Real Words

Guest Post by Robert D. Flach (the Internet’s “Wandering Tax Pro”)

My name is Robert D Flach.  I have been preparing 1040s for people in all walks of life since 1972, and have been writing the popular tax blog THE WANDERING TAX PRO since 2001.

Kathryn has asked me to address the following question:

“A lot of the money that I get from blogging is ad revenue or affiliates revenue (when items I link to on Amazon sell, etc.) I’m not really sure how that’s supposed to get reported on my income for tax purposes”

So here goes!

Why does someone write a blog or create a website with free information and services?

The answer is simple – to get attention.

I do not mean that in a bad way.  Let me explain.

A tax professional may create a website and/or write a blog with helpful tax planning and preparation information to bring his/her expertise in the field of taxes and the services, fees, etc of his/her practice to the attention of potential clients, hoping to get new business.

A professional writer, in any field, may create a website and/or write a blog to bring his/her writing abilities to the attention of online and print publishers in an attempt to get writing assignments.

An individual, a professional in any field or a performer, may also create a website and/or write a blog to bring his/her product(s) – a book, a newsletter, special reports, a CD, a DVD, software, etc – to the attention of the public and generate sales.

Or anyone may create a website and/or write a blog with helpful, interesting or entertaining content to get the attention of the public so that they will visit the site/blog frequently and click on ads which will generate commission income.
While I do have an active tax preparation practice I no longer accept new clients, so I do not use THE WANDERING TAX PRO to get new 1040 business.  But I do use it, and my websites, to showcase my writing abilities, sell my “homemade” products, and generate commission income from affiliate programs.  I also use my tax practice website – www.taxproservicescorp.com – to provide information and instruction to my existing 1040 clients.

Part of the motivation of the website creator or blog writer may well be a genuine desire to help his readers or a love of writing.  Blogging gives me great pleasure.  But for the most part every blog and website has an underlying business purpose.  It is either related in some way to an existing for-profit business or is in itself a for-profit business.

Income generated by a for-profit business is taxable income.  It is subject to federal and possibly state income tax, and may also be subject to “self-employment tax”.

While many websites are tied in to an incorporated business, in general the writer of a stand-alone blog is a “sole proprietor” who reports business income, and expenses, on IRS Schedule C (or Schedule C-EZ) as part of the annual Form 1040 filing.  The total amount of advertising revenue would be included in “Gross receipts or sales” on Line 1 of Part 1 of the Schedule C (or Line 1 of Part II of Schedule C-EZ).

Against this income you can deductthe applicable expenses of your blog “business” in Part II of Schedule C (or on Line 2 of the C-EZ).

Under Internal Revenue Code Section 162(a) you are allowed to deduct “all ordinary and necessary business expenses paid or incurred during the taxable year in carrying on any trade or business”.  An “ordinary” expense is one that is common and accepted in a field of business, and a “necessary” expense is one that is helpful and appropriate to your business.

My fellow tax-blogger Kelly Philips Erb, aka the TAX GIRL, has written an excellent report on “46 Tax Deductions That Bloggers Often Overlook” which lists many of the specific business deductions available to bloggers.

If there is a net profit from the blog “business” of more than $432 the total profit is also subject to the “self-employment tax”.  If the profit is $432 or less there is no self-employment tax liability.  The self-employment tax is the equivalent of the FICA (Social Security and Medicare) tax paid by employees.  However, while employees pay half of the tax and employers pay the other half, in the case of a sole proprietorship the Schedule C owner pays 100%, since he/she is considered to be both employee and employer. 

The self-employment tax is calculated on IRS Schedule SE my multiplying 92.35% of the net Schedule C profit by 15.3% - or in effect 14.13% of the net profit.  The same maximum earnings subject to Social Security tax ($102,000.00 for 2008 and $106,800 for 2009) applies to the Social Security component of self-employment tax, so if your W-2 exceeds this amount the self-employment tax assessment will be a much smaller number.  One half of the self-employment tax assessment is deducted as an “above-the-line” adjustment to income on Line 27 of Page 1 of Form 1040.

If, as is often the case during the first years of such a venture, the expenses of producing, maintaining and promoting a blog exceed the income it generates from affiliate commissions, advertising sales and other sources you will have a deductible loss.  This loss can be used to reduce taxable income from other sources, such as W-2s, interest and dividends, etc.  A $1,000 loss from a Schedule C for someone in the 25% federal tax bracket translates to at least $250 less in tax!

I say “at least” because a net business loss will reduce your Adjusted Gross Income (AGI) – and therefore could increase various deductions and credits that are affected by AGI.  The actual federal tax savings from a $1,000 Schedule C loss could end up being much more than $250.
 
But there is a catch!  In order for an activity to be considered a bona fide, legitimate business for federal income tax purposes, and for a net loss to be deductible, the intent of the activity must be to make a profit.  Otherwise the activity is considered to be a “hobby” and subject to different rules and limitations.

What does this mean?  In order for a stand-alone blog to be considered a business in the eyes of the IRS you must expect that it will eventually pay for itself and then some.  The purpose for creating the blog must be to generate a profit.  If you start a blog for personal pleasure, just because you enjoy writing about a subject, and join a few affiliate programs or Google Ad-sense to try to make a few bucks toward the cost of maintaining the blog it is a hobby.

If your blog is considered to be a hobby you must report all of your hobby income as “other income” on line 21 of Form 1040.  According to an IRS “Summertime Tax Tip” article, “If your activity is not carried on for profit, allowable deductions cannot exceed the gross receipts for the activity” and “deductions for hobby activities are claimed as itemized deductions on Schedule A”.

Under the hobby rules income is reported on Page 1 of the 1040 and increases your Adjusted Gross Income.  Expenses, limited to the extent of the income reported, are deductible as “miscellaneous expenses” only if you itemize on Schedule A, and only to the extent that total miscellaneous expenses exceed 2% of your Adjusted Gross Income.

The IRS has a special rule which states, “An activity is presumed carried on for profit if it makes a profit in at least three of the last five tax years, including the current year”.  If your blog’s activity meets this test it is automatically considered to be a bona fide business.  (On the other hand, if you can prove a genuine profit motive there is no limit to the number of years in which you can have net losses.)  

But if your blog is connected in some way with a business activity then the blog activity itself does not have to generate a net profit for the expenses to be fully deductible. 

Advertising and promotional expenses are considered to be “ordinary and necessary” expenses of any business.  If maintaining a blog to generate national exposure and enhance your reputation for expertise in a particular business or profession is a component of the overall advertising and promotional plan of your business then all expenses associated with maintaining and promoting the blog are deductible business expenses.

In my case, if I were using THE WANDERING TAX PRO to promote my 1040 practice and acquire new clients then all its costs would be fully deductible - whether or not any advertising or affiliate income generated by the blog ever exceeded the direct costs.

In this case the advertising and affiliate income from the blog is added to income from the business or practice on Line 1 of the Schedule C. 

As you can see from this post taxes for a sole-proprietor are truly complicated.  Albert Einstein once said, “The hardest thing in the world to understand is the income tax”.  And former Treasury Secretary Paul O’Neill observed, “Our tax code is so complicated, we’ve made it nearly impossible for even the Internal Revenue Service to understand”.  I strongly recommend you consult a competent tax professional.  You can locate a tax pro in your area at www.taxprofessionals.com.

I hope you have found this guest post helpful.