My writing focus has always been food, wine and travel, but all writers, regardless of their specialty, must be aware of tax fundamentals. It doesn’t matter if you sell your work to a daily newspaper, a quarterly publication or online outlets—the basics are identical. A recent audit helped me more fully understand taxes, write-offs, gray areas and the value of proper record-keeping. Here’s how mine went, plus some tips that could save you some real headaches.
It was a Thursday when I came home and found my wife looking ashen. She held in her hand a notice from the Internal Revenue Service that we were being audited. We are both self-employed: I’m a full-time freelance writer; she’s a massage therapist. To suggest that panic set in quickly is an understatement. The first thing we did was call our tax-preparation people, with whom we had worked for years—Actors Tax Prep, Inc. (whose president, David K. Rogers, was kind enough to review this article).
Audits, I learned later, are triggered in two ways. The first is via the Differential Infraction Score, an accumulation of points an IRS computer records for each “suspicious” element of your return—for example, abnormally high deductions compared to income. When it reaches a certain number only the IRS knows, that can lead to an audit. The second method is for an IRS computer to simply pick you at random, which is the case with about 25 percent of audits.
A harsh reality is that audits will cost you valuable time and money. In addition to having to pay for an enrolled agent to represent us (more on this later), the amount of time it took us to pull receipts and format them into Excel spreadsheets was a burden. For example, I am the restaurant critic for the Santa Barbara News-Press, and my reviews appear each Friday. I visit each restaurant twice, if not three times; therefore I had amassed 145 individual receipts, all of which needed to be put in chronological order.
And that was just one category out of more than 25. Others included business gifts, business-travel meals, photography for articles and books, registration fees for professional development, small equipment for home-based use and website-maintenance expenses.
At the time, I was working on a book, too, so the audit doubled my stress load. We asked for (and received) an extension due to my book deadline and international travel schedule. We met at the local IRS office.
Being as fully prepared for the audit as I was, the actual meeting took less than an hour. Here’s another reality: Being audited doesn’t mean you’ve done anything wrong. It turned out I owed the IRS nothing, my records were in order and my deductions all valid. One issue that might explain my audit is that I aggressively take deductions, though all are allowable.
When all was said and done, I paid no money to the IRS, though my wife and I did spend more than $1,000 for the time and expertise of the enrolled agent, not to mention at least 100 hours pulling receipts, obtaining bank records and doing other paperwork.
If an audit letter ever arrives in your mailbox, here’s what you need to know.
How to respond to a tax audit
First, panic. Second, get to work. Hire an enrolled agent to handle the audit with you. An enrolled agent is a tax preparer who has the background to pass a grueling three-day IRS exam on every aspect of tax knowledge. The IRS then licenses that person to represent taxpayers at every level of an audit or collection matter. An EA can also be a former IRS employee who has at least five years’ experience in audit-related matters and is now involved in private tax practice.
Yes, you can represent yourself. But an EA will know better than you do how to deal with the IRS, from setting appointments to refiling your return (if need be) to getting you taken more seriously during the audit. If you show up to an audit with a bag of receipts, looking disheveled and anxious, and are unfamiliar with the laws, you’ll have a tough time.
Also, most IRS auditors are predisposed to accept information presented before any receipt is examined, based on your business-like appearance, the professional respect you show them, whether you’re accompanied by a qualified representative and your opening comments.
Vital tips for freelancers
Home-office deduction. There’s a perpetual myth you can deduct whatever part of your home your office is in. The IRS has strict rules about what constitutes an “office” and, if it wishes, can come into your home and examine yours.
If you deduct 100 percent of your work computer, then your work computer must be used solely for writing, pitching and editing. If you use it for personal emails, shopping or anything not directly associated with your work, that’s a violation. You can only deduct costs incurred for a portion of your home based on the percentage of your residence used exclusively for business.
Business credit cards. The IRS wants to see a business credit card that shows work-related transactions only, and the same goes for your business checking account. If you’re audited, the IRS will ask to see all bank statements, including all deposits. Those deposits must be accounted for to verify that money you received was actually a publisher’s check, a royalty check or a reimbursement check (which can’t be deducted). This means you may have to pay your bank a fee to retrieve the documents, which can be expensive. A potential way around this deposit problem: Keep detailed records.
The importance of keeping clips as proof of your work. I took a huge stack of newspaper clips, magazines and website printouts to my audit and purposefully dropped them on the table, hoping I’d dramatically show that I was prepared. The material was never questioned.
The business-vs.-hobby issue. The IRS expects you to show a profit two out of every five years. If you exceed that limit, the IRS can re-examine all five years, and may rule that your writing is not a professional endeavor but a hobby. While hobby expenses are deductible, the deductions are limited to hobby income, which totally eliminates the benefit of claiming a loss to reduce other income.
Bottom line: You are a writer and therefore you are a business. Treat yourself as such. Get in the habit now of maintaining proper records.
Michael Cervin is a full-time freelance writer and speaker and the author of five books, including four national travel books. Notable publications include Decanter, Wine Enthusiast, Skywest and more than 80 others.
*This article originally appeared in the March 2012 issue of The Writer.