Taxes? Who thinks about the tax ramifications when they are self-publishing a novel? I most certainly did, and you should, too.
There are two types of organizations the IRS and State Treasurers see writers falling in: hobbyists and professionals. Serious problems arise when an author moves between the two groups and doesn't adjust accordingly!
Hobby Writers: while they might make some money off their writing, do not take steps to improve profitability, turn vast majority of money back into running their hobby. A good example would be a short story writer who runs a blog with advertising on it that covers her website operating expenses.
Now, that same short story writer gets popular. Suddenly, her advertising costs aren't just covering her hosting expenses, but bringing in $100, $200, $500 of extra money in per month. Uh-oh. Someone just turned into a business!
Generally, a business is any activity that makes a profit in 3 of the last 5 years.
Here's the million dollar question (okay not really a million dollar question, but important):
CAN AN UNPUBLISHED WRITER WORKING ON HIS OR HER FIRST NOVEL CLAIM EXPENSES RELATED TO SELF-PUBLISHING THAT NOVEL BEFORE IT COMES OUT?
Yes. Yes, you can.***
And here's the ***, you must be in this for the win. This means, yes you can claim a reasonable loss for writing your first novel. Examples of reasonable expenses might be cover art, web hosting space, office supplies, etc. Should you go out and splurge on a $4,000 gamer's delight desktop and make it a tax-write off? I wouldn't unless you are planning on making that computer a work computer first and foremost. If you go out and buy a reasonably priced "work" laptop? Sure, and you can depreciate it, but that's a whole blog post by itself.
The bottom line is you must keep records. Actual receipts or bank statements showing the purchases. I use Mint.com to keep my financials straight so I can tag expenses as they come it. I also have a separate bank account just for my writing income and expenses. All of these little things make it clearer to the IRS should I get audited that I am serious about my writing business. And don't make the mistake that just because the profits you make is considered "fun money" by you and your partner that the IRS will agree that means you don't "live off it." They won't.
Another must have if you are going to take a loss for your first year writing (and MOST businesses take a loss in their first year due to start-up costs), is a BUSINESS PLAN. Don't break out into a sweat. A business plan is just a document you write that shows your plan for becoming profitable. It gives an expected publication date (or in the case of a writer pursuing traditional publication, an expected date of a deal). It shows how much you expect to make, either in sales or in an advance, and where that money will be cashed out to you, the owner, or reinvested into the company. We don't write on typewriters anymore people, you should have a plan to get that novel written and making you money in the next 24 months.
WHETHER YOU DO OR DO NOT ITEMIZE DEDUCTIONS, YOU DO HAVE TO REPORT YOUR INCOME.
Here's the deal on Internet writing. Many websites find loopholes around reporting income greater than $600 to the IRS for their users. Either the website is based in Canada, or they label it as something else. n the end, it doesn't matter. The responsibility to report YOUR income is on YOU.
If you have given your social security number (or FEIN) to a website that is paying you via Paypal or any other manner of transfer, the IRS can find out how much you made. If you HAVEN'T given your SSN to a website that is paying you via Paypal or any other manner of transfer, the IRS can find out how much you made.
How? You still bank in the United States, right? Imagine you get audited for something else, and suddenly you find yourself trying to explain these lump sum transfers into your bank account. Remember, even gifts over a certain amount you have to claim as income.
BEWARE THE TAX DOWNSIDE OF SUCCESS!
Another problem self-published, or any writer can face, is success. That's right. As you start making money, the IRS wants some withholding. Now, when you work for an employer, this is automatic. You set it up with a W-4, and your employer withholds a certain percentage for federal and state taxes, and pays half of your Medicare and Social Security taxes. As a writer, you are self-employed, and on the hook for the full 15.4% (this doesn't include your federal and state tax obligations, just the self-employment tax).
If you are going to OWE the federal government more than $1,000 when you go to file your taxes, you MUST make quarterly tax payments to avoid penalties.
There isn't a hard and fast threshold on when you need to start making quarterly payments. In my case for example, my husband and I file jointly, and his withholding more than makes up for my current tax obligation at the end of every year. We still get a tax refund. However, since we are military, I file state taxes on my own and have to be very careful there. States require quarterly payments too, but the rules vary. Some states only require quarterly tax payments if you are required to make federal tax payments (a loop hole I fall into), some have a monetary threshold based on the taxes you'd owe the state. It just depends, but all states have a website now and you can look yours up.
If you don't feel comfortable estimating a tax return to figure out when you'd owe more than $1,000, then make quarterly tax payments. You get the money back when you file if you don't owe enough tax to need it. The only downside is you lose any interest you could have earned had that money sat in your bank, IF it was going to sit in an interest bearing account. Some writers I know use their quarterly tax payments to make a "cash stash" for their projects next year. I don't agree with this philosophy; if you can save it for a tax bill, you can save it in a savings account. But that's just me.
Also, if you are getting into the area of enough profits that you wish to hire an accountant, ask about moving your reporting dates. As a business, you have the ability to file a form with the IRS that says your fiscal year runs from June 13th to June 12th of the next year, or any year-long span you choose. Some accountants will offer a discount for their services if you stay away from January-April (tax season) and September-October (end of the government fiscal year, time when many government contracting companies do their reporting also). This means you won't bring added stress to their busiest times, and depending on how you time it (late July/August) you'll probably get better service and a glimpse at the tax changes to come and can plan ahead more.
Finally, use your local Small Business Administration. It's what they are there for. Their help is free, and their goal is to help small business owners navigate the myriad of state and federal laws concerning business. Plus, they are a great resource for grants and loans.
"Cancelled" arriving Late Summer 2011. A robotics engineer asks his business partner to marry him, but a previous one-night stand is having his baby.