It’s June 13 and in the U.S., the first set of estimated tax payments for 2012 are due at the end of the week.
And if you’re making money from your writing, and you have to pay U.S. income taxes, you need to be aware of this. You may not owe estimated taxes, but if you do owe them and don’t pay them, you’ll end up with an estimated tax penalty on top of the taxes you already owe.
The U.S. government requires everyone to make income tax payments that total to the lesser of: 90% of your current year’s tax liability, OR 100% of your last year’s tax liability. More on this in a minute.
If all you have is a normal day job, these payments are withheld from your paycheck and you don’t have to worry about them. If you are totally self-employed, you have to make estimated tax payments. If you have both writing income and a normal day job, you have a choice: you can have more withheld from your regular paycheck, or you can make estimated tax payments to cover your writing income. The catch is that a) figuring out how much more to withhold can be tricky because of FICA (see below) and b) you have to keep a close eye on your writing income and adjust the withholding at your day job if you don’t want to over- or under-pay, and this tends to be a nuisance and make employers unhappy about the extra paperwork after a while.
Estimated tax payments are due unevenly, on April 15, June 15, September 15, and January 15 (for the prior year). There are three philosophies about estimated taxes. The first holds that it is better/cheaper to keep careful track of your current year’s income and make sure to pay 90% of the taxes you expect to owe, even if it means you have to adjust the payments in the middle of the year because you have a sudden influx of income. People who go this route need to keep careful records, so that if the IRS asks why you delayed payment of half your taxes until the fourth quarter, you can prove that it was because you got a ginormous advance payment in December – i.e., you didn’t have that income until the fourth quarter.
The second idea is that tracking and predicting income so carefully is too much trouble, so it’s better to pay 100% of last year’s income taxes in four equal payments. Sure, this means that some years you’ll overpay and others you’ll underpay, but it will probably even out…and it’s an easy, certain way to be positive that you aren’t going to face any nasty surprise penalties at the end of the year.
The third is that it depends: if you have a big drop or a big rise in income, you go for the “90% of actual taxes owed this year”; if your income is pretty much the same, you calculate your estimated tax payments based on the “100% of last year’s taxes” figure.
Note that “current year’s tax liability” for purposes of estimated taxes includes FICA (Social Security) withholding as well as income tax withholding. As a self-employed person, you owe both the employee half of FICA withholding (7.65%) and the employer half (7.65%), for a total of 15.3% right off the top. Whichever way you choose to calculate, do not forget about this.
Also note that the IRS does not care whether you take your advance in copies, or whether you sell copies and use that money to buy more copies. As far as they’re concerned, it’s all income (and if you’re selling copies straight to readers, you probably owe state income tax, too. And sales tax, for which you need a sales license.)
If you’re right at the start of your writing career, have a day job, and get minimal income from writing (say, a few hundred bucks from short story sales over the course of a year), the easiest route is probably to adjust your withholding at your day job. Eventually, you’ll want to switch to estimated tax payments. In my own case, my first sale was a novel, which meant I got an advance, which was a big enough bump that I made estimated tax payments right from the start.
Deciding which way to handle the taxes on your writing income is more a matter of situation, personal temperament, and budgeting skills as it is of picking a “right” way. If you know that keeping tabs on your writing income and adjusting your estimates will drive you absolutely crazy, go for the “100% of last year” method. If you make a huge sale in the first quarter, and you know yourself well enough to know that you are going to be VERY unhappy if you have to pay all the taxes on it come the following April 15, make estimated payments that are more than 100% of last year. If the huge sale was last year, and this year your writing income will be half what it was then and you don’t have money sitting around, use the “90% of this year’s actual taxes” to figure out your estimated payments. You don’t have to pick one method and stick to it forever.
From a cash flow standpoint, the first two estimated tax payments (April 15 and June 15) are usually the hardest: April, because it comes at the same time as your annual tax payments (though it’s not so bad if you’re getting a refund that you can apply), and June because it’s a mere two months later, not a full quarter.
Taxes, including estimated taxes, are one area that is sufficiently important, sufficiently tricky, and sufficiently changeable that I recommend finding a good accountant sooner rather than later. Keeping up with the changes in the tax code is a full-time job, and I already have one of those. Exactly when you head to an accountant is up to you; if you’re only making $329/year in short story sales, it’s probably not worth it; if you have $50,000 in advance money coming in this year, it’s long past time.