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Copyright 2005 Tara K. Harper.  All rights reserved.

TARA K. HARPER
WRITER'S WORKSHOP
Taxes and Finances for Writers -- updated!

The examples and suggestions here are for information
and anecdotal purposes only.

 

Four Suggestions
Quitting Your Day Job
Managing the Money
The Cost of Doing Business
Self-Employment and Other Taxes
Adding Your Income on to Your Spouse's Income
Retirement Deductions and Tax Rates

Keep These Things in Mind...

Also:
How much money does an author make, anyway?


NOTE:
TKH is not an accountant.  The examples and suggestions here are for information and anecdotal purposes only, and will hopefully 1) help you learn to ask ask good questions of your accountant, and 2) help you realize that becoming a self-employed writer usually means that your tax burden will change significantly.

You should always consult a certified public accountant for advice about tax law, deductions, retirement contributions, etc, as they pertain to your situation.


Four Suggestions

Over the years, I have learned many lessons as a self-employed writer and contractor.  Some of these lessons were hard ones.  Hopefully, the information and examples provided here will help you ask the right questions of your accountant for your situation, and will help you realize some of the potential pitfalls of becoming a self-employed writer.

The best suggestions I can give you for becoming a self-employed writer:

  1. Don't quit your day job unless you have two years of income stashed away to hold you till you begin to see significant earnings from your writing.
  2. Get an accountant who understands IRS law/regulations for writers and artists.
  3. Set up a separate checking account, credit card, and safe deposit box for business expenses and documents.
  4. Assume that you have to set aside 50% of your income for taxes.  That way, you'll always have enough to pay the IRS.

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Quitting Your Day Job

Don't.  Not unless you have two years of income sitting in the bank to tide you over.  You will need these savings until you begin to earn an adequate income from your own writing.

If you are a fiction author, your income depends on 1) whether or not the publisher likes your work enough to purchase it, 2) whether the publisher still likes it enough when you're done with it to publish it, and 3) whether the public enjoys your story enough to buy 40,000 or so books.  That's a lot of uncertainty.

If you do earn out (begin to see royalties), when do you get this money?  The publisher usually takes months to process the monies you receive.  For example, my royalties for the April-September timeframe are usually received by my agent in January of the following year.  My agent then holds the check for 10 business days before he cuts my check and mails it to me.  My foreign publishers cut royalty checks only once a year.  I've never figured out when I get audio royalties; they just show up every couple of months.  The bottom line is that I see checks very few times a year.  I have to budget the entire year based on an expectation of two or three major "paychecks."

Authors cannot usually count on selling their work at all, let alone being paid at a particular time.  Many writers often find themselves with no money coming in for years.  Without a second job, your finances may look quite grim.  You will need to have savings in the bank to carry you through these times, because these savings are your lifeline to your work.   Without that financial buffer, you might not be able to buy groceries or make the rent in order to keep a roof over both you and your manuscript.

Yes, keeping a day job means having less time to write.  It means splitting your attention between your "real-life" job and your fiction writing.  However, it also means being able to pay the bills.  Keeping a part-time day job may be, for most writers, the best of both worlds.  Sometimes, it is enough to take a short one- or two-month contract in order to refill that savings account for your next year's stint of writing.

A day job is a form of security.  If you don't need that security or income, if your spouse is wholly supporting you, if you have a trust fund to pay your bills, if you're living off an inheritance, then go ahead, quit, and devote yourself to your fiction.  If you do need that financial security to support your children, pay your bills, buy your printer paper, then keep the job and write in the evenings or on weekends.  Keep the job so you can keep your home.  Let your desperation and urgency to write push you to make the most of your free time.

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Managing the Money

American book publishers usually pay within three months of the completion of your "work," (signing a contract, acceptance of a manuscript, on publication, etc.) .  They also pay royalties usually twice a year.  That's it.  If you're a novelist, you will have to learn to stretch each check for six months.  If you write short stories, your income will be less predictable, but will arrive more often.   I suggest that you look carefully at your spending and earning patterns before you commit fully to being a full-time, self-employed writer.  One thing I can say is that it has certainly taught me to budget.

