An author attempted to argue that income from her publisher should be divided between income from writing, which would be subject to self-employment tax, and income related to other items covered by her contract are not subject to self-employment. However, in the case of Slaugther v. Commissioner, TC Memo 2019-65 the Tax Court did not agree with her view.
The taxpayer in question is a well-known and successful author. During the years involved in this case, the taxpayer spent from 12 to 15 weeks engaged in writing. In addition, during those years she spent additional time building as a brand author. The opinion describes a brand author as “one who provides prestige or reliable profits to a publishing house.” She spent significant additional time meeting with publishers, agents, media contacts and others to “protect and further her status as a brand author.”
The taxpayer received two types of payments from her publisher each year. One type is a nonrefundable advance, while the second is a royalty based on revenue or profits from the work in question. She was not paid any amount from the royalty payment category until the total computed amount for that category exceeded the nonrefundable advance she had already been paid.
The author’s position was that while her writing may be self-employment income, most of what she was paid was for, effectively, being herself—that is, the “brand” of the taxpayer.
The Tax Court described the rights beyond just the ability to publish the manuscript that are found in the contracts:
The contracting publishers receive more than just the right to print, publish, distribute, sell, and license the works and manuscripts written, or to be written, by petitioner. They also secure the right to use her name and likeness in advertising, promotion, and publicity for the contracted works. Petitioner is required to provide photos and be available for promotional activities. The contracts include noncompete clauses which vary in scope, from requiring that the specified manuscript be completed before others, to prohibiting petitioner’s entry into another contract until her writing obligations are met. Publishers also secure the right to advertise other works in petitioner’s books, qualified by the requirement that petitioner consent to the specific advertisements. Several of the contracts allow for, but do not require, a share of advertising proceeds to be paid to petitioner as a condition of her consent. Finally, the contracts include an exclusive option for the respective publisher to negotiate the contract for petitioner’s next works.
Petitioner also receives more than just her advances and royalties. For instance, some contracts include a marketing guaranty requiring the publisher to spend a minimum amount on marketing for petitioner’s books. Although the publishers fund the marketing plan, petitioner’s agent retains the authority over its development. Another example is petitioner’s option to purchase the publisher’s plates at a reduced cost for any book that goes out of print and that the publisher refuses to reissue or license. In that instance, the rights in the work also revert to petitioner.
The various requirements of the contracts and the additional benefits described above appear to be standard in the publishing industry. It is not standard, however, to assign a particular value to such rights and benefits in the contracts. Petitioner’s contracts are no exception; they do not allocate the advances or royalties between writing the works, promoting the works, noncompete clauses, or exclusive options.
The accounting firm that worked with the author to prepare her return came to the conclusion that the taxpayer’s income could be bifurcated between income for writing, which would be self-employment income, and income from the non-writing portions of the payment, which would not be subject to self-employment taxes. As the opinion continues:
To prepare her 2010 and 2011 returns, petitioner turned to the same tax preparation firm she has worked with for approximately 20 years. Several people from the firm, including Karen Wesley, a certified public accountant, worked together to prepare petitioner’s 2010 and 2011 returns. Ms. Wesley has been licensed since 1989, prepares roughly 300 tax returns per year, and has worked with petitioner for approximately eight years. In order to prepare the returns, petitioner first met with a bookkeeper and then with Ms. Wesley to review questions and ensure that the firm had everything it needed. For each return, the firm worked as a team and addressed any follow-up issues with petitioner on the phone. After finalizing the return, petitioner reviewed it with Steve Harless, the paid preparer who signed the return.
Over the course of working with petitioner and talking with petitioner’s agent, it became apparent to Ms. Wesley that petitioner was compensated for more than simply writing. Ms. Wesley came to understand that an author’s earned income is generally the amount paid for actually writing but that petitioner’s income was higher because she was also paid for her name and likeness. Ms. Wesley concluded that any amount paid to petitioner for the use of her name and likeness was “investment income”, i.e., payment for an intangible asset beyond that of her trade or business as an author. Ms. Wesley noted the distinction between investment income and income generated from writing because, in her opinion, only the latter would give rise to self-employment tax. Ms. Wesley therefore concluded that petitioner should pay self-employment tax only on the amount that publishers pay her for writing and not on amounts paid for her name and likeness.
Although the preparers conducted research to determine the income allocable to petitioner’s trade or business, they found no definitive authority in the particular instance of a brand author’s income.
The accounting firm did run into a problem about how to divide up the income, since the publisher did not separately designate payments for “pure writing” separate from those related to the author’s brand. The Tax Court described how the firm went about dividing up this income and reporting it, noting the accounting firm:
… decided to report all of the advances and royalties petitioner received on a Schedule E, Supplemental Income and Loss, subtract the portion relating to the trade or business of writing, and report that amount on a Schedule C, Profit or Loss From Business. The Schedule C amount, therefore, represents the team's calculation of petitioner's trade or business income. The preparers calculated the amount of petitioner's self-employment tax due using only the Schedule C income amount; they did not calculate any self-employment tax due from the balance of the advances and royalties left on Schedule E.
