Reporting royalties and other income collected from the sale of books and ebooks (as well as many other intellectual properties that you can own) depends on what capacity you have decided to collect the income in. If you have not registered a specific type of business with the Federal Government and your home state then you should be reporting your book revenue on Schedule C, which is attached to your Form 1040. You are not required to register a business for your book writing but you are required to report income that exceeds $10.
***WHATEVER YOU DECIDE, MAKE SURE YOUR RECORDS ARE IN GOOD ORDER! I HIGHLY RECOMMEND OPENING UP A SEPARATE CHECKING/SAVINGS ACCOUNT, EVEN IF YOU DO NOT CREATE A BUSINESS ENTITY***
The types of entities you can use to report business income are as follows:
- Corporation (or a 'C' Corporation): This type of business entity pays income tax at the business level. Uses Form 1120 U.S. Corporation Income Tax Return
- Corporation (with 'S' election): This type of business has the business activity flow through to the owner(s). Uses Form 1120S U.S. Income Tax Return for an S Corporation
- Partnership (two or more owners) This type of business has the business activity flow through to the owner(s) Uses Form 1065 U.S. Return of Partnership Income
- Single Member LLC (just you) This is a registered business with you as the sole proprietor, mostly giving you a business name, identification numbers and some liability protection. Uses Form 1040 - Schedule C - Profit or Loss from a Business
- Individual (just you) this is where you have provided your personal information for collecting royalties and other income. Uses Form 1040 - Schedule C - Profit or Loss from a Business
- (PLEASE NOTE) Calling your writing business SUPER WRITING NINJA AUTHOR XYZ does not make it a business, it would be considered a 'Doing Business As' moniker, you need to register a business for it to be a legitimate name. Many states also require that you register your DBA, so be careful if you want something used other than your own name!
Why do I have to report business income from book sales, why can't it just be income?
The easy answer is that the government tells you to report it that way. The reason is this, besides the Corporation and 'S' Corporation in 1 and 2 above, all the other forms of business income are taxed as self-employment income, which means you will be calculating and paying self-employment taxes on the entirety of that income (unless it is under $400 Net)
What are self-employment taxes?
For our purposes, self employment taxes are based on the total, net business income you report from a Schedule C or from a Form K-1 received from a Partnership. The purpose is to capture the Social Security and Medicare taxes that you would have paid had you been compensated with wages from an employer. In addition to employee (you) taxes, the employer (you, also) is responsible for SS and Medicare as well, essentially doubling the amount of taxes you pay as a self-employed business owner. (Employee SS and Medicare 5.65%, Employer SS and Medicare 7.65% as of 2012, making Self Employment taxes 13.3%) And that is just for self-employment Tax, you also pay taxes based on your income tax bracket, which includes the business income.
Example: You have $100,000 in net, self-employment income. Assuming you have no other wages, you would owe $13,300 in self employment taxes and you would still have to add your business income to your total AGI (Adjusted Gross Income). You are allowed some additional expenses that are not permitted through the business to help reduce your AGI.
NOTE: There is a cap on the amount of wages and self employment income subject to Social Security. For 2012 the maximum is $110,100. Most likely in 2013, employees will be responsible for 7.65% again, as the 2% credit is set to expire.
Is it better to create a 'C' Corporation or an 'S' Corporation then?
The catch on a 'C' Corporation is that it still has to pay taxes on the net income, and taxes increase very quickly to the top tax bracket. Owners are then double taxed when they want to take non-wage distributions out of the business, which is treated as a dividend. There are some ways to help avoid the double tax penalty which I will bring up a little later.
Another part of both the 'C' Corporation and 'S' Corporation is that you must pay yourself reasonable wages. What are reasonable wages for an author? Good question, I don't have a straight answer for you but look at
this IRS webpage in relation to 'S' corporation compensation issues. I work with a lot of veterinary clients and we use a pretty solid professional compensation rule at my office. It uses a percentage based on their actual production of veterinary services and we generally add a percent of the gross revenue that we consider management and administration related. I have not dealt directly with an author using either Corporation type for business but I will be looking into it in the near future, especially with upcoming tax law changes set to begin in 2013.
The purpose for the 'reasonable compensation' rule is that 'S' Corporation net business income is not subject to self-employment tax, so owners try to save on taxes by paying themselves extremely low wages. The reverse is true for 'C' Corporations, they are better off paying the owner all of the net income they can in the form of bonuses to avoid the double tax issue. There are a few other factors that go into both Corporation types but since owners have to pay themselves wages, they then have Unemployment taxes and the business still owes the Employer portion of SS and Medicare taxes. Both types of Corporations have to deal with payroll related tax forms and filing requirements that would not be present if there were no other employees.
My best suggestion would be to talk to a reputable CPA firm if you are committed to making a business out of writing.
