Slaughter v. Comm'r
| Decision Date | 04 June 2019 |
| Docket Number | Docket No. 13256-14.,T.C. Memo. 2019-65 |
| Parties | K. SLAUGHTER, Petitioner v. COMMISSIONER OF INTERNAL REVENUE, Respondent |
| Court | U.S. Tax Court |
Charles E. Hodges II, Lynn E. Fowler, and James E. Brown, for petitioner.
David Delduco, John W. Sheffield III, Courtney S. Bacon, Christopher D. Bradley, and Shannon E. Craft, for respondent.
WELLS, Judge: The instant case involves determinations of deficiencies in self-employment taxes pursuant to section 1401(a) of $155,931 and $110,670, and section 6662(a) penalties of $31,186 and $22,134, for petitioner's tax years 2010 and 2011, respectively. Petitioner is a successful author who during the years in issue received substantial royalty income pursuant to several publishing contracts. Respondent contends that all of the payments petitioner received from her publishing contracts during 2010 and 2011 were derived from her trade or business as an author and, therefore, are subject to self-employment tax pursuant to section 1401(a).1 Petitioner contends that only a portion of the payments is allocable to her trade or business, which she defines narrowly to include only her writing.
The central issue we must decide is how much of petitioner's income from publishing contracts is derived from her trade or business and, therefore, subject to self-employment tax.2 If we conclude that petitioner understated the amount of her trade or business income and that there are deficiencies, we must then also decide whether the section 6662(a) and (b)(1) negligence penalty applies.
Petitioner resided in Georgia when the petition was filed. During taxable years 2010 and 2011, petitioner spent roughly 12 to 15 weeks in Georgia engaged in writing. Petitioner has worked since the 1990s to establish herself as a brandauthor because it was her determination that the difference between writing generally and writing for a living is branding. 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.
During the years in issue, petitioner received payments pursuant to contracts she had entered into during the years 1999 through 2011 (contracts). The contracts all provide for payments in a similar manner. The publishers agree to make two types of payments. The first is a nonrefundable advance, paid in the respective ways set forth in the contracts. The second is a royalty, or a portion of the revenue or profits generated by the sales of petitioner's manuscripts.3 Thecontracts specify the royalty rates applied to the revenue or profits from the works; only the amounts in excess of the advance amounts are paid as royalties.
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.
On her Federal income tax returns for 2010 and 2011 petitioner deducted as a business expense the cost of leasing a vehicle to attend media interviews and promotional events. She also deducted the cost of hosting her own promotional events. Not all of petitioner's meetings and events were within driving distance of Atlanta, however. For marketing purposes, many of her meetings were scheduled in New York City. While there, petitioner often attended meetings, conducted media interviews, and participated in publishing industry events such as trade shows. During the years in issue petitioner also met with a fellow writer to collaborate on a script for a possible television series. To facilitate her various activities, petitioner rented an apartment in New York City and deducted the rent on her 2010 and 2011 returns (NYC apartment). Petitioner also deducted the cost of business gifts to agents, editors, publishers, and others.
Petitioner's promotional activities and writing have created a very successful brand and body of work. In petitioner's case, her brand includes her name and likeness as well as her reputation, goodwill, and existing readership. Book buyers walk into book stores and request petitioner's books using her name rather than the title. Petitioner has developed good relationships with booksellers and librarians, which help to sell her books. She also maintains contact with her readership through social media, websites, and a newsletter.
Petitioner was not a brand author when she signed her first contract in 1999. By the time she entered into her contract in 2007, she had become a brand author and her typical advance had grown eightfold. Today, petitioner spends the same amount of time writing a book as she did in 1999. The change in income is due to petitioner's cachet as a brand author, i.e., her ability to attract and engage readers, speak in front of a crowd, and recommend other authors within her publishing house. Petitioner's name is valuable to her publisher because it is how book buyers identify her books. Because petitioner sells books and is able to entice people into book stores, she fits into her publishers' business "like a jewel in the[ir] crown." In short, publishers now pay more for petitioner's work because of her brand.
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 followup 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. They 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...
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