Making the transition from hobby writer to paid professional is a big step. The writing world swiftly changes when one goes from not having to worry about things like customer satisfaction, sales, and even taxes. Many people don't realize that writing is a business, and income is taxed. It comes as a shock and surprise when it becomes very important to track earnings, expenditures, and receipts.
This is the way I handle my taxes and accounting. This won't work for everyone, but because I'm a US citizen living abroad as a self-employed entity, I have to report taxes when I earn $400 or more. While some of this won't apply to you, the big ticket items likely will.
While I'll do my best to make this as streamlined as possible, the simple truth of the matter is that the government doesn't make it easy for self-employed earners to track and report their taxes. It's really worth it to hire an accountant to deal with your taxes if you're self-employed and earning a significant amount of money. If you're only earning a few hundred dollars here and there, however, a tax-preparation program will probably be sufficient.
What do I need to record for tax purposes?
Just knowing you have to file your taxes isn't enough. Writers have an interesting list of deductions that can be claimed. Now, what you can claim varies on where you live. Where I live, I can claim things like computer purchases, software (when used for writing), paper, writing journals, and even pens. I can claim heating and electrical costs in the house, as well as anything that impacts my writing career.
Some of these things are pretty simplistic. Others? Not so much.
Here is a quick list of things I keep around for tax purposes:
Here are a few other things that you can record and claim as deductions:
The key point here is that you can only claim deductions that are relevant to your business of writing or editing. If I take a client out for lunch and we discuss business, I can claim this as a business expense.
What is the point of filing business deductions?
Running a business of any sort is expensive. The government acknowledges this by offering deductions. Essentially, deductions lower your amount of taxable income. This can be confusing, so sit tight — it isn't really all that hard once you understand the key concept. Here is a quick example of how a business deduction works:
I earned $10,000 in 2012. I spent $2,000 on eligible business deductions. I am taxed a rate of 20%.
Before deductions, I would owe the government $2,000. However, I spent that $2,000 on various business expenses. Because of this, I can deduct the $2,000 from my total earnings. My $10,000 of earnings suddenly becomes $8,000 of taxable income. Instead of paying $2,000 in taxes, I now only owe the government $1,600 in taxes.
Thus: $10,000-$2,000=$8,000. $8,000 x 0.20 = $1,600.
A common mistake I've seen is that people will assume a deduction means you don't have to pay that much in taxes. Instead, it refunds you the percentage of taxes you'd owe on that amount. Here is how I calculate my savings from deductions, using the example from above.
$2,000 x 0.20 = $400.
So, because I deducted $2,000 from my main earnings, I saved myself from having to pay $400 in taxes. These expenses do add up over time. They'll still cost you money, but at least you won't have to pay the tax man his 20% on top of everything else you're already spending to make your writing or editing career a reality.
Can I really deduct things like editing services, cover art, and formatting fees from my taxes?
Absolutely. These are reasonable and expected business expenses for a writer. Without these services, you can't bring a high-quality product to the market. While the government may require you to file invoices if you're audited, the government expects you to spend a certain amount of money on preparing your goods for sale. Your writing is your product. Just make certain you have your editor or cover artist invoice you or have a way to show that you paid for these services if the government decides to audit you. Many people use Paypal as a way to pay for services, and it is extremely simple to create an invoice in Paypal.
Just remember, it might be tempting to deduct things that aren't writing related, but the government does have the right to audit you. If you can't prove your expenses, you can be seriously penalized for tax fraud.
It's really, really not a good idea to play around with your deductions. There are a lot of things you can deduct, but really, it isn't wise to deduct your tea and coffee expenses even if you think you can't live without it…
Do I really need to track all of my sources of income?
It's a really good idea. I track my income by client and book source so I can see exactly where my earnings are coming from. The IRS requires certain forms to be filed if you're paid over a certain amount from any single source. Amazon, for example, requires you to file your w-8 or w-9 to avoid their auto-payment of taxes to the IRS. This form allows amazon to file a different form noting how much you made to the IRS.
Amazon will send you this earnings form as well, so you can file your taxes.
Amazon's system is a bit disconcerting, but their customer service folks will help you if you know what questions to ask. Fortunately, if you live in the USA as a citizen, the form is really simple. It's anything but simple if you aren't a US citizen or if you're a US citizen living abroad.
You must renew this form with Amazon every three years.
What software should I use to track my income, deductions, and taxes?
I use excel. I have a very simple spreadsheet that shows how much I've earned, whether or not clients owe me money, and how much taxes I should put aside. Because writers are self-employed, you are responsible for withholding your own taxes. This is where that equation above comes really handy. Remember, the amount you earned multiplied by your estimated tax rate is the amount you will owe the government.
I reserve 40% of my earnings for taxes. This is higher than my known tax rate of 34%. I do this because I'd rather reserve too much than not have enough in the savings account when it comes time to pay the tax man.
I really recommend adding a few extra percent to your estimated tax rate, especially if you're near the point of shifting brackets.
Do I really need to reserve funds in a saving account to pay my taxes?
Yes. Just do it. You will regret it later if you do not.
What other surprises can I expect working as a self-employed writer?
You can expect to have to pay extra taxes to cover your social security. This takes many people by surprise. If you're new to writing professionally, take a few minutes to call the IRS and ask them about your rates and how your social security is handled. Just because you're self-employed doesn't mean you can get away without paying into social security. There are a few ways out of it, but it usually involves living in a different country that is covered under a similar program.
You should give the IRS a call.
Surprisingly enough, the IRS actually has a very good phone-based service. It's worth making the call so you can ask questions about your taxes. While they won't hold your hand and do the math for you, they will tell you exactly what forms you need, what sort of things you need to record, and how you can go about dealing with your US taxes.
Is a tax accountant necessary?
This varies person to person. As a US citizen living abroad, because I live in a country covered by a tax treaty and I made below a certain amount, I was able to use software for free. Because I did not have many deductions for last year, it was very simplistic. If you have a lot of deductions or you made an exceptional amount of money, I really recommend hiring an accountant to help you with your taxes.
The $100 you'll pay them is worth sparing the major penalties that the IRS likes to impose on people who make mistakes.
Accounting and taxes can be a painful process. I spend maybe an hour or two every few months confirming my income numbers and checking my spreadsheet. By doing this, when it's time to pay the piper and deal with the tax man, the preparation process doesn't take very long at all, because the major work is already done.
Take it in small steps. If you get frustrated, work on something else for a while and come back to it. But, make sure you're also persistent. Accounting can be difficult, but if you keep your receipts and invoices organized, record them as you go, and keep prepared to deal with your taxes, the process isn't as hard as many make it out to be.
Good luck, and I hope this helps you as you're starting your writing or editing career!