With the recent end of tax season, many self-published authors have likely done some thinking about whether they could be saving more money or better protecting themselves from IRS scrutiny. They may have heard from their accountant or other authors that they can do just that by formalizing their publishing work under a business entity.
In fact, becoming a limited liability company (LLC) or Subchapter S corporation (S corp) can provide distinct tax benefits, but can carry added costs and potential inconvenience. But by considering a few key points, an indie author can figure out the right option.
The main tax savings of being an S corporation is the ability to minimize the Medicare tax. In recent years, the Medicare tax was increased by the Affordable Care Act, which can make the S corporation a worthwhile option in some cases.
All wage earners and self-employed people pay Medicare tax, which is withheld from paychecks and equates to about 1.5% of wages. Employers match the Medicare tax dollar for dollar, so those who are self-employed—including authors—are taxed double (about 3% of earnings). As a sole proprietor, a successful author earning $1 million would pay more than $30,000 in Medicare tax.
“Income from an S corp is not subject to Medicare tax,” says Robert Pesce, a partner in the media and entertainment group at Marcum LLP. “Only the salary an author is paid by the S corp is subject to the tax. So, an author with an S corporation who is earning $1 million and pays him- or herself $200,000 (a very reasonable salary at that earnings level) will only pay $6,000 (3%) in Medicare taxes, while an unincorporated author (sole proprietor) would pay approximately $30,000. The remaining $800,000 S corporation profit will pass through the corporation to the author, but it will be subject only to regular income taxes (federal, state, and local), not to Medicare tax. That’s a $24,000 tax savings.”
Pesce adds that under the Affordable Care Act, the Medicare tax was actually increased for high-wage earners in 2013, which makes forming an S corporation even more advantageous—authors earning in excess of $500,000 should start to consider this. LLCs, while also popular, do not afford the same benefit, because their income is subject to the Medicare tax.
“With traditional corporations, liability is also restricted to corporate assets,” says Khrystal K. Davis, a patient advocate and the author of Hunt for a Cure: An Unexpected Adventure to Save a Life, explaining her main reason for choosing Subchapter S status with the entity Zebra Leaf Publishing Inc. “However, corporate income is taxed before disbursements are made to employees such as the independent author. With the Subchapter S corporation, there are no corporate-level taxes. I wanted the traditional protection of a corporation—and wanted to avoid paying taxes at both the corporate and individual level.”
Of course, most indie authors aren’t bringing in tens of thousands—let alone hundreds of thousands—of dollars. Helen Sedwick, a California lawyer and the author of Self-Publisher’s Legal Handbook, stresses that in the vast majority of cases, it probably makes more sense to simply conduct business as a sole proprietorship.
“There are more than 23 million sole proprietorships in the U.S.,” Sedwick says. “They are simpler to operate and subject to fewer arbitrary rules than C corporations, S corporations, and LLCs. Simple is better.”
Operating as an entity allows authors to reduce their employment taxes if they make a net income of more than $50,000 a year from their books. Because authors who create a business entity can allocate their income between “compensation” (which is subject to employment tax) and “company profits” (which are not), those who make a substantial net income from their books can reduce employment taxes by incorporating or establishing an LLC.
The benefits of setting up a business are less pronounced than they once were, however. “Years ago, there were more tax advantages to operating as an entity,” Sedwick says. “Today, those advantages have disappeared.”
For many indie authors, the advantages of operating as a business go beyond tax savings. Patrice Tartt, a writing coach and self-published author of several novels and how-to books, set up Patrice Tartt Publishing LLC because it would it allow her to register the ISBNs of her books under her own LLC, rather than through the printer, and she thought it gave her greater control over her publishing decisions.
“People know that you are serious when you are backed by a business when self-publishing,” Tartt says. “This also allows you to bring on other authors to publish if you would like down the road.”
Davis says the added legitimacy of a business entity makes for an attractive option. “Working with a traditional publisher provides built-in legitimacy: you have the name of another entity promoting your work, and recommendations always carry more weight when they come from others,” she says. “Now, when I promote my books or myself as an author, I do so with Zebra Leaf Publishing, rather than my own name. This is important, especially when pitching stories to editors or submitting books for reviews.”
“Having a formal business entity and name can help you appear more professional to the industry—like in situations where you anticipate selling direct to bookstores or other companies,” says Jane Friedman, a digital-publishing consultant and the author of Publishing 101: A First-Time Author’s Guide. “It’s especially needed if you plan to operate a small press and publish other authors, manage and pay royalties, and so on.”
An LLC or S corp can also allow writers anonymity—say, an executive who writes mystery novels in her free time and worries that it might not go over well with the CEO of her company. “The author sets up a corporation or LLC, then designates an attorney, accountant, or someone she trusts to sign documents,” Sedwick says. “This structure costs money, easily $500 to $1,000 a year. For some people, it is money well spent.”
Setting up a business can also provide a clear distinction in one’s finances. “Operating as an entity helps writers draw cleaner lines between their personal and professional lives,” Sedwick says. “They are more likely to maintain separate bank accounts and to keep better track of income and expenses.”
An S corp or LLC can also mean protection from lawsuits. A traditional publisher contracts with all necessary parties to publish and distribute a book, so if a problem arises, it’s the publisher that is named as the party in any lawsuits. A business entity serves a similar purpose for a self-published author.
“Forming an S corporation is an effective way to limit the impact of any resulting lawsuits from contractual agreements,” Davis says. “A properly formed S corporation limits any damages to the assets of the Subchapter S corporation. This prevents parties from naming you individually in any litigation. It also prevents parties awarded damages in any litigation from coming after your personal assets.”
One of the biggest drawbacks to upgrading from a sole proprietorship is that operating as an entity can present significantly more paperwork, including additional tax forms and annual state filings (along with filing fees). Sedwick points to California’s annual fee of $800, which makes upgrading a pricey option for authors who aren’t earning a big income. Considering how perplexing many government and tax forms can be, and the time and money required in keeping them straight, Sedwick recommends that authors avoid setting their businesses up as entities until they are operating at a consistent profit.
“Some states, like Virginia, have a very easy online system, and it costs $100 to file an application as an LLC,” says Friedman, who established her LLC in Virginia, where she is a resident and where “it took literally 10 minutes.” Davis acknowledges that creating a business entity isn’t for everybody, but she says it has worked out well for her. “The main drawback to the Subchapter S corporation status is the filing requirements of corporations,” Davis says. “For me, limiting the liability to the corporate assets, and avoiding double taxation was more than worth the hoops I jumped through to attain Subchapter S status.”
Types of Business Entities
There are three main types of business entities that self-published authors can consider:
Sole proprietorship: The simplest option for a self-published author, this involves no paperwork, corporate charters, filings, or filing fees. But on the flip side, it does not protect an author from liability, so he or she can be sued personally, whether for copyright infringement, a contract dispute, or anything else.
Limited liability company: As its name implies, an LLC offers protection from liability for an author—though less protection than would be provided by full incorporation. LLCs allow authors to set up a separate legal entity, protecting their personal assets in the case of lawsuits. It also requires less paperwork than full incorporation.
Subchapter S corporation: Like an LLC, an S corp protects the personal assets of an author (who is called a “stakeholder”) and provides pass-through taxation that helps the author avoid getting taxed twice. But it also requires the appointment of a board of directors and annual shareholder meetings.