suffering has never been made a prerequisite to deductibility. Success in business is largely obtained by pleasurable interest therein. Jackson v. Commissioner, 59 T.C. 312 (1972).

  5. "HOBBY LOSS" Cases

    1. Dreicer v. Commissioner, 665 F.2d 1292 (D.C. Cir. 1981), on remand, 78 T.C. 642. Wealthy gourmet denied deductions for writing. He was a writer/lecturer on tourism and dining who incurred losses in world travel. He did not have an honest objective to make a profit.

    2. Hires v. Commissioner, T.C. Memo. 1980-172. Botanical expert couldn't deduct substantial losses from writing and publishing five volume series. She didn't expect profits, she didn't conduct activities in a business-like manner, didn't properly appraise profit potential and didn't get expert advice.

    3. In Dickson v. Commissioner, T.C. Memo. 1986-182, the taxpayer was allowed deductions for at home writing and mail-order activity. Lack of profits in first year and otherwise busy schedule didn't show lack of profit motive. She spent substantial time on the activity, had demonstrated abilities and did not derive pleasure or recreation.

    4. Burrhus v. Commissioner, T.C. Memo. 1986-430. Deductions denied for story writing activities. Taxpayer lacked profit motive, had no experience, kept no records and did not conduct activity in a business-like manner.

    5. Lesher v. Commissioner, T.C. Memo. 1987-345. Computer programmer denied deduction for trip to Africa. She failed to prove that the trip was for profit-motivated writing. She had no previous writing experience and writing endeavors were more in the nature of a hobby. "Petitioner had no experience writing any type of literary work prior to her trip. Nothing petitioner wrote with respect to her travels has been published or sold. She never has engaged a literary agent to help her to publish her writing. Petitioner did not travel to Africa, Israel, and Europe to write and she did not remain in Israel in 1981 for the purpose of writing for profit. Petitioner anticipated using her manuscript as a device to support a claim for tax deductions."

    6. In Clark v. Commissioner, T.C. Memo. 1989-598. Deductions for writing denied. Taxpayer derived personal satisfaction from writing, didn't offer evidence of profit potential, hadn't completed manuscript after many years, didn't show likelihood of finding publisher, and was simultaneously engaged in other time consuming activities.

    7. Bassett v. Commissioner, T.C. Memo 1992-546. Deductions denied for research and writing activities; no profit motive. Taxpayer's activities provided him with significant personal pleasure and emotional release from stifling corporate employment in computers. Manuscript was so ludicrous it couldn't produce a profit.

    8. Callahan v. Commissioner, T.C. Memo. 1996-65. Deductions denied for writing activities; no profit motive. Taxpayer deducted over $95,000 in expenses over a six year period, reporting no income from writing for those years. As a result of her Schedule C losses, she paid no taxes for six years. She self-published two pamphlets, one on how to organize and use grocery coupons, another on how to win sweepstakes and other contests.

  6. I.R.C. § 262. Personal Expenses

    1. Section 262(a) provides that, except as otherwise provided "no deductions shall be allowed for personal, living or family expenses."

    2. Section 262(b) provides that "in the case of an individual, any charge (including taxes thereon) for basic local telephone service with respect to the 1st telephone line provided to any residence of the taxpayer shall be treated as a personal expense." This provision was added to the law in 1988. It does not mean you cannot deduct calls to your editor or agent, however. The Committee report explaining the change in the law states
      This provision does not affect the deductibility of toll charges for long-distance calls, even if transmitted over the first telephone line in a residence, or periodic charges for a service that entitles the subscriber to the privilege of an unlimited number of telephonic communications to or from persons having telephone stations outside the local telephone system in which the station provided with this service is located.

      The provision applies only with respect to the first telephone line in a residence. Thus, for example, if an individual uses one telephone line in his or her residence solely or partly for personal purposes and uses another telephone line solely or partly for business purposes, the provision does not disallow otherwise deductible charges for the latter line. If the taxpayer has only one telephone line in a residence, the provision disallows any deduction for charges required to obtain local telephone service even if the taxpayer claims to use that line solely for business purposes.

