Most self-published authors are probably more comfortable writing books than publishing them.
These days, many services and resources are available to help an aspiring self-publisher. In Part One of this series, I discussed the tax considerations relevant to authors who intend to self-publish. As publication approaches, however, these considerations will inevitably begin to shift. As you move from manuscript development to seriously preparing your book for distribution, your principal business activity changes from writing to publishing.
Once you have completed necessary pre-publication tasks, including layout, cover design, illustration and copyediting, you will need to determine how you plan to distribute your book. A variety of options are available to you, depending on your preferences and your budget. For example, you could hire a full-service self-publishing company, which can offer editing and design functions as well as distribution and marketing. On the other hand, you could focus on online retail distribution with an e-publishing service or work with a print-on-demand service to produce physical copies as demand dictates. The pros and cons of these options are beyond the scope of this article, but each choice can create different tax consequences.
If you choose to hold a physical inventory of books rather than stick to digital or print-on-demand, you will need to allocate production costs, such as materials, labor or anything else related to preparing physical books for distribution, to cost of goods sold (COGS). This allocation is an application of the matching principle that attempts to align the costs of producing inventory to the income that inventory will generate. For advance reader copies, other review copies or any promotional copies you may use for marketing, you can only deduct the COGS, not the book’s retail price per copy. There is little to no COGS for e-books, because the costs to produce an individual copy are negligible.
Once your principal business activity has shifted from author to publisher, technically you are no longer a “creative individual” exempt from the uniform capitalization rule, or UNICAP. Whereas an author typically capitalizes only a manuscript’s direct labor and materials costs as COGS, UNICAP requires publishers and producers to reasonably allocate indirect costs between production and nonproduction activities. This is because certain costs, such as utilities or depreciation on machinery, indirectly contribute to the production of inventory and should be added to the cost of that inventory, rather than deducted immediately. The steps to this calculation are too complex to discuss here in detail, but the simplified production method found in the Internal Revenue Service regulations is recommended. Those who do find themselves subject to UNICAP are better served leaving its complex application to a qualified professional.
There is a major exception from UNICAP that many self-publishers will find beneficial. Certain producers using the simplified production method to comply with UNICAP are exempt from actually applying UNICAP in any year that the business’s total indirect costs do not exceed $200,000. This should exempt the majority of self-employed, self-published authors from the UNICAP headache, since most expenses will be directly related to producing the book itself versus indirect activities.
You will also need to determine how you will handle sales if you do not select a service that will handle them for you. If you do not use a service already affiliated with an online retailer such as Amazon, you will probably want to create a website that is equipped to deal with sales transactions. There are many credit card processing services available; PayPal is very popular, but is not the only choice. At a minimum, if you are processing credit card payments, you will want a Secure Sockets Layer (SSL) certificate to ensure that customer data is properly encrypted. Here, as with editing and design, you may also choose to hire a contractor to build, maintain or promote your website. If you do, you will likely need to collect a Form W-9 from the freelancer, as discussed in Part One.
If you sell your book directly, you will also need to pay attention to sales tax. Even if you do not choose to sell your book through your own website, you may hand-sell copies at speaking engagements or trade shows. While sales tax is paid by the purchaser, it is up to the seller to collect the tax, and rules vary from state to state. If you are regularly selling books without a third-party middleman, online or otherwise, you will likely need to register as a business with your state’s tax department.
For authors who select a print-on-demand service, it is possible to avoid paying sales tax on your own book by securing a resale or seller’s certificate to establish your intent to resell those copies. This is different from a business license, and you can often obtain it online through the state agency in question. Providing the certificate to your print-on-demand service will allow you to obtain the copies tax-free; you will, however, still be responsible for collecting sales tax from the customers to whom you eventually sell the books.
Similarly, if bookstores or other retailers buy books from you for resale, you do not need to collect sales tax because the store itself will do that when the books are sold. You do, however, need to keep records of such tax-exempt purchases. Most states will require you to obtain a copy of a seller’s permit or a special form for purchases made for resale. Nonprofit organizations that can buy copies without sales tax will also have a permit or form to prove their status. The state may require you to produce your copies of such documentation to prove you legitimately did not need to collect sales tax in such instances.
If this sounds like a lot of work, it is. But given the increasing popularity of self-publishing, many print-on-demand or e-book services now take a lot of this burden away from the author. Many can handle processing payments and collecting sales tax, and typically take their fees more or less automatically as books are bought and sold. Some print-on-demand services, such as Amazon’s CreateSpace, will also provide authors with 1099-MISC forms, reporting royalty payments net of fees. This can simplify taxes a great deal for authors, because it means authors themselves maintain no inventory.
Whether you use a service or go it alone, eventually your release day will arrive and your book will be up for sale. Once the book begins to generate income, you will need to begin paying self-employment taxes on your net income from its proceeds. Depending on the service you used and your distribution channels, you may receive royalty income; such income must be entered on Schedule C with your business, rather than on Schedule E as passive income.
If you have not worked for yourself before, it is crucial to remember that you are responsible for estimated tax. The U.S. tax system operates on a pay-as-you-earn basis. As a typical employee, this means taxes are withheld from your paycheck. As a sole proprietor, this means that in most cases you must make estimated tax payments over the course of the year as long as you expect to owe at least $1,000 in tax come April.
In the case of book authorship, your income stream may not last forever. So it is especially important to save what you can in a retirement plan; you’ll likely reduce your taxes, too. While the types of plans available to self-employed individuals are beyond the scope of this article, my colleague ReKeithen Miller wrote an excellent article, “Retirement Plan Options For The Self-Employed,” which appeared in the June 2015 issue of Sentinel.
A final note on the self-published author as a sole proprietor. While self-publishing is not new, the rise of print-on-demand services and the growing popularity of e-books has quickly blurred the divide between author and publisher. While most self-published authors will probably think of themselves as writers first and foremost, it will take some time for the tax authorities to catch up to the reality of modern independent book distribution. No individual situation will be quite as cut and dried as was outlined in this article, and the unique realities faced by a particular self-publisher could lead to alternate approaches. In the meantime, you will be well served to take extra care in documenting your reasoning for various tax positions and potentially consulting a tax professional to make sure your approach is reasonable.
Many people dream of writing and publishing their own books, but it is safe to assume that no one dreams of dealing with the tax consequences. With care and planning, however, handling tax can be just a minor footnote in a tremendously satisfying experience.
