Take the Free Out of Freelance Writing

My brother, Dr. Dennis E. Hensley, put forward this advice recently in the May/June 2013 issue of Advanced Christian Writer (pages 3-4). He states:  “Outsiders to our profession think writing is fast and easy, that we have all the time in the world, and that seeing our names in print is enough payment to woo us in.  Lawyers, accountants, life coaches, psychiatrists, and fitness trainers charge for their advice and services.  The most frequent question I hear in response to this situation is, ‘But how much should I charge?’” This is where I would like to insert my own answer to this question.  Back in October 2012, I wrote a blog on this site titled “Writers: Stop Losing Money—Use This Fee Formula.”  Check it out.  In the blog, I outline a four-step process on how you should set your fees.  The formula can also be used to determine the absolute minimum fee (breakeven) if you are aggressively trying to break into a new market.  The formula covers the direct expenses of the specific assignment, the indirect costs of operating your business, your target profit percentage and the associated taxes that will be due on the assignment profit. Dr. Hensley further advises that you “match the market.  If you price your writing services too low, potential clients will wonder why your bid doesn’t match the bids of the other two writers he contacted.  Thus, you should check websites and ad brochures to find out what your competition is charging.  Naturally, there are such considerations as your level of education, experience, and previous client references.  But assuming most things are comparable, you should ask for what the market will sustain. “Don’t sell yourself short.  Writing is hard work, so you deserve proper compensation.  Move from freelance to moderately-priced-lance to outright-expensive-lance.”

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Dr. Dennis E. Hensley is the author of more than 50 published books.  His newest book, Jesus in the 9 to 5, will be released on October 18th

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Properly Reporting Royalties Received from your Publisher or Agent

What is the correct information reporting for royalty payments made by a publisher for the rights to an author’s book or other literary composition if such royalties are: (1) paid directly to the author or (2) paid to the author’s literary agent who then forwards all or part of such payments to the author?

First, the required reporting form to be sent to the author is Form 1099-MISC in any calendar year that the royalties aggregate $10 or more [Internal Revenue Code § 6050N(a) (relating to royalties)].  The royalties are reported on Schedule C in the income section by the self-employed author.

#1  Royalties Paid Directly from Publisher to Author

This is a straightforward process.  The publisher will send the author Form 1099-MISC when the royalties paid to the author aggregate $10 or more during a calendar year no later than January 31st of the following year (example:  2013 royalty payments are required to be reported to the author (and the IRS) no later than January 31, 2014).  The amount reported to you should be the gross royalties for the year.  If the publisher took out any fees or expense amounts before paying you during the year, I will explain how to handle that below.

#2  Royalties Paid Directly from Publisher to Literary Agent and then from Literary Agent to Author

In this scenario, both the publisher and the literary agent are considered “payors” of royalties for purposes of Internal Revenue Code § 6050N.  As such, the publisher must file Form 1099-MISC, reporting payments of royalties to the literary agent (named as the “recipient” on the form).  One special exception:  if the literary agent is a corporation, the publisher is not required to complete and file Form 1099-MISC on the payments made to the literary agent.

Most mistakes are made here…

The literary agent (whether a corporation or not) must file a Form 1099-MISC for the royalties paid to the author regardless of whether the literary agent receives a Form 1099-MISC from the publisher.  The instructions to Form 1099-MISC provide that gross royalties (before reductions for fees, commissions, or expenses) paid by a publisher directly to an author or literary agent or paid  by a literary agent to an author must be reported on Form 1099-MISC.  Thus, although the literary agent may have subtracted commissions and expenses before making the payment(s) to the author,  the Form 1099-MISC  required to be filed by the literary agent must report the gross amount of royalties received from the publisher pursuant to Internal Revenue Code § 6050N for each specific client-author.

Personal experience notes…

Based on my experience, I am aware that some agents are either not filing Form 1099-MISC at all or they are reporting royalties to their authors on an after-commission/expense basis.   This puts their client, the author, in jeopardy.

What can you do as an author?

If you don’t receive a Form 1099-MISC from your agent by January 31st, request one before you file your tax return.  If you receive a Form 1099-MISC with any amount other than the gross royalties paid to you during the calendar year, request a “corrected” Form 1099-MISC be issued to you (with a corrected copy also sent to the IRS).

Properly Reporting Royalties on your Tax Return

Once you receive your Form 1099-MISC with the gross royalties paid from the publisher on it (either from your publisher or your agent), you will report that amount on Schedule C as part of your gross receipts or sales in the income section of that form.

At this point, you are thinking, why do I have to report my gross royalties even though I  received a different amount of money after agent commissions or other expenses were deducted?   That is a very appropriate question.

In order for you to pay tax only on the amount you actually received, you will enter the related expenses such as the agent’s commissions in the expense section of your Schedule C (for example:  Agent’s commissions and fees would be a deduction in Part 2-Expenses of Schedule C on line 10).  Any other deductions taken from your royalties before you received the net payment would also be deductible on the appropriate Schedule C expense line.   This will ensure that you have reported your gross royalties, as required, but you have also deducted the expenses related to that income.   When you do this correctly, your business net income will include only the amount you actually received during the year.