  7. I.R.C. § Travel and Entertainment Expenses

    1. Substantiation

      1. This section was enacted in 1962 to reduce the opportunity for taxpayers to deduct personal expenditures in the guise of business expenses. Section 274(d) provides that no deduction shall be allowed under section 162 with respect to travel away from home, entertainment or gifts unless the taxpayer substantiates by adequate records or by sufficient evidence corroborating his own statement:

        1. The amount of the expense;
        2. The time and place it was incurred; and
        3. The business purpose of such expenditure.

      2. Generally, an adequate record must be written. Treas. Reg. § 1.274-5T(c)(2):
        To meet the 'adequate records' requirements of section 274(d), a taxpayer shall maintain an account book, diary, log, statement of expense, trip sheets, or similar record . . . and documentary evidence which, in combination, are sufficient to establish each element of an expenditure or use specified in paragraph (b) of this section. It is not necessary to record information in an account book, diary, log, statement of expense, trip sheet, or similar record which duplicates information reflected on a receipt so long as the account book, etc., and receipt complement each other in an orderly manner.

        Account book, diary, etc. An account book, diary, log, statement of expense, trip sheet, or similar record must be prepared or maintained in such manner that each recording of an element of an expenditure or use is made at or near the time of the expenditure or use.

      3. Documentary evidence, such as receipts, paid bills, or similar evidence is required for "(A) Any expenditure for lodging while traveling away from home, and (B) Any other expenditure of $25 or more ($75 or more after October 1, 1995), except, for transportation charges, documentary evidence will not be required if not readily available." Treas. Reg. § 1.274- 5T(c)(20(D)(iii).

      4. Revenue Procedure 94-77, 1994-2 C.B. 825, provides an optional method for employees and self-employed individuals to use in computing deductible costs of business meals and incidental expenses paid or incurred while traveling away from home. In lieu of using actual expenses, employees and self-employed individuals may use an amount computed at the Federal M&IE rate for the locality of travel for each calendar day the employee or self- employed individual is a way from home. The current M&IE rates range from $26 to $38 per day, depending on the locality. (New York is $38 per day.) Only 50% of the meal allowance is deductible.

    2. Business and Personal Travel

      1. If a taxpayer travels to a destination and while at that destination engages in both business and personal activities, travel expenses to and from such destination are deductible only if the trip is related primarily to the taxpayer's trade or business. If the trip is primarily personal in nature, expenses while at the destination that are properly allocable to the taxpayer's trade or business are deductible even though the travelling expenses to and from the destination are not. Treas. Reg. § 1.162- 2(b)(1).

      2. A deduction for travel expenses of a spouse, dependent, or other individual accompanying a person on business travel is not allowed, unless (a) the spouse, dependent, or other individual, is a bona fide employee of the person paying or reimbursing the expenses, (b) the travel of the spouse, dependent, or other individual is for a bona fide business purpose, and (c) the expenses of the spouse, dependent, or other individual would otherwise be deductible. I.R.C. § deduction is $90.

    3. Deductible travel expenses include:

      1. Meals and lodging, both en route and at the destination, except to the extent they are "lavish or extravagant".

      2. Transportation costs, including air, rail or bus fares and the costs of transporting baggage, sample cases or display materials, as well as the allocable portion of operating and maintenance expenses of automobiles.

      3. Cleaning and laundry expenses.

      4. Telephone and telegraph costs.

      5. Public stenographer costs.

      6. Commuting expenses, including the costs of transportation between an airport or station and hotel, from one customer to another, and from the place where meals and lodging are obtained to a temporary work assignment.

      7. Tips incidental to the foregoing expenses.

    4. Conventions and Meetings Within the United States

      1. Convention expenses, like other travel expenses, must be reasonable and necessary in the conduct of the taxpayer's business and directly attributable to it.

