Tax Consequences of Income Made From Freelance Writing

If any publisher or site pays a non-employee writer more than $600 during the year (for most of us out "tax year" is the same as the calendar year), the payer will send a Form 1099-MISC to the IRS and a copy to the Content Producer. [For the purposes of this article, I address only Federal tax obligations. A Producer may, in addition, have state or local taxes that are applicable.] If the payer fails to send the Form or if one has several companies for whom he or she writes, none of which has paid $600, this does not affect the requirement that the income is to be reported and tax liability assessed.

The first issue that must be addressed is whether the writing income is a "business" or a "hobby". The characterization controls how income, expenses and possible losses are treated.

At the risk of oversimplification, hobbies, also called not-for-profit activities, are those activities that are not pursued for profit. What is a business? Generally, an activity is considered a business if it is carried on with the reasonable expectation of earning a profit. It is usually more advantageous to have your writing earnings treated as a "for profit" business if, after taking into account all legitimate business expenses, the result is a net loss.

But first, what are the benchmarks to determine the nature of the activity? An activity is usually considered a business if it makes a profit during at least three of the last five tax years, including the current year. (There's a separate rule for breeding, showing, training or racing horses. I mention this to "show off"; a combination of free-lance writer and horse breeder? Go see a professional tax expert!)

The rules for determining whether or not an activity is a business or hobby is quite complex and you should seek the advice of a qualified tax professional to see how your activities should be classified. In general, the IRS uses a 9-Point Test to determine if the activity is a business or a hobby:

1. the manner in which the activity is conducted, how "business-like".

2. The expertise of the taxpayer, what are your qualifications, experience, etc.

3. The time expended on the activity. Is this a full-time operation? Does the time and effort put into the activity indicate intent of making a profit?

4. The expectation of profit; are you dependent to some reasonable extent on the income?

5. The success in other similar or dissimilar activities, have there been similar activities that have made a profit in prior years?

6. The history of income and losses. If there are losses, are they due to "start-up" costs or unusual circumstances?

7. The amount of "occasional" profits. Have there been operational changes in the activity designed to increase profits?

8. The financial status of the taxpayer. Has the activity generated a profit in past years?

9. How personal pleasure or recreation contribute to the business. Are you having "fun" as a primary motive or do you continue the activity to generate income?

The consequences of the hobby/business determination are significant in the treatment of business net losses. If the writing, in the case in point, is a business, then income and expenses are reported and calculated on Schedule C of the Federal Tax Form 1040. This schedule, when completed, determines the profit or loss resulting from the business activity. If there is a loss, that loss is shown on line 12 of Form 1040 and would offset other income earned through other activities. There is no limit on the amount of loss that may offset income earned elsewhere.

On the other hand, if the activity is a hobby, aggregate gross earnings are reported on line 21 of Form 1040. Expenses from the business (as, for example, the cost of magazines and newspaper required for research, depreciation of assets used in connection with your writing, business cards and other such expenses, are reported on Schedule A of Form 1040 - only if deductions are itemized. If the number and amount of possible itemized deductions, for medical expenses, taxes, casualty losses, and the like, are less than the "standard deduction" it may be better to forgo itemization and use the standard.

There are, moreover, limits on the amount of expenses that may be deducted on Schedule A. First, in regard to hobby expenses, the amount cannot exceed the amount of hobby income; second, such expenses are considered "miscellaneous itemized deductions" and you may only deduct the portion of them that, along with any other miscellaneous deductions, exceeds 2 percent of your adjusted gross income.

Depending on your particular tax circumstances this can result in all income from the hobby being taxable income with no offsetting deduction for hobby expenses.

As noted, if this seems incomprehensible, having your return prepared professionally may be a good bet. There are, in addition, free tax preparation services, listed on the IRS website for taxpayers with total income less than $52,000 annually. For those with gross incomes greater than that amount, a number of tax preparation companies assist in preparation and filing of returns at a modest cost.