Writers are masters of words, not numbers. We tried to disappear in the back of algebra class and still suffer anxiety dreams about quadratic equations. Then along comes tax time, and we are forced to assemble, decipher and compute income and expenses, or risk paying Uncle Sam more than our share.
Experts estimate that 40 cents of every dollar earned goes to pay taxes. Did you know you may be able to shave a few cents off of that – and still be completely legal – without enduring math more complicated than addition and subtraction? The key question has nothing to do with math.
Is Your Writing a Hobby or Business?
Suppose you write in your free time. You submit short stories to magazines and occasionally receive a small check. While you may dream of best-selling success, you are not actively pursuing making a profit from your writing. Consequently, the IRS will consider your writing a “hobby.”
This is a bad tax situation. If you make any money from your hobby, you have to report the income, but you are limited in deducting expenses related to your hobby. Typically, you may deduct hobby expenses only up to the income received from the hobby.
So if you make $1000 from your writing, but spend $2500 in conference costs, contest fees, office supplies, and other writing expenses, you must report the $1000 as taxable income and may use only $1000 of your expenses as deductions. The other $1500 is money spent without a tax benefit.
In contrast, if you run your writing as a business (as defined by the IRS), the remaining $1500 could be used to offset income from your day job, saving you up to $750 in taxes, depending on your tax bracket and where you live.
Sounds like good math to me.
When Does Writing Become a Business?
You may have heard the old rule that a business is considered a hobby unless it shows a profit for three out of five years. In practice, the IRS is not as strict as the three-out-of-five-year rule. If you demonstrate you have a serious intent to operate a business at a profit, the IRS will generally give you some slack.
According to the IRS website, they take the following factors into consideration:
- Whether you carry on the activity in a businesslike manner.
- Whether the time and effort you put into the activity indicate you intend to make it profitable.
- Whether you depend on income from the activity for your livelihood.
- Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
- Whether you change your methods of operation in an attempt to improve profitability.
- Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
- Whether you were successful in making a profit in similar activities in the past.
- Whether the activity makes a profit in some years and how much profit it makes.
- Whether you can expect to make a future profit from the appreciation of the assets used in the activity.
Vague standards, aren’t they? It would be nice if the IRS gave clear rules about when a hobby becomes a business, but nothing in tax law is that simple or direct.
What’s a Writer To Do?
If you are self-publishing and making some regular income, then it may be time to treat your writing as a business for tax purposes. In real life terms, this means the following:
- Set up your business properly. Obtain a separate Federal Employer Identification Number (EIN), a seller’s or resale certificate, and any business licenses required in your local community. For more details, download (for free) SETTING UP YOUR SELF-PUBLISHING BUSINESS.
- Promote and advertise. Promote yourself and your book on social media and other venues. Maintain a website. Print business cards and bookmarks.
- Follow tax rules. Collect and pay your sales tax. If you are paying an independent contractor (other than a corporation) $600 or more in any year, ask for a W-9 and report the payment on a 1099-MISC and the equivalent state form.
- Separate your personal and business finances. Open separate PayPal and bank accounts and run only your business income and expenses through those accounts. Set aside a credit card for business use only.
- Maintain decent records. In tax audits, more people are nailed for losing receipts than for cheating. If you don’t have a file cabinet (a real one since the IRS wants paper records), get one. It’s tax deductible.
- Network. Join professional organizations. Attend writing-related conferences, and better yet, speak at them.
- Develop a business plan. The IRS is more likely to believe you intend to make a profit if you have some kind of plan to show how and when that is going to happen. Developing a business plan is an eye-opening exercise for most writers. You can’t develop a sensible publishing budget without one.
- Keep writing. Show the IRS you are in this venture for the long haul.
There is no need to incorporate or form a business entity. Your business is just as legitimate as a sole proprietorship. Maintaining an entity is simply too expensive, unless you are making $10,000 or more in net income. In that case, don’t worry about hobby rules, but discuss forming an entity with a tax professional to save on self-employment taxes.
The Joy of Deductible Expenses
One of the nice consequences of running a business is Uncle Sam will share in your expenses. If an $800 conference fee is deductible as a business expense, then a percentage of that fee would have gone to pay taxes anyway, depending on your income bracket.
The general rule is that ordinary and necessary expenses of operating your business are deductible, including:
- office supplies and postage,
- magazine subscriptions,
- telephone charges,
- printing costs for business cards, bookmarks, and postcards,
- advertising costs,
- costs for software, such as design, video-editing, manuscript editing, and analytics,
- fees and royalties paid for fonts, images, music, and other content,
- writing club dues,
- website hosting and online backup costs,
- subscription costs for HootSuite or other web-based services,
- payments to freelancers, such as editors, copyeditors, designers, web designers, and publicists,
- research expenses, including travel,
- cost of books you give away to reviewers or in promotional giveaways,
- contest entry fees,
- copyright registration fees, and
- potentially, a portion of your car and home expenses.
Many expenses incurred in the years prior to your first book launch will be deductible as start-up expenses, so save those receipts as well.
Have I Lost You?
It makes sense to hire a tax accountant when you set up your business. so you start off on the right foot. A good tax advisor will save you money in the long run and get you a few steps closer to quitting your day job.
Finally, I must end with all the usual disclaimers.
If you ask a lawyer a question, her favorite answer will be “it depends.” Every taxpayer’s situation is unique. Nowhere is that more true than with tax law. All this information is general in nature; the technical details would fill a bookshelf.
The IRS requires me to say the following: CIRCULAR 230 DISCLAIMER: If and to the extent that this post contains any tax advice, I am required by the Internal Revenue Service’s Circular 230 (31 CFR Part 10) to advise you that such tax advice is not a formal legal opinion and is not intended or written to be used by you, and may not be used by you, (i) for the purpose of avoiding tax penalties that might be imposed on you or (ii) for promoting, marketing or recommending to another party any transaction or matter addressed herein.
And finally, I am an attorney licensed to practice in California only. This information is general in nature and should not be used as a substitute for the advice of an attorney authorized to practice in your jurisdiction.
Helen Sedwick, is a Contributing Writer for The Book Designer. She is also an author and a California attorney with thirty years of experience representing businesses and entrepreneurs. Her latest book is Self-Publisher’s Legal Handbook: The Step-by-Step Guide to the Legal Issues of Self-Publishing.
You can find more information about Helen here.
Disclaimer: Helen Sedwick is an attorney licensed to practice in California only. This information is general in nature and should not be used as a substitute for the advice of an attorney authorized to practice in your jurisdiction.