Originally published on Forbes.com.
There can be really good money in crime fiction. That is the first lesson in K Slaughter v Commissioner, a Tax Court decision released last week. The second lesson is that there is a lot more than writing involved in accessing that money. Finally, there is a tax lesson, an illustration of Reilly’s Eight Law of Tax Planning – Before thinking outside the box, take a good look inside the box. K Slaughter’s advisers passed up a well-known planning technique for their own clever plan. It did not end well.
Who Is K Slaughter?
K Slaughter is Karin Slaughter author of the Grant County series and the Will Trent series. The Grant County series is from the viewpoint of a woman who is a pediatrician and part-time coroner in a small Georgia town and her chief of police ex-husband. Will Trent is with the Georgia Bureau of Investigation.
I’m a fan of crime fiction, but my covivant is much more dedicated than I. I commissioned her to read Blindsighted, which kicked off the Grant County series. CV thought the character, plotting and pace were good, but found the graphic violence and gruesome details too much. De gustibus non est disputandum.
Big Dollars
Ms. Slaughter was challenging deficiencies of $155,931 and $110,670 for the years 2010 and 2011. What makes these numbers dramatic is that they are deficiencies in self-employment tax. As you read the case, you will see that she probably ran through the social security maximum with income on which she did pay self-employment tax. If you do the math(i.e. divide by 0.0295), you’ll get that she had income excluded from SE tax of over $5.1 million in 2010 and over $3.7 million in 2011. (The computation may be a little more complicated than that. Regardless, the income is, as we say, a number.)
Samuel Johnson remarked that “ No man but a blockhead ever wrote except for money “. No evidence that Karin Slaughter is a blockhead.
So You Want To Be An Author
Another interesting part of the case is a pretty extensive discussion of what is involved in becoming the sort of branded author that can make that kind of money. Writing is one of those careers to which many are called. You can find in this decision some advice on how to become one of the chosen.
A brand author is one who provides prestige or reliable profits to a publishing house. When she decided to become a writer, petitioner set out in a businesslike fashion to obtain stationery, a reputable agent, and a contract with a New York publishing house. She succeeded in working with a media coach and publishers to develop her name and likeness into a successful brand. Therefore, in addition to writing, she spent time during 2010 and 2011 meeting with publishers, agents, media contacts, and others to protect and further her status as a brand author.
I checked in with my high school friend Thomas A Burns author of the Natalie McMasters Mystery Series. (Natalie is a millennial private detective trainee college student. Being Natalie’s friend is more hazardous than vacationing in Cabot Cove, Maine.) Tom confirmed that the work of building a brand is partly writing consistent stories so that your readers keep coming back for what they have come to like and also quite a bit of promoting. There can be a lot more time spent promoting than writing.
The Tax Lesson
Slaughter’s CPA firm was sensitive to the fact that there were two aspects to her job. One was actually writing the books and the other was her brand. They took the position that the income attributable to the latter was essentially the return on an intangible asset making it not subject to self-employment tax.
I can see some merit in the argument. The Tax Court has recognized the value of an authors brand for purposes of the estate tax in at least one case. Virginia C. Andrews wrote a serious of novels in the “children in jeopardy” genre beginning with Flowers In The Attic in 1978. After her death, the series continued under the V.C. Andrews name with Andrew Niederman doing the actual writing.
The Estate of Virginia C. Andrews did not include the V.C. Andrews name as an asset, but the IRS insisted it had economic value. The Tax Court agreed with the IRS in principle, although it carved back its valuation. In a similar vein, we are waiting with bated breath to learn what the Michael Jackson name is worth.
According to the decision Ms. Slaughter’s advisers came up with their own methods for splitting the income into two pieces. (They reported all the income onto Schedule E and then transferred a portion to Schedule C)
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 Tax Court wasn’t buying it.
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. 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.
The Other Way
In my Monday morning quarterbacking, I have to be sensitive to the notion that there may be some factor constraining the available choices – state income tax or perhaps a business constraint for example. Barring that, however, it seems that Slaughter could have achieved her goal with an S corporation that paid her a reasonable salary. I don’t know how many authors do it that way, but as I mention in this piece, one of them was Newt Gingrich.
The exposure comes in this technique when your salary is unreasonably low. The case law indicates that the IRS only goes after people whose salary is way unreasonably low. The problem that IRS has is that in the case of C corporations, they are going after salaries being unreasonably high.
So if Slaughter had been working for her own S corporation drawing a salary of say $400,000, she could have avoided most of the SE tax that way. And it is an “in the box” technique.
Now More Than Ever
The S corporation as a vehicle for authors like Slaughter is supercharged by Section 199A which allows a 20% income tax deduction for the flow through income, provided the W-2 is sufficient. Writing is not one of the specified fields like health or performing arts that is excluded from 199A for high-income people.
Assuming she does not have a team of minions writing for her she would need an S corporation so she can pay herself W-2 wages. I discuss the optimal amount here. You would absolutely not want to make the argument that she is getting paid for the brand rather than the writing since that might fall under one of the dreaded SSTB categories that don’t qualify for the deduction. The example in the regs is not a writer, but you should be able to get the ideas.
L is a well-known chef and the sole owner of multiple restaurants each of which is owned in a disregarded entity. Due to L’s skill and reputation as a chef, L receives an endorsement fee of $500,000 for the use of L’s name on a line of cooking utensils and cookware. L is in the trade or business of being a chef and owning restaurants and such trade or business is not an SSTB. However, L is also in the trade or business of receiving endorsement income. L’s trade or business consisting of the receipt of the endorsement fee for L’s skill and/or reputation is an SSTB
On The Bright Side
The good news in the decision was that that the Tax Court threw out the accuracy penalty.
Petitioner engaged the services of several qualified professionals to prepare her tax returns, including a certified public accountant with many decades of experience. Petitioner provided everything requested from her, and the preparers were satisfied with the information. It was reasonable for petitioner to rely on her preparers’ expertise, considering that she has no background in finance, law, or tax.
Other Coverage
I picked this up from Lew Taishoff who titled his post The Brand.
But ultimately, no books, no brand. Perhaps a more carefully drafted publishing contract might differentiate between royalties for brand enhancement, and just plain literature.
Janet Novack covered this case at an earlier stage – Tax Thriller: Best Selling Crime Writer Karin Slaughter Versus The IRS.
Amy Lee Rosen has Author Owes $266K In Self-Employment Taxes, Tax Court Finds behind the Law360 paywall.
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