Expense Confusion Lingers for Self-Employed Writers

Resident tax guru Julian Block answers some pointed reader questions on expense reporting for freelance writers, which remain despite IRS guidance.

Query: I’m a self-employed freelance writer, whose output includes hundreds of articles for print and electronic publications, as well as several books.

Back in the pre-pandemic autumn of 2019, the publishers of a now-defunct magazine agreed to pay me $20,000 for several tell-all articles that reveal extramarital affairs, shady business dealings and other transgressions committed by prominent A-listers and boldface names in cosseted enclaves like Hollywood, Silicon Valley and Wall Street.

While I usually ask and receive considerably more for those kinds of articles, I decided to settle for $20,000. Why? Because my publishers didn’t ask me to surrender all rights to the articles. Instead, they agreed that I retained rights to use my material in other ways.

I then thought retaining rights opened the way to get big bucks from sources like books, movies, speaking gigs and other opportunities in the broadening economic landscape for brand-name writers.

Let’s pivot from what I thought was going to happen to what actually happened early in 2021, when I gave the articles to my publishers, along with my bill for $20,800, comprised of the $20,000 fee, and $800 for reimbursement of travel (mostly, pre-pandemic), and other expenses I incurred in the course of research undertaken during 2019 and 2020.

A few weeks later, their magazine went kaput, and I received nothing from them. Last I heard anything about them, they decided to help federal agencies investigating criminal acts by publishers at other outfits.

The feds gave rewards to my publishers, sequestering them in witness protection programs. As long as they’re there, securely beyond my reach, I’m never going to receive the $20,000.

The next pivot is to Form 1040 time. I know where the various out-of-pocket expenditures aggregating $800 go on which lines of Schedule C (Profit or Loss From Business).

I consider that to be an unfair outcome. What’s fair is that I should get to further reduce my income taxes with a bad-debt deduction on Schedule C for that unpaid $20,000.

I anticipate that I’ll end 2021 in a 30 percent federal and state bracket; the $20,000 write-off works out to a savings of $6,000––not monumental money, but enough to entitle me, my wife and our kids to some sumptuous spreads at five-star restaurants and stays at top-tier resorts.

Just how helpful is a decrease of $20,000 in the net profit figure on Schedule C? It helps in two ways.

First, it noticeably decreases my liability for self-employment taxes on Schedule SE. Second, it increases my itemized deduction for medical expenses on Schedule A (deductible only to the extent that they exceed 7.5 percent of adjusted gross income).

Do I enter the $20,000 in the expenses part of Schedule C for 2021? Or should I amend 2020’s return in order to claim it? Or amend 2019’s return?

Answer: The IRS won’t allow you to claim any deduction for the $20,000 on any of your 1040s.

The insurmountable snag: the agency characterizes you as a “cash-basis taxpayer.” That’s how the IRS designates individuals (a category that includes almost all filers) who generally don’t have to report payments for articles, books and other income items until the year that they actually receive them and don’t get to deduct their expenses until the year that they pay them.

Because the IRS doesn’t require you to count the $20,000 as reportable income, it doesn’t allow you to deduct an equivalent amount. When would the IRS say that it’s okay? Only if you were an “accrual basis taxpayer” (few individuals are) and had previously counted the $20,000 as reportable income at the time it became due to you, could you deduct it now. As it hasn’t actually arrived, chalk it up as a lost cause.

What’s ahead is that generally, Internal Revenue Code Section 262 allows writers to deduct the “ordinary and necessary” expenses that they incur in the conduct of their businesses. This holds true even if they suffer repeated losses for the years in question.

But Section 262 isn’t the last word. Writers and other creative types also have to reckon with Section 183. It prohibits deductions for losses when they’re claimed by supposed “businesses” that, upon scrutiny by IRS auditors, turn out to be “hobbies.” The rational for the restrictions: the agency’s auditors continually convert deductible “business” losses into nondeductible “hobby” losses.

Homework Assignments for My Dear Readers

Several future columns will focus on tax court decisions that resolve business-versus-hobby disputes. To help readers better understand those decisions, I’m assigning some advanced readings:

Those decisions disclose that the courts usually side with the IRS’s attorneys; some of their victories are slam-dunks, especially when the agency’s legal eagles joust with taxpayers who represent themselves. Still, savvy taxpayers, like that above-mentioned documentary film maker, have notched some impressive wins.