      2. In general, self-employed persons and employees are entitled to deduct expenses incurred in attending conventions and other meetings only when a sufficiently direct business purpose is the primary motivation for the taxpayer's attendance and renders other nonbusiness purposes for attendance (usually vacation) secondary in importance.

      3. The business relationship test is satisfied if the agenda of a convention or meeting is so closely related to the taxpayer's position as to show that his participation in attending the meeting was for business purposes. For example, the convention expenses of doctors attending medical society meetings, lawyers attending bar association meetings, secretaries attending a convention of the National Secretaries Association have all been held deductible. The convention expenses of a writer attending a writers' association meeting would also meet the business relationship test.

    5. Foreign Conventions and Cruise Ships

      1. Section 274 disallows any deductions for expenses allocable to a convention, seminar, or other similar meeting outside the North American area unless, taking certain factors into account, it is as reasonable for the meeting to be held outside the North American area as within it.

      2. In general, expenses related to conventions, seminars, etc. on cruise ships are not deductible unless (1) the convention is directly related to the active conduct of the taxpayer's trade or business, (2) the cruise ship is a vessel registered in the United States, and (3) all ports of call are located in the United States or possession countries.

      3. Special substantiation rules apply to foreign conventions and cruises. The person claiming the deduction must attach to his return a written statement signed by him which includes information about the total days of the trip and the number of hours each day devoted to scheduled business activities, and a program of the scheduled business activities of the convention.

    6. Entertainment and Business Meals

      1. Entertainment expenses are deductible only if the outlay qualifies as an ordinary and necessary business expense under section 162, is directly related to the taxpayer's trade or business and is substantiated in accordance with the requirements of section 274(d).

      2. "Directly related" entertainment usually involves a business discussion or negotiation that looks forward to an income or other business benefit at some specific future time, and business must actually be conducted during the entertainment period, or it may involve an expense to keep a customer's goodwill that is incurred in a clear business setting. Entertainment at a nightclub, floor show or ball game must usually directly precede or follow a substantial business discussion and the taxpayer must be able to show he had a clear business purpose in making the expenditure. Lavish or extravagant entertainment is not deductible.

      3. 50% Rule. The deduction for otherwise allowable business meals (including meals while away from home on business) and entertainment is limited to 50% of cost. (These deductions are also subject to the 2% floor on second tier miscellaneous deductions on Schedule A; however, that floor does not apply to deductions taken on Schedule C.)

    7. Gifts

      1. The cost of a business gift or a gift made in an income- producing activity may be deductible as a business expense, but only up to $25 per recipient per year. I.R.C. § 274(b).

    8. Foreign Travel

      1. "In the case of any individual who travels outside the United States away from home in pursuit of a trade or business . . . no deduction shall be allowed under section 162 . . . for that portion of the expenses of such travel otherwise allowable under such section which, under regulations prescribed by the Secretary [of the Treasury] is not allocable to such trade or business."

      2. The regulations provide a complicated mathematical formula to allocate foreign travel expenses between personal and business expenses. Treas. Reg. § 1.274-4(f).

      3. The allocation rules do not apply (i.e., the expenses are fully allocable to business) if (i) "the individual incurring the expenses did not have substantial control over the arranging of the business trip," or (ii) "if the individual . . . can establish that, considering all the facts and circumstances, he did not have a major consideration, in determining to make the trip, of obtaining a personal vacation or holiday."

