My recent article about forming your own self-publishing imprint generated a few questions about what business entity would serve writers best when creating their imprints: a sole-proprietorship, a limited liability company (LLC), or a Subchapter S corporation (S-Corp). I have talked about these three business entities before, vis-à-vis a tax standpoint. So, I thought it would be helpful to revisit the subject in view of starting your own self-publishing imprint.
First, it is important to understand the differences between these three business entities. The info is relatively simple, so no need to grab the ibuprofen (save it or that “something stronger” for tax time…or after your book launch party).
1. Sole-Proprietorship
A sole-proprietorship is an unincorporated entity owned by one person, namely you, the writer. You and your writing business are one in the same. Most writers operate as a sole-proprietorship. It is the default entity until an LLC or S-Corp is formed. Sole-proprietorships are the simplest structure of the three entities because it involves no paperwork, corporate filings, board of directors, or special fees. (I had you at no paperwork, right?)
Sole-proprietorships can conduct business under the sole-proprietor name, like Matt Knight Publishing or Matt Knight Books. But if you plan on sharing your publishing business with a partner, then a sole-proprietorship is not a business entity option for you.
Sole-proprietorships operate just like any other business when it comes to hiring contractors, freelancers, and employees. But keep in mind, you as the sole-proprietor are not an employee of the business, because the IRS sees a sole-proprietorship and the writer as one in the same.
Besides being the easiest and least expensive form of business to create, there are other advantages you gain as a sole-proprietor with an imprint. All the profits and losses from your writing business are reported on your personal tax return and not on a separate business tax return. This means:
1) You can deduct your business expenses (all those costs preparing a book for publication, as well as marketing and selling it) from your tax return;
2) If you file jointly with your spouse, business losses can be used to offset your spouse’s income (woohoo! major tax savings because you will have plenty of upfront expenses when launching your imprint and first book); and
3) You can avoid double taxation because a publishing imprint that is a separate legal entity like a corporation would pay corporate income taxes, and your writing/CEO salary would also be taxed.
Simple, right? Cheaper upstart. Many tax benefits. Easier tax preparations. Well, hold your britches. Nothing’s perfect.
There are two downsides to a sole-proprietorship.
1) Your net income after expenses will be subject to self-employment tax, currently set at 15.3%. If you are not making much money from your books, this will not be too bad (tax-wise at least; low sales, however, might require that “something stronger” I mentioned earlier). Self-employment tax becomes painful when you start making major bucks. Exactly what you wanted. No whining. It is a good problem to have. Here are two articles if you want further information on self-employment taxes (The Balance and Accounting Web).
2) You are personally responsible for any liability (e.g. copyright infringement, contract disputes, defamation), which puts your personal assets at risk. There is no protecting against personal liability incurred through your writing business activities. However, this may not be as bad as it seems either. More on the liability issue below.
2. Limited Liability Company
An LLC is a hybrid form of a legal entity with the tax efficiencies and operational flexibilities of a sole-proprietorship plus the limited liability of a corporation. An LLC requires a minimal amount of paperwork to set up, and usually low filing fees (requirements and fees vary per state so do your research). Filing can be easily done yourself, or hire a CPA or lawyer if you do not mind the added cost.
In most cases, a writer would create a “single member” LLC, with the writer as sole owner. The LLC is considered a “pass-through” entity, which means the LLC passes the income and losses from the business to the LLC owner (the writer) who claims the profits and losses on her personal tax return (exactly like a sole-proprietorship). An LLC does not pay federal income tax or state tax depending on the state. For example, an LLC in California pays $800 per year minimum (called a “franchise tax”) regardless of whether the LLC does any business or operates at a loss. Other states are different, so check with a professional.
While an LLC does not provide any tax benefit over a sole-proprietorship (and may even cost a writer more depending on state filing fees and taxes), it does provide a legal buffer to protect personal assets (see “Liability” below). True to its name, liability is limited.
3. Subchapter S Corporation
An S-Corp is a special type of corporation created by the IRS with the ability to pass through corporate income, losses, deductions, and credits to the shareholders, namely you. An S-Corp is the more complicated entity of the three. It requires more effort to set up and maintain. The tax returns are more complicated. But it does provide a few tax advantages over the other entities.
Like the LLC, the S-Corp is a flow through entity. Profit is transferred to the personal income tax returns of the corporate shareholders in the form of salary and dividends. This means an S-Corp does not pay federal taxes or state tax (depending on the state). Using California as an example again, S-Corps are subject to the $800 minimum franchise tax, and 1.5% tax on net income. Other states are different, so check with a professional.
The main tax advantage of an S-Corp is minimizing the self-employment tax paid by sole-proprietorships and single member LLCs. S-Corps are not taxed like sole-proprietorships. S-Corps can allocate their profits between compensation and company profits. Only the salary you pay yourself from the S-Corp, as opposed to all the profit, is subject to Social Security and Medicare taxation, which is quite a savings. The rest of the S-Corp company profit is passed through to you and subject only to regular federal and state taxes. See the following articles for great examples of the potential savings: Robert Pesce; Jonathan Medows, and Laura Shin.
Besides the tax advantages, the other benefit is an S-Corp protects personal assets from liability (like an LLC). Be careful to maintain and adhere to the S-Corp legal requirements like annual state filings and fees, and holding board of director meetings. If not, a plaintiff suing the S-Corp could “pierce the corporate veil” and sue the owner personally.
Liability
While it might sound appealing to protect personal assets with the protection offered by an LLC or S-Corp, in reality, the business of writing is not extremely risky. We do not sell smart phones that explode or vehicles with faulty ignition switches.
This is not to say writers are not sued. Whether you are traditionally published or self-published, it takes a village to shepherd a book to market. There are contracts with publishers, agents, designers, and copyeditors. There are copyrights to navigate (graphics, images, song lyrics), defamation and right of privacy claims to avoid (see my earlier post on defamation for more info), and employees to maintain should you have full-time research and personal assistants. All of these are potential litigation hotspots for writers.
Incorporating might help protect a writer’s personal assets from breach of contract, creditor debt, or employee disputes, but issues of defamation, privacy, and copyright infringement result from the writer’s actions. As Helen Sedwick notes in her article on The Book Designer, “someone would sue both the corporation and the writer for these claims.” Most likely, a plaintiff would have no problem proving the corporation and the writer are one in the same.
One option is acquiring insurance as an alternative to incorporating. If a writer does not make enough income to benefit from the tax advantages of incorporation, the money spent to set up and maintain a business entity could be used instead to pay for business liability insurance or an umbrella policy that covers infringement and defamation. For example, a two million dollar umbrella policy would allow one million for litigation fees, and one million for damages. These type of policies typically run from $200 to $1000 per year depending on the coverage. Helen Sedwick also suggests looking into Media Liability Insurance for even more protection. If you are worried about being sued, consult a legal or financial expert to discuss the best asset protection plan for you.
To Incorporate Or Not?
After all that info, what is the best entity option for writers starting their own imprint?
This is such the lawyer answer, but it depends on the facts: how much money you make from writing, what you are writing, and how risk-averse you are. If you are a writer who makes a living from her prose, then incorporation might make sense. For the majority of authors, writing only supplements their current income, making a sole-proprietorship perfectly fine. It is the least expensive of the three options, so writers can avoid the added costs incurred with the other two options. It is the simplest to maintain, so a writer can avoid the inconveniences of all the required paperwork and filings for each business entity. Plus, writers can take a home office deduction too.
Once you make consistent profit from your writing, reconsider your business entity status. It might make sense at that point to incorporate.
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