What's the difference between $100,000 in royalties received by by an author on:
1.  Your one and only book or
2.  Your third book in three years?

About $15,300 in additional tax, if you are in the second category. You see, as a general rule, all royalties received for writing are subject to what is called "self-employment tax". The only exception to this is when an individual in not regularly engaged in writing activities. Regularly means more than once, generally. A court case (Langford, TC Memo 1988-300) held that a writer was not subject to self-employment tax because they took a five-year hiatus between writing their first and second edition of their book. That five-year period met the criteria of "not regularly engaged in authoring activities".

For all other authors(category 2 authors), you are subject to both an income tax and self-employment tax. Authors who are considered sole proprietors (no legal entity or a single-member LLC) must report their royalties on schedule C (which is attached to form 1040 - individual income tax return). Royalties subject to both taxes include advanced royalties (royalties received in advance of book sales) and ongoing royalties (royalties received on each book sale).

The gain on the sale of an author's rights are treated as ordinary income and subject to both an income tax and self-employment tax. Unfortunately, there is no capital gain treatment on the sale of a book's copyright.

Authors receive a form 1099-Misc from their publisher or agent for royalties paid to them during the year. This amount must be reported by the author on their schedule C.If the publisher or agent fails to issue the author a form 1099-Misc., the author is still obligated to report all royalties received during the year.

Deductions - Authors may deduct certain expenses. These expenses include:

• The cost of books and subscriptions;
• Depreciation/amortization on computers/software;
• Editing fees;
• Home office expenses (assuming no other office exists outside the home);
• Professional or organization fees/dues;
• Supplies;
• Telephone and Internet expenses;
• Transportation and travel expenses;
• Workshops and conventions.

Authors who are sole proprietors or certain qualified employee-owned corporations are exempt from the Internal Revenue Code section 263A Uniform Capitalization rules (UNICAP rules). UNICAP requires that certain expenses be capitalized (not deducted).

In order to be able to offset expenses against royalty income received during a year, an author must be considered to be engaged in a for-profit business activity. This is known as the Hobby Loss rules. Under the Hobby Loss rules, theonus of proving the author's business is a hobby and not a business, ison the IRS. They look at all of the facts and circumstances of theauthor's "business" to determine if the activity is a hobby or a business. An author is given the benefit of the doubt and considered to be in business when their gross royalty income received for three or more years (out of five consecutive years) exceeds their expenses for those years. If an author fails this three year test, the IRS presumes the author's writing activity is a hobby and will only allow a deduction for expenses to the extent of the author's royalty income. When an author is considered to be engaged in a hobby, they are precluded from deducting any losses (expenses in excess of royalty income) from their "hobby".

I wish to thank the 22 year old Congressional staff members who write the tax code and regulations, the IRS for their incomprehensible explanations thereof and the tax court rulings for making the U.S. income tax system as complex as it is, thus affording me and many other CPAs the opportunity to make a living in a completely unnecessary field.

For more information please consult with your tax advisor or attorney.