Travis here. There's no writing wednesday today as Rachel is writing the last inches of No Good Dragon Goes Unpunished. As such, she's sealed herself into the writing chamber. Woe be to me or any other mere mortal who seeks to breach that line.
Normally, I'd try to have a fun business or numbers post too keep things rolling but, well, its tax season. Which means that I'm spending all my time getting our taxes ready for the accountant. That's right, I'm not even actually doing taxes, just doing the questionnaire for someone else to do our taxes.
So, in the spirit of the season, here's a little window into what tax time looks like for us and, probably, other authors. USA based ones at least. I know nothing about other country's taxes.
Now, I can't give tax advice, so I'm just going to talk about Rachel and I. Hopefully you will benefit from our experiences.
The Dragon of Taxes
This tax thing is no joke. I spend a lot of time and effort to manage it. Why? Well, historically 90% of our income has no withholding on it. That means we have to pay all our owed taxes at tax time. I.e. April the following year of earning it.
Until last June, Rachel operated as an implicit sole proprietorship. That's what most authors are as its the default status if you do business, aren't an employee, and haven't formally created a business entity for your author stuff.
Sole Prop sucks a lot tax wise. Basically, all our income is personal income but we also have to pay self employment taxes too (15.5% roughly at time of writing). If someone is earning a middle-class living in America off book money, not impossible at all with self pub, then they are probably paying about 35% or more of their earnings in taxes when we add up every tax. (I'm aggregating a LOT for that number btw. Ad velorum, property, state, etc..)
I've seen studies that add up all the taxes paid by someone of our income bracket and it can be north of 40%. Now, before anyone thinks I'm anti-taxes, I'm not. I love police, fire departments, roads, the FDA, and so on. Big fan of civilization here. However, I think that 40% is an unfairly high level, hence my complaining. I mean, look at the social services they get in those 50% Scandinavian countries! We're kinda wasteful with our money in America.. but I digress..
What's important for authors here is the size of the tax bill that comes due in April. We'll have to shell out a single check that covers something like 25% of our income from the last year for this. If you make any real money selling books, this'll be you too most likely.
Lemme put a number on that to drill this point home. Say you're books do great and you make $60,000 in a year. Depending on your tax situation, that might result in a $10,000 to $15,000 tax bill.
I'm sure those of you starting out are like, "I'm not going to have to worry about this for years!". Just keep in mind that any tax bill can be a real shocker if you are used to a normal job with normal withholding and you usually get a refund from the govt at tax time. Earning even a couple thousand from an ebook will likely reverse this situation.
Given that most Americans (forgive me everyone else) have less that $1,000 in savings, this can be a big gotcha I feel and worth warning people about.
Prepare for Taxes or Death by Taxes
A LOT of what I do for Rachel and I is financial. A lot of the financial work is making sure that we pass through the tax time window like an arrow instead of hitting it like a bird.
How I do this is both simple and complicated.
- I track our earnings on a monthly basis
- I estimate our tax burden as we go using a worst-case-scenario method
- I make sure we save up enough money to meet our tax burden
Ideally I do this as the money is earned. We have a special savings account that I move income into to cover for taxes. This way the money doesn't show up in checking. Money in checking is always at danger of either (A) getting eaten on accident or (B) providing a false sense of security and wealth.
A real example that happened - one time I had to tell Rachel that we couldn't afford something we wanted. I forget what it was, a modest vacation probably. At the time though, we had $25,000 in the bank. Why was I putting on the brakes? Well, because I knew how much we'd earn and spend and owe over the next 6 months and, basically, that $25,000 was already spent as most of it was to go to taxes in April the next year. In the end, I was right and we did need it.
Typically in December, I'll get together with my accountant over email and get a quick estimate on our likely taxes, just to make sure I haven't totally messed up. If I have, well, its December and there's 4 months to try and fix it.
How is this complicated? Well, item #1 is complicated once you start getting into deductions, business expenses, non-writing income, and so on. Again, this isn't me giving tax advice, so if you want to do this, you'll have to go educate yourself, talk to professionals, and get the tools to do this tracking yourself.
My weapons of choice are a yearly tax guide on deductions, mint.com, and MS Excel. Mint is invaluable as I'm able to review transactions monthly and tag things as taxes, taxable, business expenses, deductions and so on. This is a huge time saver when March arrives and I have to start answering questions like, "how much did I spend on non-federal taxes in 2015?"
How the Business Changes Things
Everything I've been talking about up till now is how Rachel as a Sole Proprietorship (that I file jointly with) have handled things. This year though, things are changed both for the more complicated and the better.