    9. Travel for Research

      1. IRS agents, and the Tax Court judges, are very suspicious of deductions taken for travel, especially travel to "fun" places. For example, in Nemish v. Commissioner, T.C. Memo. 1970-276, the taxpayer and his wife traveled to Reno and Carson City, Nevada, Monterey and Carmel, California and the Lake Tahoe area of Nevada and California. The Tax Court said,
        We are not convinced that petitioner's travel expenses are deductible: The evidence does not establish any proximate relationship between his travels and his writings. In response to a specific question on this point, petitioner testified that he needed 'background' on certain localities, but his testimony leaves open the worrisome question why he, an airline pilot whose major business is travel, needed background only on areas located near recreational resorts, where he and his wife journeyed and admittedly engaged in the activities normally carried on by vacationers. He introduced into evidence several short stories which he had unsuccessfully offered for publication, but he made no effort to demonstrate how his travels aided in their production. And the setting of his projected novels is not in the West, where he incurred the disputed expenses, but in an entirely different part of the country. We do not think the record justifies a finding that the expenses of his holiday excursions were incurred for business purposes.

      2. From this we may conclude that if there is a proximate relationship between the author's travel and her book, if the author can demonstrate how the travel aided in the production of the book, and if the book is set in the area where she traveled, the expenses would be deductible.

      3. In Stern v. United States, 71-1 U.S.T.C. (CCH) § 9375 (D.C. Cen. D. Calif. 1971), the plaintiff was a resident of Los Angeles in 1965. In that year he spent 335 days in New York City preparing a book. He claimed a deduction for his 1965 taxable year in the amount of $6040.00, covering travel expenses in connection with his stay in New York. The deduction was disallowed, and taxes and interest were paid in the sum of $1114.77. Plaintiff was an expert on the life and work of David Wark Griffith, a deceased film director. Plaintiff spent many years studying and arranging the papers of said D. W. Griffith, located in the Museum of Modern Art in New York City. The court first determined that Stern was in the business of writing in 1965, and, therefore, that, "The expenses were ordinary and necessary expenses of carrying on plaintiff's business of a writer, and hence are deductible under 26 U.S.C. § 162(a). [Citations omitted.] Plaintiff's expenses were for meals, lodging, and travel; these are expressly provided for in 26 U.S.C. § 162(a)(2)."

    10. Club Dues

      1. "No deduction shall be allowed . . . for amounts paid or incurred for membership in any club organized for business, pleasure, recreation, or other social purpose." I.R.C. § 274(a)(3).

      2. Under the final regulations, the dues disallowance provisions of section 274(a)(3) apply to any membership organization a principal purpose of which is to conduct entertainment activities for members or their guests or to provide members or their guests with access to entertainment facilities, such as country clubs, golf and athletic clubs, airline clubs, hotel clubs. The dues disallowance provisions of section 274(a)(3) do not, in general, apply to (1) civic or public service organizations such as Kiwanis, Lions, Rotary, Civitan, and similar organizations; (2) professional organizations such as bar associations and medical associations; and (3) certain organizations similar to professional organizations, specifically, business leagues, trade associations, chambers of commerce, boards of trade, and real estate boards.

      3. Professional organizations like Romance Writers of America, Novelists, Inc., etc., are not "clubs." Dues paid to professional organizations are deductible.

  8. I.R.C. § 280A. Office in the Home

    1. Section 280A(a) provides that with respect to a taxpayer who is an individual or a Subchapter S corporation, no deduction is allowed with respect to the use of a "dwelling unit" which is used as a residence by the taxpayer during the taxable year. To the extent that the residence is used only for personal purposes, the section merely restates the rule that personal living expenses are not deductible.

    2. Section 280A(c) provides five exceptions to the nondeductibility rule for space used in a trade or business. All five exceptions require that the residence be used on a "regular basis" for the qualifying activity. Intermittent use does not qualify. Three of the five exceptions require "exclusive use" of at least a portion of the residence, including:

      1. Use as the principal place of business for any trade or business of the taxpayer;

      2. Use as a place of business which is used by patients, clients, or customers in meeting or dealing with the taxpayer in the normal course of business; and

      3. In the case of a separate structure (e.g., an artist's studio, a florist's greenhouse, a carpenter's workshop) which is not attached to the dwelling unit, use in connection with the taxpayer's trade or business.

        The remaining two exceptions, storage space for inventory and day care for children, adults over 65 or mentally or physically disabled persons, do not require exclusive use.

