When starting your first business, taxes are usually the last thing on your mind. But when tax time does crop up, suddenly you experience a mountain of worries: Am I doing it right? What kinds of taxes do I need to pay?
Never fear. This is the simple tax guide you need to understand what taxes you owe, when you owe them, and how to calculate them. If you read this advice, you’ll be able to rest easy knowing that taxes for your Etsy shop aren’t as scary as you might think.
Annual Income Taxes – Due Every April
We’ll start with the big bugaboo and the tax you’re probably already quite familiar with — annual income tax. Annual income tax is simply a tax on any income you’ve made — it’s what you’ve been filing and paying since you became an independent adult.
Etsy sellers also have to pay income taxes on their Etsy sales; the only difference is that this is considered “self-employment income,” and Etsy sellers must fill out a form Schedule C “Profit of Loss from Business.” Don’t let the term “business” fool you — you must file Schedule C even if you’re a sole proprietor and haven’t registered your business as a corporation.
You owe taxes on the net profit from your business — that is, the total amount of income you made, minus your business expenses. The amount you pay increases as your Etsy business’s net profit increases.
One important thing to note is that the United States has a “pay-as-you-go” income tax — meaning that you’re supposed to pay your income taxes as you earn money, not just at the end of the year. This is why an employer takes taxes out of each paycheck for their employees. Self-employed people are also required to “pay as you go,” but the responsibility for remitting taxes to the IRS and state government taxing body is solely theirs. Self-employed people are required to pay these “pay as you go” taxes quarterly, which brings us to ...
Quarterly Estimated Taxes — Due Quarterly
To put it simply, if you have a business and you’re expecting to owe more than $1,000 in taxes for the year, the IRS expects you to pay a fourth of the tax you owe each quarter. Quarterly estimated tax due dates are April 15, June 15, September 15, and January 15. (The dates may move slightly if one of the dates falls on a weekend or holiday.)
To pay your estimated quarterly taxes, you can do one of two things: You can fill out a form 1040-ES and send it to the IRS address nearest you, or you can file electronically using the Electronic Federal Tax Payment System (EFTPS). You have to enroll in the EFTPS before you use it, but after you are all set up, you can use it like an automatic debit for tax payments if you wish, and can even pay taxes over the phone.
Of course, the big question here is, how do you know early in the year what your annual net profit is going to be? First off, that’s why these are called “estimated taxes.” While you can’t quite know your net profit, you also often don’t know which tax deductions you can take, which will lower your tax burden. (Common income tax deductions include mortgage interest paid and child credits.)
Fortunately, since this number is difficult to determine, you will not be penalized by the IRS as long as you pay an amount equal to the amount of taxes you owed last year. (You can find this number by checking last year’s 1040 tax return.)
Looking for more information on Quarterly Estimated Taxes? Read Wrapping Your Head Around Quarterly Estimated Taxes for more detail.
State Income Taxes — Due Annually and Quarterly
For the most part, state income tax is also due annually, and most states require self-employed people to pay quarterly estimated taxes as well. Each state varies, though, so we recommend looking up your state’s department of revenue or discussing state tax obligations with an accountant.
While not an income tax, sales taxes are another form of tax that online sellers have to deal with. Essentially, sales taxes are collected by states and localities to pay for things like roads, schools, and other publicly funded endeavors. They do this by adding a percentage to each sale, and it’s up to the seller (you!) to collect this tax from buyers and remit it to the proper place either monthly, quarterly or, in some cases, annually. Generally, you will need to collect sales tax when you make a sale to a customer who resides in a state where you have a physical presence. For example, you live in California, you would need to collect sales tax from your California customers. Find out more about sales taxes in How to Determine Your Sales Tax.
We hope this guide has calmed any nerves you have about income taxes. Remember, if you have any questions or qualms at all, consult an accountant or ask the tax and financial professionals over at the Outright Community.
What have you learned about taxes? Share your tips in comments.