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Should I Inc.?

Should I Inc.?

As both a writer and tax advisor, I’m often asked by authors whether it makes sense for them to incorporate their writing business. The answer is – it depends.

Writers have several options when choosing the form through which to operate.

A sole proprietorship is owned and operated by an individual, usually under the owner’s name, though the owner can register an “assumed name” for their business with their county clerk’s office.

Limited liability companies, a.k.a. “LLCs,” function with the flexibility of a sole proprietorship, yet have the advantage of also providing limited liability protection for business owners without the formalities required for corporations.

S corporations are small, closely held corporations, while C corps are often publicly traded and widely held. Both S and C corporations are required to have bylaws, hold shareholder meetings, and maintain extensive books and records to document corporate actions.

The simplest business form, and the one that makes sense for the vast majority of writers, is the sole proprietorship. However, some business owners choose to form a separate legal entity for their businesses in order to achieve limited liability protection or certain tax benefits. Beware, though. Business advisors have their own interests at stake. Often the primary result of forming an LLC or corporation is to generate fees for the advisor.

The Liability Issue. Despite lawsuits against writers such as J.K. Rowling and Dan Brown, legal action against writers is rare. Still, nobody wants to face the potential loss of personal assets. Forming a separate entity through which to operate a writing business can protect a writer’s personal assets from being seized to satisfy a judgment if the business is sued and loses the lawsuit. However, because forming and running an LLC or corporation costs more time and money than a sole proprietorship, a writer should seriously consider whether a real risk of liability exists before forming a separate business entity. In most cases, the risk of losing a lawsuit is negligible and forming an LLC or corporation isn’t worth the time and cost.

Tax Considerations. The income of LLCs and S corps is not subject to tax at the LLC or S corp level. An LLC with only one owner can report its income on a Schedule C just as if the business were a sole proprietorship. For S corps, a separate tax return must be filed (Form 1120S), but the form is an informational return only and no tax is paid with the return. Instead, the S corp’s income flows through to the shareholder’s individual income tax return, where it is reported on Schedule E and taxed at the individual income tax rates.

Unlike S corps, C corps are subject to tax at the corporate level. In some instances, the formation of a C corporation can save tax by permitting the division of income between the writer and the corporation and thus spreading income over the lower tax brackets for individuals and corporations. Unless the income of the C corporation is high enough, though, the cost of paying a professional to prepare the corporate tax return, as well as the costs associated with operating a corporation, may exceed any tax savings. Moreover, the writer would need to be paid a salary from the C corporation, which would require payroll taxes to be withheld and reported and a W-2 to be issued to the writer at year end. Thus, in many cases, the formation of a C corporation would unduly complicate matters and impose additional expense on the writer. What’s more, the income of a C corporation whose primary income is from royalties may also be subject to “personal holding company tax,” which is a 15% tax in addition to the income tax. A tax pro would need to examine a writer’s specific financial situation to determine whether forming a C corp makes sense.

Writers should also be aware that for state income tax purposes, the formation of a separate legal entity may subject their income to additional taxes the writers may avoid by operating as a sole proprietorship. Thus, forming a separate legal entity can backfire tax-wise, resulting in additional taxes and filing requirements and taking up more of the writer’s precious time and money.

The Bottom Line. The bottom line is that in the vast majority of cases it’s best to operate as a sole proprietorship. But if your writing is high stakes or high income, you should consult your legal or financial advisor to determine if forming a separate entity is right for you.

Diane Kelly’s debut novel, “Death, Taxes, and a French Manicure,” will be released in Sept. 2011.  Sign up for Diane’s newsletter, full of tax tips and writing news, at www.dianekelly.com.

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