In 2015 we became Aaron/Bach, LLC. (with the S-Corp tax status)
Sadly it was mid-2015, so I have half a year of Sole Prop taxes combined with the new overhead of half a year of business taxes. This is the pain year, but next year's taxes should be a LOT easier for me to handle because of this division.
What are the benefits of being an LLC like this? There's a LOT, too many to go over here really. If you are interested, go read up, there's endless resources on the web.
As relates to this post, taxes, there's three big advantages to forming a company like this,
- We have company accounts and a ledger. This nicely puts all our business transactions in one place and divides business from personal most excellently. Its SO much easier to hit up QuickBooks for our financial reports than it is to build them by hand in excel using Mint.com data.
- 100% of our revenue is no longer subject to self-employment tax. This is the TL;DR version but businesses only pay employment taxes on payroll. LLCs and S-Corps can distribute money to employees and members in more ways that just payroll. *
- We can do withholding on our payroll, which off loads a lot of tracking and money management chores from me.
*clarification - I'm just talking about self employment taxes here. This setup helps with limiting self employment taxes but not income taxes.
By setting reasonable salaries for Rachel and I, we only have to pay those extra taxes on our salaried income. This is a very big savings and it'll get bigger as we get bigger.
That said, there's a ton of benefits that I'm not talking about here. One of them that does need to be talked about is my own salary.
Protecting Your Partner
I spent all of 2014 working for Rachel and not anyone else. I work easily 80 hours a week being her marketing guy, financial guy, story helper, alpha reader, sounding board, secretary, IT guy, researcher, house husband, and general leg work person. If its not writing-related or Rachel-only, I try to take it on so she doesn't have to.
According to the IRS I made basically $0 in 2014. This was a HUGE problem for us as banks and certain desirable tax deductions thought that I was basically unemployed for that year. The problem goes well beyond that legally and socially but its too much for today.
Now though, as part owner of Aaron/Bach, LLC, I have a real job again and real salary again. This protects me and our family in many ways. As Rachel's partner, it protects my economic value both for myself and for her.
Lastly, its more fair to me. I work hard for Rachel's and my dream. I may not write the actual books, but I have put a lot of time and effort into them here in the background.
Anyway,
If this stuff interests you, and I hope it does, you need to look before you leap. Go read up in detail on how LLCs and S-Corps work. At least talk to an accountant before you do anything. Preferably also a banker and a lawyer. LLCs are not simple and there's a lot you can mess up through ignorance.
I read through LLCs for Dummies after starting ours and I wish I'd done so beforehand. Fortunately, we have a wonderful accountant who's helped keep us from making any regrettable mistakes so far.
A short post today, yeah right
If you read this far.... thanks! I know this isn't the most exciting Writing Wednesday material. Its important stuff to know though and I hope that you can benefit from hearing about our experiences.
In the end, surviving taxes as an author comes down to being prepared. That's the whole point of this post really. Know what's coming and prepare yourself for it. The methods I use work for me, but they aren't the best or only methods out there. Find something that'll work for you.
We have more posts on managing author money and taxes on the blog, so please check them out if you want to read more on the different topics that I touched on today.
Lastly, would anyone be interested in an in-depth post about LLCs and such? I brushed by a lot of material today and am curious if you all want to hear more on this from Rachel and I.
As usual, if you like the post, please share it around.
Cheers,
-Travis
Very interesting, thank you. And yes, please, more on LLCs!
ReplyDeleteTravis, Omg, more please, yes, yes, please. I set up as a sole prop with a small press business name (so I could put down a "publisher"). I'm petty sure I did it wrong, but I haven't even put anything up on Amazon yet, so nothing for sale, and no income, and no need to pay anything yet.
ReplyDeleteBut the tax thing scares the booties off me. More on how you guys actually manage that end would be would be manna from heaven. What and how to deduct, what software, anything!
Thank you for jumping in today! I always enjoy your posts as much as Rachel's. And Yay for getting a salary - we are so conditioned in our world that even if you're doing the work, until you can say that, it never quite feels real or right.
My hubby and I aspire to having problems like these. My writing chops/backlist aren't quite equal to Rachel's yet, but I'm hungry and learning. Taxes are something that I am increasingly concerned about, mostly because nobody talks much about them. If you did another LLC post, I'd be highly interested.
ReplyDeleteGood job, Travis! Sometimes we readers forget that the awesome books by Rachel Aaron rely on more than just one awesome person to get the novel finished. You both work hard, and the stories are amazing.