For example, I manage my income through a set of bank accounts.  I put my royalty and other writing checks into only one account--an "income" account.  I then "pay" myself each month from this account.  I keep separate accounts for the house, for taxes, for education, for my truck (repairs, maintenance, etc.), for references, for travel, and so on.  This helps prevent me from overspending, from eating into the money sitting so tantalizingly near in that other, income account.

Your accountant might suggest that you keep a separate checking account for business expenses.  This adds overhead, but helps keep your business accounts clear.  If you are going to use a credit card, make sure you have a separate card for business items vs. personal items.  Separate accounts and credit cards help you keep good records for your accountant.   They also helps prove that you do have a home business and that you are self-employed, rather than a hobbyist.

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The Cost of Doing Business

If you are self-employed, you have to remember that you (not an employer) now pay the costs of doing business.  This means paper and pens, computer upgrades, electricity, phone charges, business cards, lawyer's fees, etc.  Even though you can take these things as tax deductions, they are still cash out of your pocket.  And, tax deductions are not a 100% savings.  It seems obvious, but some people seem to have a mental block about that.  It's something I hear over and over from people justifying a purchase because it is also a tax deduction.

This is reality:  if you spend $100 on office supplies and deduct that $100, you did not save $100 in taxes.  You saved only the tax on that $100--which is probably more like $20 to $30.  Thus, you really spent $70 or $80.

For example.  You buy $200 of office supplies, and your total tax rate is 25%.  You deduct the $200 as a business expense.  This means that, with a 25% tax rate, you saved $50 in taxes.  Bottom line:  you spent $200 and saved $50.  You did not save $200.  Essentially, you paid $150 for the office supplies.

It might be better to think of a tax deduction as a sale price on an item, rather than mistakenly consider it a 1:1 ratio of savings.

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Self-Employment and Other Taxes

If you are self-employed, you will probably have to pay a self-employment (or "corporate") tax.  When you work for a company, the company pays this tax for each employee.  When you work for yourself, you have to pay the tax on yourself.  In Oregon, the self-employment tax is on top of the standard income tax (we don't have a sales tax, thank gawd).

For example, if your income tax has averaged 15% in the past, and the self-employment tax is 10%, the tax rate on your writing earnings is now 25%.  If it averaged 20% in the past, it will now be 30%.  You must remember to set aside enough money for taxes to pay this difference when the IRS bill comes due.

There are also local bonds and taxes to keep in mind.  These include property taxes, public-transportation taxes (in Oregon, this is the Tri-Met tax), local school and library bonds, and so on.  Don't forget to factor them in to your plans!   They are in addition to your standard state and federal taxes.  

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Adding Your Income on to Your Spouse's Income

If you have a spouse, your tax rate is not likely to be figured for your income alone.  Instead, your income will be added to your spouse's income, and taxed as if it is the higher income.  This is the "marriage penalty," and it can be a confusing and hard lesson to learn.  Filing married but separately vs. filing jointly doesn't really make a difference in the tax burden of the household, but it can make a difference in the tax burden of the individual spouses.

For example, your wife earns $50k, and you earn $20k from writing.  So your household income is $70k.  If you file jointly, both your wife's $50k income and your $20k income are then taxed as if they were $70k incomes.  

This is key:  Your writing income of $20k/year is not taxed at the $20k/year rate, but at the $70k/year rate.  Which means that the tax burden might not be the 24% you expected, but a whopping 39% -- not counting local measures and bonds.

Here's why:  Your spouse, who has the "day job," probably already has her taxes taken out by her employer for her $50k/year income.  She is not paying the 15% corporate (self-employment) tax, which you, as a self-employed writer, must pay.

