I have a friend, a retired aerospace engineer turned artist, who hates bookkeeping. He sells his art at local art shows, and from his home. When he makes a sale, the money goes into a steel cash box. When he buys supplies the money come out of the box. When he wants to know how much money he has made from his art, he counts the contents of the cash box. This is elegant in its simplicity, but would be a nightmare should he ever be audited. Are you a hobby writer or a writing business?
A Writing Business
Whether you are a fledgling writer, just dipping your toe into the waters of publication, or have waded in up to your knees, and are seriously considering going for a full swim, looking at your writing as a business instead of a hobby will help you plan for the future. Here are a few tips on the business of writing to make tracking your self-employed income and expenses easier.
How Much Income is Income?
In the USA, the IRS says that if you earn less than $400 per year from a small business or hobby activity you do not need to claim it as income; anything above that needs to be claimed on your annual income tax report. Incomes from employment or investments have very different allowances and vary by age and situation.
What Form?
A recent IRS newsletter stated that the most common mistake that authors make when filing their income taxes is to use the Schedule E: Rents & Royalties form to report income from writing. While this would appear to be the perfect solution for you, the “royalties” referred to here are income received from leasing or selling water, mineral or oil rights on property you own, not payments from the sales of books and articles.
The form we, as writers, should use is the Schedule C: Income and Expenses from a Small Business.
If, like my friend above, you are allergic to all forms of bookkeeping you can claim your writing income as “other income” on your personal 1040 form. This allows you to stay out of trouble by paying taxes on the income, but does not allow you to deduct business expenses from that income before it is taxed. The Schedule C allows you to categorize expenses and deduct them from your gross income (total writing income received) and pay taxes only on the net income (income minus allowed expenses). In cases where you have invested heavily in a book and sales have not taken off yet, you may end up with a negative amount of income from your writing business that will offset personal income from employment or investments, thus reducing your overall taxes.
The 3 of 5 Rule
However, the IRS can (and I stress the word can) invoke their “3 of 5” rule that says that any for-profit business that does not show a profit for three out of any five years can be forcibly declared a hobby and may not deduct business expenses. Non-profit businesses are not saddled with this, but must be registered and licensed as a non-profit corporation.
This rule was implemented when tax advisors advised their rich clients to start a hobby/business, and run it poorly, to generate a negative cash flow that would offset personal income. This way they could escape some of their tax liability.
This rule is, however, not an automatic “three strikes: you’re out” run by the computers. The IRS knows that new companies may run at a loss for several years as they earn back start-up costs. Economic conditions can place strains on a company that will cause them to run at a loss for a time. Reorganization can cause a company to stumble for a while as it gets its’ stride back. Therefore, they have a series of tests that can be applied should they flag your writing business as a potential tax dodge. They are:
- You carry on the activity in a businesslike manner,
- The time and effort you put into the activity indicate you intend to make it profitable,
- You depend on income from the activity for your livelihood,
- Your losses are due to circumstances beyond your control (or are normal in the start-up phase of your type of business),
- You change your methods of operation in an attempt to improve profitability,
- You, or your advisors, have the knowledge needed to carry on the activity as a successful business,
- You were successful in making a profit in similar activities in the past,
- The activity makes a profit in some years, and how much profit it makes, and
- You can expect to make a future profit from the appreciation of the assets used in the activity.
Test number 1 means (in part) keeping a pristine set of books. Slipshod or nonexistent bookkeeping just screams that you are not serious about your business of writing and will likely result in increased taxes, penalties and late fees should you be audited.
DIY or Hire-out?
Some authors say that they are really, really busy writing; they don’t have time to track income and expenses and file receipts. No problem; hire a bookkeeper. Your Yellow Pages will have all manner of bookkeeping services listed to choose from. You don’t have to pay the high prices of a CPA if you don’t want to. People who are employed as bookkeepers in a business will often offer their services to a limited number of clients on their own time and can work fairly inexpensively. Your only responsibility will be to mark receipts as to what they were for and put them in a shoe box to be delivered periodically to your bean counter. Understand, however that hiring an incompetent bookkeeper will cause you all manner of heartache – check references.
If you’ve got more time than money, a basic bookkeeping program for your computer can be acquired for around $39. A used copy may be had even cheaper from EBay, Amazon, or some software stores.
Most writers are not going to need the high-end features included in the high priced accounting software packages. If you do no work-for-hire (just write books) you don’t even need invoicing, just a General Ledger with report generating capability.
Simple bookkeeping can be done on a spreadsheet program (like Excel) or even on paper. But doing it manually on paper will be the most time consuming and will require some knowledge of accounting procedures to get the calculations right. Software eliminates the need for anything but a basic understanding.
Next Time
In the next episode I’ll talk a little about setting up a basic chart of accounts for your writing business and what you need to watch for in categorizing your expenses. Along the way I’ll discuss some aspects of business start-up.
Was this helpful to you? If so please leave a comment below. Questions? Same thing. Thanks for reading!
Excellent timing for an excellent article. Too often people will overlook this side of things. I did my taxes yesterday. Fortunately I’ve run a small business before so I had my ducks in a row…otherwise I’d probably be kicking myself for reading this a day late. 🙂
Thanks, Rick! I filed mine recently too – they’ll have to wait on the check for a while, but the return has been submitted electronically. I had hoped that this series of articles might catch a few hopeful authors when they’re thinking – or should be thinking – about these topics.
Shared all over the internet for you. I wish I could make this my business.
Anyone can make it their business, Stu – some might have to make a few sacrifices at first: like living in a house, driving a car, eating… little luxuries. But seriously, even doing it as a side-line, if one hopes to make income from it it’s never too early to look toward proper record keeping and expense budgeting. Call it practice for when you become a world famous playwright and author!
I haven’t had to file yet, but may need to this year.
So far I keep a ledger — general expenses (ink/paper), then expenses & income by project.
I need to get more organized about it though. Thanks for the reminder, another thing to add to my list in March.
Sounds like you’re on the right track there, Mary. It doesn’t have to be complicated, just organized. Thanks for joining in. Are they blowing the dust off you observatory yet?