ReplyDeleteYes, a post on LLC's would be very useful. Thank you for putting in all the hard work to give us this very beneficial information!
ReplyDeleteVery interesting, thank you!
ReplyDeleteThere is a baldy by the name of Gan KongBin from Malacca who worked for a few years in Singapore. This creep is a pretentious ass who is all smiles and acts friendly but to people who know him he is cunning and evil hearted. Hopes he dies a horrible and painful death ...piece of shit!
ReplyDeleteI would be interested in more, and thanks for the information.
ReplyDeleteThis comment has been removed by the author.
ReplyDeleteHave an S-type corp and an amazing accountant as well. Makes a world of difference. I actually have a day job in addition to the S-corp so it makes it more interesting than what you have, but also no self employment issues as I get no payroll from the S-corp.
ReplyDeleteGood on you for taking a big step!
Thanks everyone! I'll put together a post on business structures for authors soon then. (Well soonish.. It's gonna be looking hahaha)
ReplyDeleteHi Travis -
ReplyDeleteMy 'practical job' is accounting and I've been doing taxes for years. You did a good job tackling this subject (and you certainly deserve a salary for all the support work you do!), but I thought I should help out by clarifying a couple of points.
First, having a separate bank account for tax funds is an excellent idea, and you're absolutely right to act as if that money doesn't even exist for anything else. However, rather than paying all the tax after the end of the year, most self-employed taxpayers should be making quarterly estimated tax payments throughout the year. If you don't, you may be subject to underpayment penalties -- especially if you owe a significant amount of tax, such as the $10k+ you mentioned -- and those penalties will surely be far more than the interest you'll earn by having that money sitting in the bank all year. Calculating those estimated payments and giving you vouchers and payment instructions is something your tax accountant should be doing.
Second, I just wanted to make sure no one got the wrong idea about LLC's and self-employment tax. Just turning your business into an LLC doesn't guarantee you will avoid having to pay self-employment tax. An LLC is a pass-thru entity normally taxed as a partnership, which means there's no tax at the company level and all the income flows through to the owners, where it's reported on their individual tax returns. With this type of business, in which one actively participates, any net income from the LLC will qualify as self-employment income. So you have to pay yourself enough in wages to completely zero out all the income at the LLC level, or you'll still be looking at a self-employment tax bill at year end.
Also, when you shift everything to W-2 income, you're still paying the same amount of tax, it's just treated differently and paid 'as you go'. For many people, it's psychologically easier to deal with withholding from each paycheck than to see that tax bill in one big scary chunk! But one thing to keep in mind is that when your business has payroll, it's very important to have excellent record-keeping and to make sure you make all of your payroll tax deposits on time, because payroll tax is one area where they are really strict about penalties. For just a couple of employees, the QuickBooks payroll feature usually works well; if you have more than that, using a payroll service that will handle all the deposits for you is often a good idea.
Hope that's helpful, and if you have any questions, feel free to ask. :)
This comment has been removed by the author.
Delete"Earning even a couple thousand from an ebook will likely reverse this situation."
ReplyDeleteYep, but thank goodness I had expenses to off-set the increase in taxes this year. At what point in earnings is it a good time to think about moving away from filing as sole proprietorship? I heard $150k as the limit from other author groups, but I'm wondering if that is too high if you already earn a good middle class income from your day job.
Thanks,
Annie
(Had to repost my reply b/c my phone autocorrect murdered too much and I can't edit it for some reason.)
ReplyDeleteGreat reply L.C. McGehee! Thanks for bringing in an expert opinion on this.
We have run the numbers with our accountant and I decided to pay the penalties rather than deal with Quartly payments.
As for the self-employment taxes, my understanding is that if we don't pay them on allocations, but only on the money paid out as payroll from the company. Which goes to just Rachel and I at the moment.
Ideally not all of our allocations are distributed as payroll.
That's my hope anyway. This whole reasonable compensation thing is frustratingly vague so far.
I didn't cover this topic in the blog post because, I'll be honest, we are struggling to figure out what reasonable compensation is for an author. What's market rate for her? What data do I use to set her salary and my salary? I've been asking professionals and other author's with LLCs to find out, but no luck so far.
Fortunately we are in a situation were we didn't have to answer that question in 2015 but will for 2016. (If you have a good idea btw I would LOVE to know). Figuring this out is my #1 priority for 2016.
Thanks again for a great comment!
@Anne this is something you should ask an accountant. You need a professional who can look at your situation and advise you specifically.
