In the latest installment addressing the tax concerns of freelancers, IRS Section 183 of the tax code, contains a carefully worded safe-harbor clause for small business owners. It's one of a few ways the IRS differentiates between business income and hobbies.
Section 183 presumes that freelance writers, as opposed to a hobby, provided the business has a net profit, meaning, in IRS lingo, the excess of receipts over expenses in any three out of the last five consecutive years.
(By the way, Congress, in its wisdom, decided that writers, photographers, artists and the like aren’t as deserving as individuals involved in the breeding, showing or racing of horses. A precisely worded exception confers an easier standard on them. They only have to show net profits in two out of seven years.)
Consequently, freelancers usually do not have to fret if they have at least three profitable years during the last four. Satisfying that stipulation entitles fully deductible expenses this year. It’s okay even if this year’s 1040 form reports a loss.
Suppose form 1040 reports losses in more than two out of five years. It’s not fatal. The IRS permits that freelancers conduct a “for-profit” business, provided they pass the “facts and circumstances” test.
What follows are some of the factors that IRS auditors reflect on when they grade this test. In our experience, the auditors are reasonable. They never consider one factor to be conclusive; one person’s hobby can turn out to be another person’s business.
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For starters, IRS graders never require freelancers to be the smartest person in the room, though, understandably, they’ll want to know if they are on top of what they are doing, or, if not, relies on knowledgeable advisers.
Another likely question: How much time and effort do freelancers expend in the conduct of their career as a writer? The burden of proof to establish that is on the taxpayer, not the IRS.
Do they keep accurate and thorough records? To placate graders, they should save records of payments for expenses such as supplies and equipment. Ditto for queries to publishers and programs from writers’ conferences.
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Something else they’ll ask: Is the taxpayer really trying to make money as, say, a writer or photographer?
It all depends. For instance, IRS examiners figured out long ago that freelancers who submit articles or photos to publications that pay only in copies usually are hobbyists.
But they also acknowledge that it’s possible for freelancers to qualify as a professional writer, even when their are employed full-time in some other field––as is the case with many freelancers. They concede that they can earn a paycheck elsewhere and nonetheless have a legitimate freelance-writing business.
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Consequently, freelancers should prepare themselves to show skeptical examiners why it made sense for to endure unbroken financial losses while endeavoring to replace a struggling business with a successful operation.
Your Tax Pro on Demand,
Monica Marie Stuart
215.550.3636
