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Why it is important to carefully characterize income

While writing can be a good source of money, it requires a lot more than simply putting creative ideas onto paper. In the case of K Slaughter v. Commissioner, it provides an important tax lesson.

An author of multiple book series challenged deficiencies related to self-employment tax. The author could be considered a brand author. Brand authors are publishing house authors that help bring in reliable profits as well as prestige to a publishing house.

To become a success the author had worked with a media coach, an agent, and had a contract with a top-notch NYC publishing house. This means that she was not only writing during the years at issue, she was also furthering her brand as an author.

A tax lesson for all authors

She had two aspects to her job. Her first was the actual writing job, and her second was building her brand. When filing her return, her CPA attributed income earned on her brand as a return on an intangible asset and not subject to self-employment tax.

While the Tax Court has recognized the value of the brand of some authors. In this case, the issue was in part related to valuation. To split her income, she kept details on how long it took her to produce a manuscript to determine the portion of income related to writing. The remainder was attributed to her brand.

The Tax Court did not agree with the strategy of splitting the income. It found that her brand was part of her business or trade and therefore subject to self-employment tax.

How to avoid this situation

If the author had formed her business as an S corporation and paid herself a reasonable salary, the self-employment tax deficiency might have been avoided. In this type or setup, she would pay tax on the salary she drew from her company.

Fortunately, in this case, the IRS was willing to wave the tax accuracy penalty because all the involved parties cooperated through the entire IRS investigation.

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