This post is part of my Business of Writing series. As part of this series, I discuss law and taxes, so it's important for you to remember that I'm neither a lawyer nor a tax professional. This is not advice -- it's my understanding and, in many cases, what I do and why. You should take this as the base to develop your own knowledge and understanding, or consult the appropriate professionals. Also, I live in the US, so am really only speaking to US law and the US tax code.
The short answer, for most authors, is don’t. It provides little or no benefit with increased expense and complexity.
The longer answer is maybe, and depends on your specific circumstances — the decision also requires maths, so there’s that.
Let’s look at the most typical options you have for running your author business.
This is likely where you’re at now if you’re reading this. It’s just you, doing business as yourself. You might have filed a DBA (Doing Business As) for your state, but that doesn’t change that it’s you, personally, doing business.
In this method, you file a Schedule C form with your 1040 and the profit from your business is added to your personal income. You pay personal income tax on it, as well as “self-employment” tax, which is just the portion of Social Security and Medicare that an employer would typically pay “on your behalf”.
As an aside, do not assume that the “self-employment” tax is some sort of penalty you’re paying for being self-employed in your own business. Just because an employer “pays” it, doesn’t mean that it doesn’t come out of the workers’ checks. To an employer, it’s still a cost of having that employee — whether that 8%-or-so is paid to the employee or to the IRS makes zero difference to the employer so far as the costs go. If they weren’t paying it to the government directly, it would likely result in increased wages due to market forces.
Regardless, that’s Sole Proprietorship — it’s simple, easy, and the default state of your author business. There’s nothing you need to do to set it up or continue in that state.
The next step up the business chain is the LLC, or Limited Liability Corporation. It is a separate legal entity from you — something people sometimes have trouble wrapping their heads around. So far as the law is concerned, the LLC becomes something that can own property and will outlive you.
If you set it up this way, or anything other than sole proprietorship, you’ll be selling the rights to your books to the LLC, then you’ll own shares (typically 100% for an author) of the LLC, and make decisions as an officer of the LLC.
In this instance, for tax purposes, you’ll still be filing Schedule C with your 1040 and the business profit will flow through to your personal income, where you’ll be taxed at that rate and pay the “self-employment” tax. There are no tax benefits to an LLC for a single-owner author, and there are some small startup costs and ongoing paperwork and expenses.
It might run you a few hundred dollars if you have an attorney set up the LLC for you, less if you do it yourself, then there’s usually an annual charge from your state and some paperwork to file. It’s not complicated or expensive, but it is moreso than a sole proprietorship.
The two main benefits of an LLC do not typically apply to authors. These are partnership and liability.
An LLC allows you to divvy up the shares of the business amongst several people — but that’s not something you’re likely to do as an author.
The main benefit of an LLC is limited liability (it’s right there in the name), which means someone could sue the business, but the business owner’s private assets are protected. Meaning they can get the store but not the owner’s house.
The thing is … you’re not running a lawn service company. You have no employee who might drive a riding lawn mower over a five-year old. Your writing is, in fact, unlikely to kill toddlers …
Unless you’re writing Fun Games with Sharp Objects for Five-year Olds, but even then the limited liability isn’t going to help you because you’re an author — if you get sued, it will be for something you wrote, whether you defame someone or the toddler plays Your Towel-Cape is Magic – You can Fly!
Either way, they’re going to sue you, personally, as well as the company, and that corporate veil will go up faster than the curtains in Who Can Find the Most Things that Burn?
The one area in which an LLC is beneficial to an author is in death. Yes, you’re going to die one day, but you’re creating an asset which will live beyond you and may provide royalties to your heirs for decades after you’re gone — those assets will also cause innumerable headaches for your estate’s executor and possibly your heirs unless you take steps to ease the transition. An LLC can do that by providing a smooth transfer of ownership in the rights to your books, as well as obviating the need to change your personal accounts to someone else’s.
I’ll get into estate planning in more depth in a later post, but for now just know that this is really the only benefit an LLC provides to an author.
Except that you can elect to have an LLC treated as an S Corp by the IRS. It’s an option, and gives you the tax benefits of the S Corp (below) with the simplified annual paperwork requirements of the LLC. So that hybrid is likely the direction I’ll go when it’s time.
Incorporation (S Corp)
There can be a tax advantage to Incorporating, but it’s so dependent on your individual circumstances (your book income, any other income, your spouse’s income, etc.) that it’s impossible to make the decision without running the numbers — i.e. doing your taxes as though you were a sole proprietorship, then doing them again as a corporation and comparing the results. This is why I recommend consulting a professional if you’re considering it.
In general, it’s not something you should consider or worry about until you’re making six figures from your book income. If you typically end the year having spent all of your book income on either writing expenses or personal expenses. It’s only if you have money left over, quite a bit of it, that a corporation begins to make sense.
This is because the primary advantage of a corporation has to do with taxes. Basically, you can pay yourself a salary and leave excess profits in the business or take them as dividends/distributions — your salary is taxed personally, along with SS and Medicare taxes, but the profits you leave in the business are taxed separately at the, possibly, lower corporate rate or the even lower dividend rate.
Don’t think you can just take it all as a dividend, though, because the IRS does say you have to pay yourself a “fair” salary out of the corporation. What “fair” is … well, that’s not defined. It should be the equivalent of what salary you’d earn doing that job for an employer on the open market, in theory … but how does that apply to an author?
But you might be opening yourself up to state corporate taxes as well, especially if you live in a state with no personal income taxes. And your salary has to be “reasonable” to keep you from making it too low or too high based on the work. And there are host of other what-ifs that might impact the decision.
So if you’re making more than six figures and typically have money left over every year, you might want to consult a tax professional about incorporating. Other than that, Sole Proprietor is probably good for, unless you’d like to make things simpler for your heirs, in which case consider an LLC.
[Edited May 2017]
As if it weren’t already complicated enough, President Trump’s proposed tax plan (one of them, anyway), impacts this decision. It’s been proposed to lower the corporate rate to 15% but also allow sole proprietors and LLCs to elect that corporate rate. This appears to be in lieu of rolling the profit over to earned income and paying SS & Medicare taxes on it. So for 2017, there might be a wait-and-see attitude that’s best. Talk to a qualified tax professional about your situation, but also bring up this possibility as they might not be aware of it.