Editor's Note: This article was updated on November 6, 2015.
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 simple tax guide will help point you in the right direction when it comes to your tax obligations. (Of course, each person’s tax situation is different, so we recommend you consult with a local tax accountant who is aware of your specific circumstances.) Although we can't give you specific tax advice, this basic information will help you rest easy knowing that taxes for your Etsy shop aren’t as scary as you might think.
US Federal Income Tax – Due Annually
We’ll start with the tax you’re probably already quite familiar with — federal income tax. This 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 in the US have to pay income taxes on their Etsy sales. Unlike income reported on a W-9, income from your Etsy shop is considered “self-employment income,” and Etsy sellers must fill out a form Schedule C: “Profit or 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. Additionally, you will likely be subject to a self-employment tax and need to file a Schedule SE: “Self-Employment Tax.” If you have other employment income besides what you earn from your business (income from a full-time job, for example), keep in mind that you will only pay Social Security taxes up to a certain income cap. (Medicare taxes on income aren't limited, however.)
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 business’s net profit increases.
If you had more than $20,000 in sales and received more than 200 payments through Direct Checkout during the year, you will receive a 1099-K from Etsy. This reports to the IRS the gross amount of sales you had on Etsy. Don’t fret though! You only pay tax on your net income, so your business expenses will offset the gross income to arrive at your taxable income. Read this FAQ for more details about the 1099-K.
Another 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 ...
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 these 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 to 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 system 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.” Although you can’t quite know your net profit, you also often don’t know which tax deductions you can take to possibly lower your tax burden. (Common income tax deductions include those for 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. Looking for more information on what possible tax issues might arise by operating a small business? Read the IRS’s Tax Guide for Small Business for more details.
State Income Tax — 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 Department of Taxation, Franchise Tax Board or the equivalent local tax authority) and discussing your state's tax obligations with an accountant.
Although not an income tax, sales taxes are another form of tax that 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 local endeavors. They do this by adding a percentage to each sale, and it’s up to you as a seller to collect this tax from buyers and remit it to the proper place either monthly, quarterly or, in some cases, annually.
The laws vary by state, but sellers generally need to collect sales tax from a buyer when that buyer lives in a state where you have a physical presence (also known as “nexus” in tax lingo). For example, if you live in California, you would need to add on, collect and remit California sales tax on any taxable charges made to California customers. (Keep in mind that, while sales tax typically applies to the sale of tangible goods, not all sales are taxable, and the rules vary by state.) For more on sales tax, including what qualifies as “nexus” and how to determine what rate to use, read How to Determine Your Sales Tax.
Value Added Tax
Additionally, if you are based in the US and happen to sell items via digital download to buyers located in the European Union, those sales will be subject to VAT (Value Added Tax), a tax charged on most goods and services in the EU. On Etsy, you aren't responsible for adding VAT to your digital listing prices; Etsy will handle that. EU buyers — not Etsy or Etsy sellers — will automatically pay VAT as part of their total purchase price when buying digital items, such as digital patterns, PDFs, and e-books. Etsy will take the VAT paid by the buyer and remit it to the relevant EU tax authorities. Read this FAQ for more on VAT.
We hope this guide has provided some helpful basic information about taxes. Please note that tax laws change frequently, and this information is not tax advice or legal advice. You are responsible for any use of this information. Please consult an attorney or tax expert if you have any questions.