Business or Hobby?

Before we talk tax deductions, there’s a key definition you need to keep in mind. To take most of the deductions I’ll mention, you have to be categorized as a business by the IRS. The notion of a ‘business’ overlaps with ‘contractor’ and from a practical point of view there isn’t much to distinguish a sole proprietorship (business) from a contractor. Both categories pay self-employment taxes and may have to file quarterly estimated tax payments. For freelancers, the deductions are so similar that it doesn’t matter what you call yourself.

So, are you a business? Here’s what the IRS says are the defining characteristics–

• “A trade or business is generally an activity carried on for a livelihood or in good faith to make a profit.” No matter how much or how little you write, to qualify as a business, you have to have a profit motive. You prove this by getting paid, or by trying to make money even if you don’t actually make a dime.
• The IRS also says, “You do not need to actually make a profit to be in a trade or business as long as you have a profit motive.” Quit writing for free and quit writing solely for contests or just to get your byline posted somewhere.
• And the IRS tells us what they are going to look for: “You do need, however, to make ongoing efforts to further the interests of your business.” What does that mean? Well, it means I bid for jobs. And whether or not I get any particular job, the notice that oDesk emails to me gets saved. That’s my proof. Pretty sweet huh? You get turned down for a job and it works in your favor anyhow. Just print out a screenshot of all the email titles from oDesk (which show the dates- hence ‘ongoing’) and file it under ’seeking work’.
• One last nugget from our government friends: “You do not have to carry on regular full-time business activities to be self-employed. Having a part-time business in addition to your regular job or business also may be self employment.” You do have to keep your part-time business separate as far as income and deductions go, but that’s not hard. Just keep different records for the business stuff- receipts and bank statements showing income. By the way, you do have a separate bank account for funds transferred from oDesk, right? Right?

The more business-like you appear, the less likely you will have problems taking deductions against your business income. Get a DBA (doing business as). In Michigan, where I live, it’s a simple matter of paying $15 to the County Treasurer’s Office. I gave them a name for my business and they gave me two certified certificates showing I was registered.

Even though I am a sole proprietor and freelancer, having a business alias is a boon. It allowed me to open a bank account under the business name, get a credit card and bank statements under that name (for record keeping), and makes it makes the IRS happy.

Let’s deduct.

Here’s a handy phrase for you– income tax neutral. That’s what the money you spend on your business is. You count it as income, but then you immediately deduct it under expenses. Note that it isn’t, in most cases, tax neutral. We pay sales tax when we purchase items for the business, and when we buy services, whoever we buy from will eventually pay taxes on the money we dole out.

So, what can we buy that is income tax neutral? Well, the IRS has a nice phrase for this too: “ordinary and necessary”. Mechanics need wrenches and lion tamers need whips (I assume). Freelance writers need things too.

Here’s a short list of stuff I’ll be deducting this tax year:

• A couple hundred dollars in books- a few on copywriting and writing in general, the 2008 Writer’s Market guide, a Roget’s Thesaurus, and whatever else I buy that’s writing related this year.
• Software for my computer. I need to upgrade so I can deliver finished work in Adobe format. Since my computer is used solely for my business, any software I buy for it is income tax neutral.
• Paper, printer cartridges, pens, notepads (yes, I still use notepads), labels, blank CDs for backups, and the assorted minutia that fills my desk drawers.
• Business card and letter stock. I don’t use many business cards, so I just buy the print-it-yourself type.
• A new printer. I figured it would be nice to have, and it’s deductible.
• I bought some RAM for my current system, and I’ll be buying a laptop this year.
• Cable modem costs– this is trickier, since I buy cable services for phone, TV, and Internet. I will have to pro-rate some reasonable amount for business use.
• A new ergonomic keyboard. Wouldn’t want to get that nasty carpel tunnel.
• Fees charged by online freelance sites. oDesk charges the buyer, I don’t pay it, but other sites require fees from providers to bid. These fees are deductible, being necessary for you to conduct your business.

What’s not on the list.

All of the above are ordinary and necessary for a freelance writer. One important deduction I left off the list is for a home office. Although I qualify because I do have a small area that is used exclusively for business, calculating and taking the deduction is worth less to me than just claiming the normal deduction for having a home. I have read that claiming a home office is one of the items that get your taxes a second look and I don’t want to stick my neck out for the small amount it may save me.

Here are some iffy deductions that I won’t be taking:

• Automobile mileage. I do drive a little strictly for business purposes. To and from the library, to the store for supplies… short, insignificant trips. Since mileage is another hot button (the sort of deduction that gets abused), I’m just leaving it off this year. Certainly, if you travel any great distance for your business, document and take all the mileage you are allowed.
• Electricity costs. Too much trouble to document.
• Coffee. Would I drink less coffee if I weren’t writing? Maybe so, but I can’t see trying to justify this one. Is it ordinary? Is it necessary?
• Books I’d like to have that aren’t directly related to writing. I could claim books I bought just to read as important for developing myself as a writer, but novels, poetry, and newspapers aren’t really necessary items. If I had to purchase a specific book for a specific job I would claim it. I would also document why I needed it and which job it was for. Don’t try to deduct more for a job than the job paid though– you are a business, remember? Unless you got burned on a job, no one is going to believe you are out for profit if your costs exceed what you made on the project.
• Overdue library fines. I get a lot of these. But they are, after all, my own fault. I wouldn’t call being too lazy to return a book on time ‘ordinary’.

That should be enough to give you the flavor of what is and what isn’t allowed. Just picture yourself having to explain a deduction (in response to a letter of inquiry from the IRS) a year or more from now. Do you really want to stretch the truth that far to save a buck? Better to stick to the ordinary and the necessary and reduce your worry and stress.

What do you claim?

If you’ve stuck with me this long (over 1200 words), I suspect you have your own ideas about what is and isn’t deductible. I’m not a tax professional and I’d like to hear what others are deducting and avoiding. Share your hot tips with our readers– I’d love to save a few more dollars (legitimately).

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