IRS criminal investigations

Self-Employment Tax Plot Unraveled by Court


A recent court case revolved around the issue of whether an author's income from marketing and licensing endeavors should be treated as self-employment income for tax purposes. 

Oct 5th 2021
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In a new case decided by the Eleventh Circuit Court of Appeals, Slaughter, CA-11 No. 20-10786, 8/3/21, a famous author of crime novels was held liable for underreported self-employment income.

Generally, a self-employed individual must pay federal income tax as well as self-employment tax on the net self-employment income received during the year. Net self-employment income is essentially your gross income from your business activities less deductible business expenses.

This income is subject to income tax at ordinary income rates. The self-employment tax rate is double the regular payroll tax rate for employees—15.3% instead of 7.65%—but half of the tax is deductible.

Facts of the new case: The taxpayer is a best-selling author who lives in Georgia. She is known for her gritty crime fiction novels.

In 2010, the taxpayer received more than $5.4 million from publishing contracts after deducting her agent’s fees and expenses. However, on her income tax return for that year, she reported only $875,000 as gross business income.

After taking business deductions, the taxpayer calculated a self-employment tax of $18,725 on that income and reported the remaining $4.55 million as supplemental income. Similarly, in 2011 the taxpayer received about $3.6 million from her publishing contracts after deduction of her agent’s fees and expenses.

But on her income tax return for that year, she reported only $930,000 as gross business income. After deductions, she computed a self-employment tax of close to $18,000 on the income and reported the remaining amount as supplemental income. Again, the taxpayer didn’t report any self-employment tax on the supplemental income.

The taxpayer asserted that only part of her income for her writing services should be subject to self-employment tax. She argued that marketing and licensing fees fell outside the domain of her writing business activities. Conversely, the IRS disputed her claims.

 According to the courts, net earnings from self-employment is defined as gross income derived by an individual from any trade or business carried on by the individual less the deductions attributable to the trade or business. The taxpayer is engaged in a trade or business if he or she is continuously and regularly involved in the activity for the purpose of turning a profit.

The Circuit Court also stated that the business expenses deducted by the taxpayer support the position that all of the income constitutes self-employment income. This included the following write-offs:

  • Advertising expenses, such as expenses relating to the taxpayer’s website, plus other marketing costs.
  • Rent for an apartment in New York City where she stayed while attending trade shows and meeting with publishers.
  • Payments for a vehicle she drove to interviews, promotional meetings and other networking events. (The vehicle was the same model as the one driven by one of the main characters in her books).
  • Catering costs and gifts for business associates.

The Court determined that these deductions illustrated that promotional activity was an important part of the taxpayer’s writing business and is consistent with the tax treatment of the “supplemental income” as self-employment income.

End of the story: All of the taxpayer’s income is treated as self-employment subject to taxes. At least the Court let the author off the hook for a negligence penalty since she relied on the advice of tax professionals.

For knowledgeable CPAs, there was no real mystery to this tax outcome. Make sure your clients are prepared for reality.

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By Lewis C. Taishoff
Oct 7th 2021 15:46

As you say, this decision is no surprise. The interesting part is the "brand name" gambit, keeping taxpayer as individual, rather that using the played-out single-stockholder Sub S or single-member LLC dodge.

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