The question of whether writers should form a business entity for their publishing work generated lengthy conversation during the ThrillerFest tax panel I moderated in July (see my post last week for take-home tax tips from the panelists). Most writers hope that changing from sole-proprietorship to a Subchapter S corporation (S-Corp) or limited liability company (LLC) will save taxes, provided better protection against liability, and import greater legitimacy in the marketplace and with the IRS. Here is what the panelists had to say about these three business entities for writers.
Most writers operate as a sole-proprietorship. It is the default entity until an LLC or S-Corp is formed. You and your writing business are one in the same. Sole-proprietorships are the simplest structure of the three entities. It involves no paperwork, corporate filings, board of directors, or special fees. All the profits and losses from your writing business are reported on your personal tax return and not on a separate business tax return. Net income after expenses will be subject to self-employment tax, currently set at 15.3%.
The downside to a sole-proprietorship (besides the self-employment tax) is that you are personally responsible for any liability (e.g. copyright infringement, contract disputes, defamation), which puts your personal assets at risk. There is no protecting against personal liability incurred through your writing business activities. However, this may not be as bad as it seems. More on the liability issue below.
2. Limited Liability Company
An LLC requires a minimal amount of paperwork to set up, and usually low filing fees (requirements and fees vary per state so do your research). Filing can be easily done yourself, or hire a CPA or lawyer if you don’t mind the added cost. In most cases, a writer would create a “single member” LLC, with the writer as sole owner. The LLC is considered a “pass-through” entity, which means the LLC passes the income and losses from the business to the LLC owner (the writer) who claims the profits and losses on her personal tax return (exactly like a sole-proprietorship). An LLC does not pay federal income tax or state tax depending on the state. For example, an LLC in California pays $800 per year minimum (called a “franchise tax”) regardless of whether the LLC does any business or operates at a loss. Other states are different, so check with a professional.
While an LLC does not provide any tax benefit over a sole-proprietorship (and may even cost a writer more depending on state filing fees and taxes), it does provide a legal buffer to protect personal assets (see “Liability” below). True to its name, liability is limited.
3. Subchapter S Corporation
An S-Corp is the more complicated entity of the three. It requires more effort to set up and maintain. The tax returns are more complicated. But it does provide a few tax advantages over the other entities. Like the LLC, the S-Corp is a flow through entity. Profit is transferred to the personal income tax returns of the corporate shareholders in the form of salary and dividends. This means an S-Corp does not pay federal taxes or state tax (depending on the state). Using California as an example again, S-Corps are subject to the $800 minimum franchise tax, and 1.5% tax on net income. Other states are different, so check with a professional.
The main tax advantage of an S-Corp is minimizing the self-employment tax paid by sole-proprietorships and single member LLCs. S-Corps are not taxed like sole-proprietorships. S-Corps can allocate their profits between compensation and company profits. Only the salary you pay yourself from the S-Corp, as opposed to all the profit, is subject to Social Security and Medicare taxation, which is quite a savings. The remainder of the S-Corp company profit is passed through to you and subject only to regular federal and state taxes. See the following articles for great examples of the potential savings: Robert Pesce; Jonathan Medows, and Laura Shin.
Besides the tax advantages, the other benefit is an S-Corp protects personal assets from liability (like an LLC). Be careful to maintain and adhere to the S-Corp legal requirements like annual state filings and fees and holding board of director meetings. If not, a plaintiff suing the S-Corp could “pierce the corporate veil” and sue the owner personally.
While it might sound appealing to protect personal assets with the protection offered by an LLC or S-Corp, in reality, the business of writing is not extremely risky. We don’t sell smart phones that explode or vehicles with faulty ignition switches.
This is not to say writers are not sued. Whether you are traditionally published or self-published, it takes a village to shepherd a book to market. There are contracts with publishers, agents, designers, and copyeditors. There are copyrights to navigate (graphics, images, song lyrics), defamation and right of privacy claims to avoid (see my earlier post on defamation for more info), and employees to maintain should you be lucky to have full-time research and personal assistants. All of these are potential litigation hotspots for writers.
Incorporating might help protect a writer’s personal assets from breach of contract, creditor debt, or employee disputes, but issues of defamation, privacy, and copyright infringement result from the writer’s actions. As Helen Sedwick notes in her article on The Book Designer, “someone would sue both the corporation and the writer for these claims.” In addition, she adds that publishing contracts include indemnity clauses whereby you the author agree to indemnify the publisher “against defamation, privacy, and infringement claims arising from your work.”
One option the panelists suggested was insurance as an alternative to incorporating. If a writer does not make enough income to benefit from the tax advantages of incorporation, the money spent to set up and maintain a business entity could be used instead to pay for business liability insurance or an umbrella policy that covers infringement and defamation. For example, getting a two million dollar umbrella policy would allow one million for litigation fees, and one million for damages. These type of policies typically run from $200 to $1000 per year depending on the coverage. Helen Sedwick also suggests looking into Media Liability Insurance for even more protection.
So what is best for you? The answer boils down to how much money you make from writing, what you are writing, and how risk-averse you are. If you are a writer who makes a living from her prose, then incorporation might make sense. For the majority of authors, writing only supplements their current income, so a sole-proprietorship works fine. They can avoid the added costs and inconveniences of maintaining a business entity. Plus, they can take a home office deduction too. Once you make consistent profit from your writing, then reconsider your business entity status.
For a more detailed analysis of incorporation, consult a professional in your state.
Photo Credit: Pexels — Tim Gouw