Most folks wrongly believe that once a writer has a book published he or she becomes instantly rich. While that does happen occasionally, it is unlikely for most writers. In fact, a small percentage of writers can actually make a living off the income generated by the sale of their written works, and that takes into account all those writers who get those fat advances. These folks are in the very small minority.
To illustrate, let's look at a few examples over the next few blogs:
First example: Let's assume that I just received an offer for my romantic suspense novel. Depending on who the contract is with and depending on whether or not I have an agent (who will take a percentage - normally 15 - right off the top) I can expect on average an advance of a few thousand dollars as a first time novelist. Let's say that advance is $5,000. Advances are often paid in two installments (first half when the contract is offered and the second half when the book is published) and go against future sales. Given the time between when a book is accepted and when it is actually published we will assume that the two royalty payments are in different tax years. Oh BTW - not all publishers offer advances.
SIDE NOTE: According to Jane Friedman of Writer's Digest Books speaking at the Aurora, Il Literary Festival this past June, 30% of all books where an advance is paid never earn back that advance for the publisher. What does this mean for a new writer? You may not get another offer from that publisher since your book didn't earn back your initial advance or if you do your next advance will be less than your first or none at all.
Okay back to my example. So, I now have $2,500 in my bank account ($2125 if I have an agent). BUT I obviously had expenses leading up to the sale of the book and I obviously have living expenses. If I'm married or have a day job the impact of this on my living expenses will be somewhat mitigated.
Let's say my expenses related to producing my novel (my product for sale) total $500 and to keep things simple let's say it's my only income. So, my net income on my Schedule C (Sole Proprietorship), which is part of my federal income tax return, will reflect gross income for my writing business of $2,500 minus the 15 percent to my agent or $375 and minus the $500 for my expenses leaving me with a net business income of $1625.
The $1625 is carried over to the federal 1040 tax form to be included in the calculation to determine income tax (if this is my only income my exemption and standard deduction will most likely zero this out). BUT as a small business owner - which is what a Schedule C is I may also owe self-employment tax.
Remember that I'm not receiving a W-2 for the $2500 because I don't work for someone else who is collecting and paying what's called payroll taxes to the respective government agencies - think medicare and social security and other taxes. Self-employment taxes are essentially applied to small business income of $400 or more net income and it's essentially a 15% tax (See IRS Form SE for the exact calculation). So, even if I wipe out my income tax I still owe self employement tax which in this case is $230. And if I didn't make an estimated tax payment during the quarter(s) in which I earned this money I will have to write a check to the federal government, and there might be penalties involved for not making those estimated payments. I just depends on my overall tax profile.
Oh, and I may even owe state income tax depending on where I live.
And BTW - royalties from most publishers are paid quarterly or even semi-annually. Again, there are not withholdings for taxes because it is the responsibility of the small business owner - you the writer - to make those payments, hence the quarterly payment process.
So you see, just because I received an advance for $5,000 doesn't mean I get to keep it all and doesn't mean I get it all at once.
Next time, we'll change the scenario and run the numbers again.