    3. "Exclusive use" means that portion of the dwelling used for business cannot be used for any other purpose. Even de minimis personal use will jeopardize the deduction.

      1. If a cot is placed in a home office to accommodate an overflow of weekend houseguests, the exclusive use test would not be met.

      2. If the home office is a converted bedroom, the presence of a bed or other bedroom furniture in the room will make the taxpayer's argument less persuasive.

      3. Even the absence of furniture which could be used for personal use will not prevent the disallowance if the taxpayer used the room for paying personal bills or doing a tax return.

    4. A "separately identifiable portion" of a room may qualify for the deduction even if the rest of the room is obviously used for personal use. The portion need not be marked off by a permanent partition, but a temporary partition or an architectural feature (an L-shaped room, for example) may be helpful.

    5. "Principal place of business" means any trade or business of the taxpayer. A taxpayer can have more than one trade or business.

      1. A free-lance author was allowed a full home office deduction for a room in her residence which she used exclusively for business purposes. Frankel v. Commissioner, 82 T.C. 318 (1984).

      2. In Commissioner v. Soliman, 113 S.Ct. 70 (1993), the Supreme Court denied an anesthesiologist a home office deduction for a room in his apartment because it was not his principal place of business. Although he managed administrative and billing aspects of his practice in the home office, the primary income-generating activities of his business were performed at various hospitals where he saw and treated patients.

      3. Soliman set out a comparative analysis test to determine if a taxpayer's home office was his "principle place of business". The home office must be the "most important, consequential, or influential" location in which he conducts his business. This requires an analysis that compares the importance of the work done at home, and the time spent doing it, with the importance of the work done elsewhere, and the time spent doing that. If the comparative analysis reveals that there is no principal place of business, a home office will not qualify as the principal place of business by default.

    6. Allowable home office expenses are limited to the gross income derived from the business activity conducted at the home office, reduced by all deductible expenses that are not allocable to the use of the unit itself, e.g., office supplies, postage, payments to others.

  9. I.R.C. § § 1401-1403. Self-Employment Tax

    1. If a taxpayer has net earnings from self-employment of $400 or more in a tax year, he must pay the self-employment tax. This tax is equivalent to the Social Security and Medicare taxes withheld from an employee's wages.

    2. The combined self-employment tax rate is 15.3%, 12.4% for Social Security and 2.9% for Medicare.

  10. I.R.C. § Estimated Tax Payments

    1. Estimated tax is the method used to pay tax on income not subject to withholding, including self-employment income. It is used to pay both income and self-employment tax. Estimated income tax payments are used to provide for current payment of income taxes not collected through withholding. If estimated income taxes are underpaid by an individual, a penalty is imposed equal to the interest that would accrue on the underpayment for the period of the underpayment. The amount of the underpayment and the amount of the penalty can be calculated on Form 2210.

    2. Two exceptions are provided by Code Sec. 6654(e) to the imposition of a penalty on underpayment of estimated taxes. An individual is not required to make quarterly payments if her tax liability for the current year is less than $500. Further, no payments are required if a citizen or resident did not have any tax liability for the preceding tax year and such year was a full tax year.

    3. The penalty for underpayment of estimated tax is calculated over quarterly periods beginning on the installment due date. An individual is subject to the penalty on the difference between the tax payments (including withholding) made by the installment due date and the lesser of the following:

      1. For a taxpayer with adjusted gross income of $150,000 ($75,000 for married taxpayer filing separately) or less, the installment amount due based on 100 percent of the tax shown on the return for the preceding tax year, if such year was a full tax year.

      2. For a taxpayer with adjusted gross income of more than $150,000, the installment amount due based on 110 percent of the tax shown on the return for the preceding tax year, if such year was a full tax year.

    4. If an individual receives wages subject to withholding, the amount of withheld tax on wages is deemed a payment of estimated taxes and is spread out equally over the due dates for estimated taxes.