The spouse is also not paying an appropriate tax rate for the $70k/year income which your household actually has.  She is paying taxes for only a $50k/year income.  However, the household income is $70,000, and if she paid the taxes at that rate, she would owe an additional (for example) $4k to the IRS.  That additional $4k burden must be paid by someone.  Since your spouse's taxes were already withheld, the person who must pay that additional burden is probably...you.  You must now add that $4k bill to your own tax burden on your $20k/year writing income.

So you're paying a 39% basic tax burden (about $8,000) on your $20k/year writing income, plus the additional $4k owed to the IRS from your spouse's income.  That's a $12,000 tax bill for a $20,000/year income.  That's a serious tax burden, and it can be fairly shocking.

Also, in my experience, it doesn't seem to make much difference whether you file jointly or separately.  I did the taxes both ways for six years.  The savings in filing separately vs. jointly was never more than $6.  I would certainly have paid more to prepare the paperwork for filing separately than I would have saved in doing so.

The basic thing to remember is this:  if you have a spouse, you could pay a much higher tax rate on your $20k/year writing income than you expect, because your income will likely be taxed at the whole-family income rate, not at the rate for your income alone.  You may have to set aside much more of your income for taxes.  Or, your spouse may have to set aside more income to pay his or her fair share of that $70k/year tax rate, instead of withholding only for a $50k income.  Either way, you could find yourself in financial hot water if you don't anticipate the actual tax burden on your earnings.

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Retirement Deductions and Tax Rates

Your tax rate can usually be reduced by deductions, which include 401K and SEP contributions (but not Roth IRA contributions).  You have to remember to add the retirement contributions to your overall financial burden, so that you have enough cash to pay both taxes and retirement contributions.  This seems obvious, but many people forget that, to get the lower tax rate, they must make a significant retirement contribution.

For example, perhaps you average a total tax rate of 25% a year.  However, this rate is dependent on a retirement contribution of 15% a year.  Let's say that you earned $60k after all deductions but your retirement contributions.  In this case, you would owe around $12,000 in taxes, because you will also pay about $9,000 (tax-deductible) into retirement.  Your overall tax rate is 25%, but your overall financial burden is around 35%.  It's an important difference.

I look at it this way:  I can pay the money to the IRS in taxes -- since without the SEP contribution, I'll have a higher tax rate.  Or, I can pay that money to myself into a retirement fund, and have the benefits later in life.  I prefer the latter situation.  You should, of course, ask your financial planner or accountant which is better for you.

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Keep These Things in Mind...

Especially for writers and others who are self-employed, it is important to get good accounting, tax, and financial advice from a certified public accountant (CPA) or other appropriate financial advisor.  Remember these things:
Get a reputable CPA who has experience handling other authors, and is well-referred by other authors.   
Tax law changes every year.  A CPA can help you keep up with proposed and approved changes.  In turn, you can help your CPA by keeping up with the tax information disseminated by the Author's Guild and other reputable writer's organizations.  These notices often offer clarifications that can help your CPA do the best job for you in yourr situation.
The tax laws in different states are also different.  For example, tax advice from an accountant in Illinois, may not be appropriate for you if you live in California.
Getting free tax advice over the internet may be tempting, but I'd just like to remind you that you get what you pay for.  Free is not necessarily a good price, especially for tax advice.
Paying for tax advice over the internet does not necessarily mean you are getting accurate, accountable, professional advice.  Before paying for any advice, check references and check their terms of agreement.  Are they accountable for their advice in the same way that your local CPA would be?   How are disputes resolved?  What happens if you get audited -- does the internet CPA sit with you at the audit?  Enquiring minds want to know...

Don't take the examples here as hard facts about your own tax burdens.  There are many ways to declare and pay your taxes.  Your accountant will help you decide what is best for you.


Copyright 2005 Tara K. Harper

All rights reserved.  It is illegal to reproduce or transmit in any form or by any means, electronic or mechanical, including photocopying, recording, or by any information storage and retrieval system, any part of this copyrighted file without permission in writing from Tara K. Harper.  Permission to download this file for personal use only is hereby granted by Tara K. Harper.


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