Taxation on those Out-of-State Speaking Fees

States Hungry for More Revenue

If part of your income derives from speaking engagements around the country, listen up!   Those states in which you physically appear and which have a state income tax want to hear from you.  Yes, they really do!  And, if they don’t, they are more likely than ever to contact you.   Most states’ revenue statutes require anyone who earns income in their state to file a state income tax return with them.  This includes residents, part-year residents and nonresidents.

When you live (or reside) in one state and perform services in another state, you are a nonresident in that state subject to the requirements of their revenue act.  Some states have a minimum income filing threshold; others do not.  For instance, Colorado (randomly selected) states on their Division of Taxation website: “There is no minimum income threshold for filing a Colorado income tax return.”  It also states: “You must file a Colorado income tax return if during the year you were: A nonresident of Colorado with Colorado source income and you were required to file a federal income tax return, or you have a Colorado income tax liability for the year.”   Colorado source income includes “payments received for work performed in Colorado either as an independent contractor or as an employee.”

The Colorado requirements are similar to most other states in the country, which is to say, “if you earned income in our state, you need to file a return and pay any tax due.”    Many states have done a poor job of enforcement in this area, but with a lagging economy and shrinking state revenues, I think that is about to change.

No Statute of Limitations

The states are not too worried.  Once they identify you, they will generally ask you to file returns for all years you earned income in their state (unless they have an amnesty “special” going on).  You see, there is no statute of limitations on returns that have not been filed yet!  The statute cannot run until a return is received.  Once you are compelled to file late returns, you will owe the tax plus late-filing penalty and interest.  You may get a break if they are currently offering an “amnesty period” or have a voluntary disclosure program but these programs just reduce penalty and interest, not the tax.

Income Allocation at State Level Only

Your federal return is not affected by where you work because your federal return covers all sources of income from whatever source (and location) derived.  The allocation of income and related expenses takes place at the state return level.   If you live in a state with a state income tax, you would file your resident state income tax return with that state.  However, if you have earned income in other (nonresident) states, you must file a nonresident tax return in each of those states where you meet the filing requirements.   In order to prevent double-taxation on the same earnings at the state level, you prepare and file your nonresident state returns first and then reduce your resident state return by those amounts.  Your resident state will often require you to show an allocation of your resident and nonresident income in order to compute your tax only on your resident income or they may allow you a tax credit for the amounts paid to the nonresident states.

IRS-State Information Sharing

Each state has an information sharing agreement with the IRS.  They look at each other’s information to check for tax compliance.  At some point, if it’s not happening already, each state will ask the IRS for a magnetic tape for all Form 1099-MISC’s issued by all businesses within their borders.  The 1099-MISC has the payee’s name, address and Social Security Number (SSN) on it.  They will then cross-reference (match) this with the returns filed in their state and “pop out” those that have not filed a nonresident return in their state.  The states may start with 2008 (or earlier) and come forward since they have no statute restriction.   From a state revenue compliance standpoint, this is “easy” money (like catching fish in a barrel).   You will be sent a letter and asked to file and pay.  If you don’t respond, the state revenue division will prepare a return for you and bill you.  Ignore the bill and the next step is to garnish your wages or levy your bank account.

My Personal Experience

When I worked for the Michigan Department of Treasury, in the Discovery (aptly named) Division, as an auditor, I developed a project to enforce the Michigan Revenue Act targeted at all “entertainers” that came into Michigan for shows around the state and then promptly left without paying any taxes whatsoever.  I started developing a database of entertainers and their managers and subscribing to Cash Box, Entertainment Weekly, Billboard, etc. to monitor the “stars” forthcoming appearances.   Next, I would, in advance, contact the artists management agency or business manager and appraise them of the Michigan tax requirements.  I remember calling a big-time Nashville business manager and telling him who I was and what I wanted to talk about.  He said, “What?  We’ve been coming to Michigan for 20 years and never paid taxes!”   I replied, somberly:  “Exactly.”    Needless to say, entertainers soon got the word that they needed to be in compliance in Michigan and revenues to the state shot up from this group.

Wrap-Up

You may go to most state revenue sites by typing in the 2-letter state abbreviation followed by .gov and clicking on the taxes section to review their nonresident filing requirements for income earned in their state.  Remember, you still have the opportunity to file prior year’s nonresident returns and amend your resident return to get in compliance.  This post has focused on professional services rendered out-of-state and how that affects your state income tax obligations.  A future post will address sales of product (books, DVDs) over the Internet and in-person within resident/nonresident states and your sales tax obligation for those sales.

Cash Basis of Accounting

Most new writers will be “cash basis” taxpayers by default.  The cash basis of accounting is your way of reporting your business income and expenses on Schedule C attached to your annual Form 1040.

On the cash basis you recognize or report your income for tax purposes when you actually receive it and you are allowed to deduct your expenses only when you have actually paid them.

One exception:  If you put some of your business expenses on a credit card (VISA, etc.), those items may be deducted in full in the current year even if a balance due remains on your account for them in the following year.  If you are showing a tidy profit around the end of November and you are low on cash, you may wish to stock up on supplies, books, hardware or software before year-end to lower your tax bill by using your credit card in December.