If you're an author, you're in the same boat. Those beautiful 1099-MISC forms from Amazon, Smashwords, B&N, Apple, etc. are arriving via mail and email, and it's time to decide how to handle your writing business for tax purposes. You'd think it would be a straightforward matter, wouldn't you?
Settle in. We've got some talking to do. At this point, consumption of caffeine is appropriate. This post is a long but important one.
There's much debate in the author community about IRS forms, and most of the discussion revolves around whether you should use:
Schedule C - Profit or Loss from Business (Sole Proprietorship), or
Schedule E - Supplemental Income and Loss (From rental real estate, royalties, partnerships, etc.)
to report income and expenses related to your writing business. In fairness, it’s a confusing topic because royalty income is reported as, well, Royalties on your 1099-MISC.
I use Schedule C, but I wanted to make sure I was giving you good information, so I called the IRS. Surprisingly, the agent I talked to wasn’t an ogre. He was rather nice, in fact. My IRS agent, John, said:
If you are actively involved in the business of writing and intend to make a profit through your writing, complete Schedule C. You can claim all the expenses related to running your book writing and publishing business on Schedule C.
However, there are two times when an author would file a Schedule E:
- if you are no longer actively engaged in the business of writing, but are still receiving royalties from your books, or
- if you hold the royalty rights to a book you did not produce.
In both cases, the earnings from those books are considered passive. For example, after a writer dies, their books continue to sell and earn royalties. The person who inherits the rights to those royalties is not actively involved in the business of producing that product; therefore, the income is passively earned. Because this income is passive, it and any related expenses are reported on Schedule E.
To add credibility to non-ogre John's comments, the instructions for Schedule E state (on page 6, first column):
If you are in business as a self-employed writer, inventor, artist, etc., report your royalty income and expenses on Schedule C or C-EZ.
Schedule C is designed to capture all the expenses related to running a sole proprietorship, which is what you, as an author, are until you form a partnership or a corporation in some form. Most of us will remain a sole proprietorship for our lifetimes.
Since the IRS says those of us who are actively engaged in the business of writing should file Schedule C, and the instructions for Schedule E even say we should file Schedule C, why the debate? It all comes down to that nasty self-employment tax.
Here's the rub: net income reported on Schedule C is subject to the 15.3% (in 2014) SE tax. In reality, you pay half that amount - you can (and should) deduct the employer portion of SE tax on page one of your Form 1040 (line 27).
Income reported on Schedule E is not subject to SE tax.
Makes Schedule E tempting, doesn't it?
Filing Schedule E means you can save 7.65% (your half of SE taxes) in taxes. However, in addition to the fact that we're supposed to use Schedule C, there's a good reason why filing a Schedule C makes sense for those of us who are self-employed.
Self-employed individuals (Schedule C filers) can deduct the cost of health, dental, and qualified long term care insurance (maximum deduction amount established by age) for themselves and their dependents to the extent of their net income from self-employment (see IRS Pub 535 on this topic). The premiums must be paid out of your pocket, not paid by an employer. Schedule E filers are not considered self-employed and cannot take this deduction.
Here's a rough example of how it works (hang with me, it's not as hard as it sounds):
You earn $15,000 in royalties from your writing business in 2014. Expenses related to that business in 2014 total $7,000. Your net income from writing is $8,000 ($15,000 minus $7,000). You'll pay $612 in SE tax ($8,000 x 7.65%).
You are a married individual and pay $5,500 in health and dental insurance premiums (out of your pocket, not paid by an employer), and $1,500 in long term care premiums for you and your spouse. Because the total of your health related insurance premiums, $7,000, does not exceed your self-employed net income of $8,000, you can deduct the full $7,000 on page one of your Form 1040 (line 29).
In this case, it benefits you to file Schedule C, despite the SE tax. "Above the line" deductions - those taken on page one of your Form 1040 - reduce your tax liability by your tax rate. (Keep hanging on, we're almost done.)
Let's say you and your spouse jointly earn $40,000. That puts you in the 15% tax bracket. The $7,000 deduction for health insurance premiums saves you $1,050 in taxes ($7,000 x 15%). Yes, you're paying $612 in SE tax, but you're also saving $438 on your total tax bill ($1,050 minus $612).
If you and your spouse earn $75,000, that tips you over the edge into the 25% tax bracket. Your $7,000 in health insurance deductions saves you $1,750 in taxes ($7,000 x 25%). You're paying $612 in SE tax, and saving $1,138 on your total tax bill ($1,750 minus $612).To get a better idea of how this deduction works in your situation, see the IRS tax brackets for 2014, here.
The information included in this post is not intended to replace the advice of your tax accountant, but I hope it helps clear up the debate.
Now I'm headed back to Forney County for a little mayhem and murder. Come join me. Nothing reduces tax-related stress like killing off a few characters.
Schedule C in pdf form / Schedule C Instructions
Schedule E in pdf form / Schedule E Instructions
Form 1040 in pdf form / Form 1040 Instructions
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