The accounting team did not have copies of petitioner's publishing contracts. To calculate the amount reported on petitioner's Schedule C, the preparers used a calendar-based approach. They applied the percentage of the year which petitioner spent writing to the total payments she received for the year. Petitioner did not provide the preparers with a work calendar. Instead, the preparers relied on petitioner's statement that it took her roughly 12 to 15 weeks to produce a manuscript for a publisher. The preparers applied a 12-week period and assumed a five-day workweek because petitioner told them she occasionally took time off from writing. For the 2011 tax year the percentage reported was higher than that for 2010 because petitioner spent more time writing.
No other adviser recommended apportioning the income in the foregoing manner, and no appraiser was employed to value petitioner's contracts or opine on the calendar-based approach. The only individuals outside the accounting firm with whom the team discussed their conclusions were petitioner and her agent.
The IRS did not agree that the income could be divided in this manner. The IRS argued that all her activities fit the definition of self-employment income found in IRC §1402(a) which provides in part:
(a) Net earnings from self-employment The term “net earnings from self-employment” means the gross income derived by an individual from any trade or business carried on by such individual, less the deductions allowed by this subtitle which are attributable to such trade or business, …
In the IRS’s view all the payments the taxpayer received from the publisher represented trade or business income related to her writing trade or business.
The taxpayer argued that Rev. Rul. 68-499 supported her position. That ruling dealt with two employees who were among five people the employer paid for licenses to manufacturer items for which the five individuals held patents. The other three individuals receiving payments were not employees of the company paying the royalties.
The ruling held that the payments to the two employees represented a royalty payment that was separate and distinct from the wages paid, and that the royalties were not subject to payroll taxes, nor were they to be included in the employees’ W-2s. The taxpayer argued that the same result should occur in her case—that this justified her “non-writing” work being treated separately from the brand assets (effectively, just being her) that she was being paid for.
The Tax Court found, though, that the ruling wasn’t relevant because self-employment income’s definition is tied to income related to a trade or business, which is distinct from the definition of wages (which generally looks at payment to an employee for services). As the Court stated:
Petitioner’s analogy fails because it attempts to adapt out-of-context definitions of employment to the definition of trade or business income under section 1402. We are not able to focus solely on the words “net earnings” to the exclusion of the words “trade or business”. The statute provides that “net earnings from self-employment” includes income derived from any trade or business. An allocation within petitioner’s contracts is beside the point if all elements are to be allocated to a trade or business.
The Tax Court found that all the “brand” activities the taxpayer engaged in were clearly related to her trade or business of being an author:
We conclude that petitioner’s brand is part of her trade or business. We construe “trade or business” broadly, and, examining all of the facts, find that petitioner was engaged in developing her brand with continuity and regularity for the primary purpose of income and profit. See Jones v. Commissioner, T.C. Memo. 1998-354; Dacey v. Commissioner, T.C. Memo. 1992-187; Hittleman v. Commissioner, T.C. Memo. 1990-325. Petitioner set out in a businesslike fashion to obtain stationery, a reputable agent, and a publishing contract. Petitioner worked with a media coach and publishers to develop a successful brand. She has spent time, including during 2010 and 2011, meeting with publishers, agents, media contacts, and others to protect and further her status as a brand author. She attended interviews and promotional events and works to develop and maintain good relationships with booksellers and librarians. Petitioner also uses social media, websites, and a newsletter to maintain her brand with her readership. Further, it is common in the publishing industry for writers to build brands and promote their work. We have held that an author’s TV and radio appearances, for example, are evidence that a taxpayer is in the trade or business of writing rather than writing as a hobby. See, e.g., Dacey v. Commissioner, T.C. Memo. 1992-187.
The issue of what is a trade or business arises quite frequently under the IRC and the Court noted that the same arises when determining what is included in self-employment income. The Court also makes clear that the view of what is included in the trade or business is a broad one for self-employment purposes. But advisers must remember that §1402(a)(1) has a long list of items that are specifically excluded from self-employment income, such as interest, dividends and rentals of real estate, that will exclude items from self-employment income even if the item is otherwise related to the trade or business.
As well, this case reminds us that although self-employment income and FICA wage seem to be a similar concept, there are not the same thing and the fact that something may fall into one category in one situation, say when someone is an employee, does not mean the same treatment will arise when the question arises in the other context.
Assume the two employees referenced in Rev. Rul. 68-499 were not employees, but rather each had a sole proprietorship where they performed services for a company manufacturing the product under license and granted that organization the right to manufacture the product that involved the patent they owned. In this case, both the payment for the services rendered to the manufacturer and the amount the manufacturer is paying for the use of that patent would likely be considered part of the same trade or business for self-employment tax purposes.