Thinking of writing a book? Do you know how your royalties will be taxed?
As a general rule, income from publishing contracts is considered trade or business income, and trade or business income is subject to self-employment tax.
But what if the author is a “brand?” That is, what if the author is paid not only for writing, but also for the author’s name and likeness (the brand)?
In TC Memo 2019-65 (Slaughter), the question was whether the income from publishing contracts could be divided between royalty income from writing and income based on the intangible asset of the writer’s brand. The income from writing would be subject to self-employment tax, while the income from use of the author’s name and likeness would be investment income (not subject to self-employment tax).
The taxpayer says that one portion of her royalty payments is derived from her writing, which is a trade or business. She says another portion is derived solely from her name and likeness, and that these are personal attributes which are not part of any trade or business.
The taxpayer says the actual writing of a manuscript is a small percentage of the value a publisher seeks from an author. An author’s work may sell on the basis of the author’s name and readers’ expectations for a particular kind of story, rather than for the quality of the writing. The total contract amount is greatly influenced by several elements, such as branding, which are not spelled out on paper but are known to both parties.
The taxpayer says the amount paid for her writing is what a publisher would pay a nonbrand author, and the excess of that amount is a separate and distinct payment for her brand. She says her brand could never be part of a trade or business because she is “not in the trade or business of being herself.” Furthermore, her brand is not “tied to the quantity or quality” of her writing, and therefore it has an insufficient nexus, or ties, with her trade or business as an author.
The IRS says that to satisfy the nexus test, the earnings must be tied to the quantity or quality of the taxpayer’s labor. The IRS says nexus between the royalties paid to the taxpayer and her trade or business of writing is enough to make all of her income from publishing contracts subject to self-employment tax. According to the IRS, there is no separate and distinct payment for the taxpayer’s “brand” because all of the taxpayer’s income is directly or indirectly tied to the selling of her books.
Here is the relevant tax law.
From section 1401(a) of the internal revenue code: Imposes a tax on the self-employment income of every individual.
From section 1402(a) of the internal revenue code: Defines “net earnings from self-employment” in pertinent part as “the gross income derived by an individual from any trade or business carried on by such individual, less deductions allowed which are attributable to such trade or business.” The term “derived”, in turn, requires “a nexus between the income received and a trade or business that is, or was, actually carried on.”
From section 1402(b) of the internal revenue code: Defines “self-employment income” as “net earnings from self-employment.”
From internal revenue code section 1402(c): To be engaged in a trade or business, an individual must be involved in an activity with continuity and regularity, and the primary purpose for engaging in the activity must be for income and profit.
WHAT WOULD YOU DECIDE?
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We conclude that the taxpayer's brand is part of her trade or business.
We construe "trade or business" broadly and find that the taxpayer was engaged in developing her brand with continuity and regularity for the primary purpose of income and profit.
The taxpayer set out in a businesslike fashion to obtain stationery, a reputable agent, and a publishing contract. She worked with a media coach and publishers to develop a successful brand. She has spent time 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. She 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.
The taxpayer contends that her brand could never be part of a trade or business because she is "not in the trade or business of being herself". Furthermore, her brand is not "tied to the quantity or quality" of her writing, and therefore it has an insufficient nexus with her trade or business as an author.
We do not agree.
The fact that the taxpayer's brand involves personal traits such as her name and likeness does not mean that it cannot form part of her trade or business. If the taxpayer's brand has commercial value, it can form part of her trade or business.
The taxpayer also misapplies the nexus test. To satisfy the nexus test, the earnings must be tied to the quantity or quality of the taxpayer's labor.
The question is not whether the taxpayer's brand is tied to the quantity or quality of her writing, but rather whether the payments for her brand are tied to the quantity or quality of her efforts in developing her brand.
The taxpayer herself admits she has worked to develop a brand. Royalties earned from her brand are not solely a result of her publishers' actions. Although the publishers fund the marketing plan for her books, her agent retains the authority over its development.
The taxpayer and her agent's promotional activities and monitoring of sales information contribute to the sale of her books. Such sales-focused work is sufficiently routine that we consider it part of the taxpayer's trade or business. Her books, in turn, sell in part on the basis of her brand strength.
The taxpayer's brand signals to readers what content they can expect from her books. The loyalty of her readership base translates into higher sales, and her high sales then enhance her brand.
The taxpayer's brand and her writing combined are monetized, first, by the selling of books, and second, by providing her with the leverage to negotiate for higher advances and royalty rates.
In sum, we conclude that all of the payments to the taxpayer pursuant to the publishing contracts are income derived from her trade or business as an author, and such income is subject to self-employment tax.
Editorial Note: The court also discussed advertising and noncompete clauses in the author's contracts and determined that those payments were also subject to self-employment tax.