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Q&A: What are the tax advantages and disadvantages of a textbook author setting up an incorporation rather than operating as a ‘sole proprietor’?

Q: “What are the tax advantages and disadvantages of a textbook author setting up an incorporation rather than operating as a ‘sole proprietor’?”

A: Stan Gibilisco, author of several textbooks including Geometry Demystified:

“I tried this when I lived in Hawaii and discovered, to my horror, that my royalty income was subject not only to their income tax, but to their ‘sales’ tax as well (they call it a general excise tax). I figured that if I formed a Nevada corporation and had all my income channeled into it, and then became an employee of that corporation, the royalty income would not be subject to that onerous tax. It was a beautiful theory, but, like so many theories, did not work. The legislators in Hawaii had thought of that before I did and the law was airtight. Love it or leave it. I left.

The corporation introduced so much new paperwork into my life, and so many new fees, that not only did I find myself paying more for the services than I would have paid in tax to the state of Hawaii, but I had less time to write (or do anything else) because of all the red tape. So I fled Hawaii to Nevada in part to assassinate the monster that I created. To this day, the state of Hawaii actually owes me a little bit of money, for I paid the tax as a Hawaii resident employee of the corporation, as per their law, and then split before the advance was earned back. (As a matter of fact it never was). It was a triple whammo. Tuition in the School of Hard Knocks, one might say.

There may be some advantage in incorporation for the purpose of personal asset protection, and I have been looking into this on account of the fact that our society seems to be evolving into an entity ‘of, by, and for corporations,’ and one might rather join ’em than try to beat ’em. This has more to do with discouraging frivolous litigation than getting around oppressive taxation. As a matter of fact, in some states, incorporation could subject a writer to the state’s corporate income tax, where there would be no state income tax for a sole proprietor. (Texas, I believe is an example). Another problem is that some states might tax an out-of-state corporation for freelancing, but not an out-of-state sole proprietor. Better talk to a good lawyer before taking off on this sort of venture. And be prepared to spend upwards of $2,000 for the advice.

When I was incorporated, my publisher issued contracts that specifically maintained the liability and indemnification clauses for me personally, apart from the corporation. Therefore, if someone were to sue for copyright infringement or libel, I would have no more protection than if I were ‘totally exposed.’

So my conclusion is that incorporation might work for any person interested in protecting their assets generally (again, a lawyer would know better than I), but as far as an author doing it with the idea of solidifying his or her security in this dangerous world, I doubt there is any benefit.”

A: Ric Martini, author of Fundamentals of Anatomy & Physiology:

“Stan gives a good overview of some of the pitfalls of setting up a corporation. However, there are some things that can either make it worth the trouble anyway, or that can ameliorate some of the expenses. Here are some thoughts worth considering, in any event. Incorporation as a C-corp (which I suspect Stan was addressing) probably isn’t cost effective unless you:

  • Have royalty earnings of $150,000 or more.
  • Need medical coverage or anticipate large medical expenses.
  • Want to set up a pension plan that will build a retirement pool quickly.
  • Want to rent office space or other facilities from yourself or others.
  • Intend to hire employees (who may be family members).
  • Need additional liability protection (which is available to corps).
  • Are advised to do so by your accountant/financial planner/attorney, who knows your financial situation and the applicable laws.

Some but not all of these issues also apply to S-corps. you can, however, switch from a C-corp to an S-corp — so if you set up a C-corp initially, you can change over at some point if that becomes advantageous. In any case, I am personally convinced that if your income is substantial and you are still a sole proprietorship, you are paying a lot more in taxes than you should be or need to be. Every factor here has its own complications and expenses (other than the first), and whether or not it sorts out will vary from one case to the next. The paperwork load — not just forms to file but records to keep, annual meetings, payroll, and so forth — is notable but I don’t find it as much of a problem as Stan did. I guess one can adapt to such things given enough time.

The last item is the biggie. It’s a major step, to be sure, and you need to sort out the parameters with a professional.”