ReplyDeleteWe brought on a lot of overhead creating this business. We did so b/c the benefits outweigh the inconveniences for us. They may not for you. Its good to look into, even if you decide that its not for you, and that's the point of this post. ^_^
Hi Travis -
ReplyDeleteGlad that was helpful. As far as figuring out 'reasonable compensation' rates, I don't believe there is any way to determine an appropriate salary for a fiction writer.
As most of us know all too well, the unpredictability of income from this business is a big part of what can make it so frustrating and nerve-wracking! We've all seen that there's often no correlation between how much an author makes from the sales of a book and the amount of time and effort that was spent on that project, much less any conventional criteria used to determine earnings potential in other professions, such as education and skill levels. (Especially since it's quite possible to work very hard on a book for many years and not make a penny if that book isn't published!)
And looking at something like the salaries paid to staff journalists or the stipend and living expenses paid to a writer-in-residence at a university simply isn't comparable in any way to Rachel's situation, because the source of her earnings potential is completely different.
The good news is that as long as you don't take salaries that exceed the amount of income your business generated in that year (causing it to show a loss), no one can say your salaries are unreasonable; you can always choose to bonus out all of the income as additional salary at year end if you wish to. And whichever way you do it, your tax burden will be the same -- the only thing that changes is when and how you pay that tax. So it really comes down to what you're comfortable with.
If there's a reason you want the LLC to show income on the bottom line, you can leave some of the income there, rather than taking it all out as salary. But it generally won't make a difference -- for instance, if you're trying to qualify for a mortgage, a bank is going to look at your Adjusted Gross Income on your tax return, and that will include both your salaries and the net income passed through from the LLC, so shifting it from the LLC to your salaries won't change that number.
If by allocations you mean draws (technically 'member distributions' from an LLC), you have to remember that all that means is that you're drawing out some of the income the business is making for your own use, so it doesn't reduce that income. And even if you drew out all the money left after your salaries and all the other business expenses are paid, and used it for personal living expenses, at the end of the year you'd still owe both ordinary income tax and self-employment tax on that income.
(I've found that understanding the difference between net income and cash flow, and particularly how draws/distributions fit into that picture, is something small business owners frequently have trouble with, so if a more detailed explanation would be helpful, I can give you an example with figures to illustrate it.)
@Anne R. Tan -
ReplyDeleteAs Travis said, the best thing to do would be to sit down with an accountant and look at your particular situation.
However, there isn't actually any reason an author can't continue to operate as a sole proprietor even if they're making a great deal of money. Since it doesn't involve owning real property or making a product or providing a service that could generate a liability risk, an author doesn't usually need to separate themselves from their writing business for liability protection.
So especially if you're traditionally published, which generally means someone else is handling the business issues and you're just collecting royalties, you may never need to worry about it.
However, if you're self-publishing and doing well enough to hire someone to assist you with aspects of the business -- which makes you an employer and opens up potential complications -- you would want to create a business entity at that point. (And an LLC usually works best for most small business owners.)
There may be other considerations to take into account as well. One reason that creating an LLC was ideal in Rachel's situation is that it's the best way to allocate some of the income to Travis and reflect his role in helping to make it possible to generate that income.
"As far as figuring out 'reasonable compensation' rates, I don't believe there is any way to determine an appropriate salary for a fiction writer."
ReplyDeleteThis makes feel better. At least I'm not missing some super obvious way. Thanks!
I heart Travis Bach!
ReplyDeleteSincerely, Fangirl Meri MacKenzie
I totally stumbled on this post today- Huge fan of Fortune's Pawn- Anyway, I work as handbag designer and I do a lot of freelance work, sometimes alongside a full time day job. I had a heck of a time this year doing my taxes because I did so much freelance last year, and even with my deductions, I paid a lot of taxes. I know it not totally the same, but your post really intrigued me. I always wondered whether opening an LLC would be good for me- I mean the IRS thinksI run my own business already... So yes, I would love to see a more in depth post!
ReplyDeleteHi Annette,
ReplyDeleteSorry for the late late reply, I do hope you have notifications turned on. To answer your question, I'm not sure. Potentially yes it could help. Do you plan on continuing to do a lot of freelance work? See, an LLC or S-Corp comes with overhead. We pay a couple thousand a year in accounting and government filing fees to maintain our company. You will need to read up, met with an accountant and figure out if having a company will save you enough in taxes to be worth all the costs and trouble that come from merely having one.
In the end, all the tax savings are kind of non-obvious in a way. You have to go into a business with a strategy in mind for how you'll achieve a savings.