The good news: your writing related expenses are tax deductible. That includes your computer, travel associated with book promos and writing research, writing conferences, website development, purchasing your URL, promotion materials, etc.
The bad news: you now have to think through all that pesky business stuff, like taxes and whether or not you want to incorporate as an LLC (Limited Liability Corporation).
It's worth noting that I am not an accounting or legal professional, so please do not take this as formal legal or accounting advice. I'm still trying to figure it all out with the rest of you. :)
Should writers incorporate as an LLC (Limited Liability Corporation)?
If you're earning income from writing but have made no moves to set yourself up as a separate legal entity, you are by default a sole-proprietorship. For many people this is perfectly fine -- you are able to file your writing taxes along with your regular tax documents, which in general makes things pretty fluid and easy to manage.
The downside is that your business and personal finances are intertwined.
More specifically, if you were to ever get sued (for example, for copyright infringement) creditors could go after your personal assets (your house, your personal bank account) in addition to any business assets. Incorporating as an LLC separates your business assets from your personal assets, so any business liability is limited to the assets associated with your LLC. (Hence the name, Limited Liability Corporation.)
Said another, incorporating as an LLC puts a layer of protection between you and your business.
Another tertiary benefit is that instead of using your SSN# on business related documents, you can use a TIN# (tax ID number) or EIN# (employer ID number), which is a little safer to have floating around in a world where identity theft is a risk.
On the downside, there's more cost and work if you choose to set yourself up as an LLC. Exact costs depend on the state you live and incorporate in, but there is at minimum a one-time fee associated with incorporating that typically starts around $350. To get the benefits of your LLC, you will need to keep your business and personal expenses separate. This may be cumbersome for some, because it means having a separate bank account that your royalties and business expenses are managed from.
In general, the likelihood of litigation (at least from the research I've done) appears to be low, and many publishing houses have contractual clauses that assume some litigation risk. But it becomes a question of how much risk you're willing to take and what you, as the business owner, are most comfortable with.
It's also worth noting that you don't have to make up your mind up right away. Some people continue on as a sole-proprietorship until their writing income becomes large enough to warrant the extra time and expense, at which time they make the move to incorporate.
Regardless of your decision, take the time to consider your options, so some research and make the choice that best suits your needs. See below for a few websites and blog posts that I found useful when doing my own research.
Handy resources to help you decide if you want to incorporate as an LLC
This website does a great job of laying out the different types of incorporation options, which include LLCs along with Partnerships and Sole-proprietorships.
Wikihow takes you through the steps to set yourself up as an LLC in the U.S.
This about.com post and this absolute write thread include some handy pro/con LLC discussions. Read through the comments - that's where the good stuff is.
This blog post also includes some great information about making the transition from hobby to business and what you should consider.
Happy writing (and incorporating!)