How to handle taxes for a self-published book
I'm thinking of publishing a book on kindle, but I don't currently have a business set up. Do you need a business to publish a book? I'm curious as to how to handle US taxes for the royalties. I wouldn't be publishing it from outside the US.
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Usual disclaimer: I am not a lawyer nor a tax accountant. But here's my understanding.
Yes, you must set up a business. You must report this income to the Federal government on Schedule C, which by definition makes you a business.
If you're thinking, "Do I have to set up a CORPORATION?", then no. You can be a simple sole proprietorship. This usually does not involve a lot of paperwork. You must check your state and local law to see what you have to do. I used to have a small side business in Ohio. There I was basically required to file a state form registering my business name and address and pay a small fee, like or something like that. Now I live in Michigan and I had to fill out a form with the city and give them some modest amount of money, I forget how much. I also had to register with the state through a website. Big long form to fill out, but I don't think I had to pay anything.
If you will be selling books directly to customers, you must register to collect sales tax. If you do all your selling through Amazon or other distributors, it's their job to collect the sales tax. In America, only the final customer pays sales tax, not anyone else in the supply chain. (Unlike VATs in Europe.)
I presume you are not going to open an office but will work from your home. Check on local regulations about home-based businesses. Many towns have regulations intended to prevent someone from opening a factory in the middle of a residential neighborhood that has trucks arriving day and night and that's churning out pollution, or to open a night-club that results in rowdy drunks wandering the streets. It's highly unlikely that a writing business is going to disrupt the neighborhood, but you might get caught on some technicality not intended for people like you.
As @StevenDrennon notes, be prepared to pay taxes. I think he's a little sloppy on his terminology: "Self-Employment Tax" means Social Security Tax paid by self-employed people. With a regular job, you pay half the tax and the company pays half the tax. (Which is all a silly fiction: as far as the employer is concerned, their half of the tax is part of what it costs them to hire you, and has to be turned over to the government just like your half of the tax. A more accurate statement would be that the amount of tax reported on your pay stub is only half of what you actually pay. But that's another story.) When you have self-employment income, you have to pay both halves, or about 15%.
In addition, you must pay regular income tax on whatever you earn. How much this is depends on what tax bracket you're in. It could be anywhere from zero to 39-point-something percent as of 2013. Plus you may have state and local taxes.
But remember to keep track of your expenses, as these are deductible. If you create a web site to market your book, your web hosting fees are deductible. If you mail copies of the book to reviewers, the cost of these books to you and the postage to mail them is deductible. If you buy software to format the book or produce artwork for the cover, that's deductible. Etc.
If writing will be a significant percentage of your income, then you need to make quarterly estimated tax payments or you'll get slapped with penalties. If you have a regular job and writing is just a small sideline, then you don't really need to worry about this. Depending on how big a sideline, it may mean you owe a little bit come April 15. If your writing is small enough compared to your regular income, it may just be a dent in your refund. Yes, I know, we're all hoping to write a best seller and get rich, but I suspect that most of us here measure our writing income in a few hundred to maybe a few thousand dollars a year.
No, you don't need to set up a business to self-publish a book. In the U.S., royalty income and all related expenses to publishing the book (e.g. paying a graphic designer to create a cover, advertising, travel expenses for a book tour, etc.) are reported on Schedule C of your personal tax return.
EDIT
Regarding Social Security and Medicare taxes, you don't use the forms 940/941 that an employer would file. Instead, these contributions are called self-employment tax on your personal return, and cover both the employer and employee portion for Social Security and Medicare. The employer portion is a deduction on your personal tax return (available even to those that don't itemize deductions).
As Steven pointed out in his answer, don't forget that you may owe additional taxes that aren't covered by withholding of any W-2 income you may have, so you may need to make estimated quarterly payments to avoid having to pay an underpayment penalty when you file your tax return.
Be aware that I'm not an authority on any of this. This is what I know about the tax implications. There's a safe way to do this, and other things that you should consult with a tax professional about. Do not rely on my advice.
You don't need to form any sort of corporation, or even file as Doing Business As (when I was doing contract work, I set up a DBA as Thornleyware. Doing that is likely to get you some free stuff from time to time, as people will send you samples like a pen or something in the hopes that you'll order more.) You can use your own name or a pen name, as the law allows you to use a false name if you're not doing it for fraudulent purposes. A corporation provides some legal protection while costing money and increasing your paperwork (not the fun kind). I wouldn't worry about it until you can afford to hire professionals.
The safe way is to report all income on Schedule C. Keep track of expenses incurred soley as a part of your business, like registration fees or supplies or postage. Deduct them. Keep records. If you don't show a profit for enough years on your Schedule C, the IRS will investigate to see if you're running a bona fide business, and records will be your friend. If you make a profit in enough years, they'll assume you're a bona fide business unless they find evidence to the contrary.
Remember to save much of what you take in through the year, since you'll have to pay a lot of it in taxes. Estimated taxes aren't scary: estimate what you're going to have to pay, and at specific dates send in a form and a check. If you pay too much, you get it back as a refund. If you pay too little, but not excessively so, you pay it at the end of the tax year. You need to take into account the self-employment tax (about 15%), Federal income taxes, state income taxes (if you reside in a state with its own income taxes), and possibly others.
For anything more than this, you need to consult a tax professional of some sort (likely an accountant who specializes - I'd be leery of trusting one of the tax preparation chains for real advice). If you have a home office, you may be able to deduct it as an expense. If you buy a new computer, you may be able to depreciate it (deduct it as an expense over a fixed number of years). If you write on it half the time and play World of Warcraft the other half, it's probably not deductible. If you go to conventions to advertise yourself, it's probably deductible. (My mother-in-law had an in-home business at one time, and her accountant saved her far more money on taxes than the accountant cost.)
You may be able to call your writing a hobby, and list it as misc income on your 1040, and therefore not pay Social Security and Medicare etc. taxes on it. You can deduct expenses. (I have a friend who made money consistently on one of her hobbies, who did that for some time.) Again, check with a tax professional.
It should go without saying that any interesting tax scheme you read about should be run by a tax professional first.
Amazon will send you a 1099 that will identify the amount of royalties that they paid you. If you are just now starting, I would strongly recommend setting aside at least 30% of everything you earn in royalties as soon as you receive it. You are now considered self-employed, and you will have to pay 15% of your royalties as self-reported income tax. You will also have the self-employment tax, or the Social Security/Medicaid portion an employer would normally pay, which is now your responsibility. That will be about 15% as well.
Also keep in mind that if you start doing well with your sales, you will probably want to start paying that 30% to the IRS every quarter as estimated taxes. If you wait until the end of the year and then show a large sum of income on which you had not paid any taxes during the year, they will slap a penalty on you for failure to pay sufficient estimated taxes. Paying the estimated taxes throughout the year will help you to avoid that.
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