The IRS makes a critical distinction between authors and hobbyists. Authors are trying to make a living selling their writing. You are deemed to be a professional if you are trying to make a profit in the last 3 of 5 years. So the intent to make a profit and earn a living is important.
If you are in the business of being an author:
Royalties from copyrights, patents, and oil, gas, and mineral properties are taxable as ordinary income.
In most cases, you report royalties in Part I of Schedule E (Form 1040). your royalty payments will be entered in the Rental Properties and Royalties section. There will be a few initial questions related to rental properties, but then you will land on a page asking, "Is this a rental property or royalty?"
However, if you hold an operating oil, gas, or mineral interest or are in business as a self-employed writer, inventor, artist, etc., report your income and expenses on Schedule C or Schedule C-EZ (Form 1040). This can be done using TT Self Employed.
If it is a hobby where you don't intend to make a living then you report the income as hobby income.
- Choose Wages and Income
- Scroll down to Less Common Income and click Start to to right of Miscellaneous Income, 1099-A, 1099-C
- Click Start to right of Hobby income and expenses
- The IRS doesn't allow you to deduct hobby expenses directly from hobby income. Instead, you can deduct expenses as an itemized deduction subject to 2% of your adjusted gross income (new tax law 2018 no longer allowed). Also, the amount that you claim as an expense cannot be greater than your income from the hobby. In other words, your hobby cannot generate a loss.
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Taxpayers can choose to itemize expenses on their tax returns or take the standard allowable deduction. Hobby expenses can only be deducted if you itemize your deductions.
If you don't have any other itemized deductions, TurboTax will deduct the greater of the standard deduction or itemized deductions. TurboTax will choose the one that lowers your overall tax liability.
If you are in the business, use TT Self Employed and enter as SE income on schedule C or C-EZ by following the interview and reporting as a business.
Costs to Create Intellectual Property
Ordinary and necessary business expenses of authors, composers, musicians, and other creators of intellectual property are deductible under Sec. 162. Additionally, costs incurred by writers (including musical composers), photographers, and artists in creating writing (including musical compositions), photographs, pictures, paintings, sculpture, etc., are exempt from the uniform capitalization rules that govern the treatment of costs incurred in the production of property for resale. On the other hand, patent creation costs must be capitalized under Sec. 263 or in certain cases may be deductible as research expenditures under Sec. 174.
Individuals who have not yet generated income from their creative activities should make sure that their business deductions are not limited by the hobby loss rules in Sec. 183. Generally, an activity is presumed to be a hobby if a profit is not earned in at least three tax years of a consecutive five-year period. However, a taxpayer can overcome this presumption if she or he can show the activity was operated with the intent to make a profit. Fortunately, the courts recognize that economic success in the creative arts frequently takes longer to achieve and thus focus on the manner in which the taxpayer pursues the activity to determine profit motive.
Regs. Sec. 1.183-2(b) lists factors to be considered to determine whether the taxpayer is seeking to make a profit. A detailed explanation of these factors and the case law is beyond the scope of this article. The reader should consult IRS Publication 535, Business Expenses, and Audit Technique Guide IRC § 183 Activities Not Engaged in for Profit for additional guidance. Historically, the IRS has aggressively litigated hobby activity cases. However, taxpayers in the creative fields who have shown they operated the activity in a businesslike manner (maintained business records and appropriate documentation) and had relevant expertise have been able to prove profit motive.
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