“To produce an income tax return that has any depth to it, any feeling,” author Frank Sullivan quipped, “one must have Lived–and Suffered.” The suffering stems not only from the necessity of giving hard-earned money to the government, but also from the nature of dealing with tax regulations. Because tax policy is one of the most potent ways to regulate society, Congress and the President frequently amend the tax laws. Yes, the IRS puts out general guides to federal taxation, such as IRS Publication 17, Your Federal Income Tax, for individuals, and IRS Publication 334, Tax Guide for Small Business, for individuals who use Schedule C or C-EZ; both are free from http://www.irs.ustreas.gov. And yes, the IRS also has a Tele-Tax service you can use to check the status of a refund or hear recorded tax information. But the advice you receive might be erroneous and is not binding on the government. And in any event, IRS publications and tapes represent the views of the IRS and are sometimes inconsistent with precedent established by the tax courts.
The good news, though, is that tax preparation can be considerably easier if you follow a few simple recommendations, and you may be able to reduce your tax bill in the process. Of course, these recommendations are not a substitute for the advice or services of a qualified tax advisor, but if you’re publishing or thinking of publishing your own work,you should be able to prepare and carry out a tax strategy that will make your accountant’s job easier in April.
The guidelines we offer in Part I will cover the simplest issues. In forthcoming newsletters, we’ll provide advice on more complicated tax issues, including the home officededuction and the hobby loss challenge.
If you’re self-employed and make money from writing or self-publishing, youmust file Schedule C–Profit or Loss from Business or Profession–as an addendum to Form 1040. Schedule C is the main form for filing self-employment income and expenses (except for prize and award income, which you may enter directly on Form 1040 as “Other Income” to avoid payingself-employment tax on it).
In addition to personal income tax, you may also have to pay state or local taxes, such as an unincorporated business tax. These taxes vary with each state and municipality, so be sure to consult the tax guidelines of your home state and locality.
Updating your records on a regular basis makes the task of filling out tax returns mucheasier come April. Consider maintaining a separate business checking account and savings account for your professional income and expenses (seeIRS Publications 552, Recordkeeping for Individuals, and 583, Starting a Business and Keeping Records, for details about the “permanent, accurate, and complete” records the IRS requires).
Record all income and expenses generated from your self-publishing project promptly in a ledger, specifying the date any money was received or paid out, the character of the receipt or payout, the source or destination of the income, and other relevant data, and supporting the entries with copies or originals of the checks, bills, and receipts.
To set up a simple and efficient ledger, use column 1 for the date, column 2 for the nature of the income or expense, column 3 for the check or receipt number, column 4 for the amount of income, column 5 for the amount of the expense, and column 6 and subsequent columns for different expenses based on your special needs (for instance, office supplies, local transportation, subscriptions, legal/accounting fees, etc.). This means entering each expense twice, once in the expense column and again under the particular expense category into which it falls. For obvious reasons, it helps to make your expense categories fit easily into the expense categories shown on Schedule C. If you are self-publishing books, you should keep track of production and printing expenses as separate categories. Computer programs such as Excel, Quicken, and Quickbook are good for this kind of record-keeping.
Although larger publishers, with average annual gross receipts in excess of $1 million, must use accrual accounting, othersmay choose either the cash method or the accrual method. The cash method requires that you include all income actually received during the tax year and deduct all expenses actually paid during that year. (Also,in a few cases, the cash method might involve including income not yet actually received, if the income was credited or set apart so as to be subject to the taxpayer’s control. For example, income received by an agent for an author will usually be taxable to the author when received by the agent.) The accrual method, on the other hand, requires that you include all income that you earned and have a right to receive in the tax year, even if you do not actually receive it until the following tax year, and that you deduct expenses when they are incurred instead of when they are paid.
Most taxpayers operate on the simpler cash method, and we’re assuming here that you will too. Similarly, since the tax year for most taxpayers is January 1 through December 31, we’re assuming that you’re also using the calendar year.
The cost of creating a work (or of acquiring a capital asset) is called its “basis” for tax purposes. When you use the cash method and deduct expenses currently, your work has a zero basis and the entire amount of the proceeds from sales will be taxable income. However, the cost of inventory may have to be deducted over several years under capitalization rules provided by the InternalRevenue Code.
One tax-saving technique for any taxpayer using the cash method is to pay as many expenses as possible in December while putting off the receipt of income until January, the new tax year. The idea is to decrease this year’s tax bill by offsetting income from the present tax year with expenses while deferring income until the following tax year. However, if you anticipate a significant increase in your income in the next year that will put you into a higher tax bracket, or if the tax rate is set to increase in the new year, it makes more sense to receive as much income during the present year as you can, and to defer paying expenses until the next one.
The distinction between ordinary income and capital gains income is an important onebecause ordinary income is taxed at higher rates than long-term capital gains.”Ordinary income” is realized from all the income-producing activities of one’s profession, and is taxed at regular income tax rates. “Capital gains income” is realized from the sale of capital assets–such as stocks, bonds, mutual funds, real estate, or precious metals. Capital gains from assets owned for longer than one year are classified as long-term gains and are generally taxed at a rate lower than the income tax rate. The tax law specifically excludes copyrights; literary, musical, and artistic compositions; letters or memoranda; or similar property held by the taxpayer who created it from the list of assets qualifying for capital gains treatment–although if you sell a copyright or a manuscript to someone else, that person will own the work as a capital asset. Also, a self-publisher’s sales of books would be ordinary income.
Grants are usually taxed as earned income, as are all monetary prizes, unless a recipient assigns an award to a qualified charitable institution. In that case, for tax purposes, the prize and the donation are not treated as income and a deductible charitable contribution, but rather as if the award was not received. If you win a monetary prize, you may enter the amount received on Form 1040 (as “Other Income”) and thus avoid paying self-employment tax on it. On the other hand, if you fear a home-office deduction or hobby loss challenge by the IRS, it might be better to enter such income on Schedule C. You should discuss how to treat a money prize with your tax advisor.
For help with respect to home office deductions and hobby losses, among other things, watch this space.
Tad Crawford is an attorney, publisher at Allworth Press in New York City, and the author of “Business and Legal Forms for Authors and Self-Publishers.” Kay Murray is Assistant Director and General Counsel of the Authors Guild, Inc.–the nation’s largest organization of published authors. This article is adapted from the revised Third Edition of “The Writer’s Legal Guide: An Authors Guild Desk Reference” by Tad Crawford and Kay Murray, available for $19.95 plus $5 shipping and handling (NY State residents must add sales tax). Order toll-free from 800/491-2808; by mail from Allworth Press, 10 East 23rd Street, New York, NY 10010; from the Authors Guild at 31 East 28th Street, New York, NY 10016; or via www.allworth.com. The book is free online to members of the Authors Guild. Copyright 2002 Tad Crawford and the Authors Guild, Inc.