    5. Taxpayers who do not receive their taxable income evenly throughout the year, like authors, may use the "annualization of income" installment method. The use of the annualization of income installment method permits a taxpayer to make installments that actually reflect the income earned in the period immediately before the installment due date (calculated on a worksheet in the instructions for Form 2210). This method may result in a reduction or elimination of the estimated tax penalty that would be due if four equal installments were made.

  11. I.R.C. § 179. Election to Expense Depreciable Property

    1. Section 179(a) provides that a taxpayer may elect to treat the cost of any tangible personal property (e.g., a computer or typewriter) acquired for use in the active conduct of his trade or business as a current expense instead of a capital asset which must be depreciated over a period of years.

    2. The § 179 deduction limit per year will increase, as follows:

          1997 $18,000
          1998 $18,500
          1999 $19,000
          2000 $20,000
          2001 or 2002 $24,000
          2003 or after $25,000

    3. The total cost of property that may be expensed instead of depreciated for any tax year cannot exceed the taxable income of the taxpayer that is derived from the active conduct of any trade or business. In other words, the taxpayer has to have taxable income from the active conduct of a trade or business to use the § 179 election, but the income can be from any business of the taxpayer, not necessarily writing.

  12. I.R.C. § 401. Pension and Retirement Plans

    1. For purposes of the laws governing pensions and retirement plans, "employee" is defined to include a self-employed person. I.R.C. §c)(1)(A). "Self-employed" is defined to include any individual who (1) has "earned income" for the taxable year; (2) any individual who would have had earned income except for the fact that her business did not have net profits for the taxable year; and (3) any individual who was a self-employed person in any previous taxable year.

    2. A self-employed person may only participate in a plan that is established for a business from which she derives earned income. And only the earned income from that business may be taken into account in the calculation of contributions or benefits.

    3. A qualified plan must be a plan established by an "employer". A sole proprietor is treated as her own employer.

    4. The contributions to a pension, profit-sharing or other qualified plan are not currently taxable.

  13. USEFUL (and free) FORMS AND PUBLICATIONS

    1. Forms
      1. 1040-ES--Estimated Tax for Individuals.
      2. 1040-PC--For use with personal computers.
      3. Schedule C--Schedule of Profit or Loss from Business or Profession (Sole Proprietorship)
      4. Schedule SE--Computation of Self-employment tax.
      5. 2210--Statement Re Underpayment of Estimated taxes.
      6. 4562--Depreciation and Amortization (§ 179).
      7. 8829--Expenses for Business Use of Your Home.

    2. Publications
      1. 1--Your Rights as a Taxpayer.
      2. 17--Your Federal Income Tax.
      3. 334--Tax Guide for Small Businesses.
      4. 463--Travel, Entertainment and Gift Expenses.
      5. 505--Tax Withholding and Estimated Tax.
      6. 508--Educational Expenses.
      7. 529--Miscellaneous Deductions.
      8. 533--Self-Employment Tax.
      9. 534--Depreciation (§ 179 explanation).
      10. 555--Federal Tax Information on Community Property.
      11. 560--Retirement Plans for the Self-Employed.
      12. 583--Taxpayers Starting a Business.
      13. 587--Business Use of Your Home.
      14. 910--Guide to Free Tax Services.
      15. 1542--Per Diem Rates (for travel within Continental U.S.)

    3. Forms and Publications may be ordered from:

      1. Forms Distribution Center
        P.O. Box 9903
        Bloomington, IL 61799

        Or downloaded from:

      2. IRIS (Internal Revenue Information Services)
        World Wide Web: http://www.irs.ustreas.gov

  14. TAX LAW RESEARCH MATERIAL

    1. Commerce Clearing House and Research Institute of America both publish multi-volume tax services. These include the statutes, regulations, legislative history, CCH or RIA's explanation of the law, as well as case summaries, lists of forms and publications, and tax planning suggestions.

    2. Any large library or law school library should have either CCH or RIA, or both.


1997 Linda Lewis


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