Tax Planning Important for Online Sellers
New business owners often wonder what is required of them when starting a business, because it’s critical to make the best decisions early on. In the state of Texas, a sole proprietor can start a business without filing entity paperwork and will record income and expenses on their personal return by default. There are reasons to start an LLC, Partnership, or S-corp, but many taxpayers do so without understanding the tax implications. For more information, I recommend reading this article https://molentax.com/the-most-important-thing-to-know-before-starting-your-own-business/ and contacting a tax professional at Molen & Associates.
Selling on the World Wide Web
Selling items on sites such as Amazon, Ebay, Etsy, and LetGo can be a simple way to earn some cash, but new sellers often worry about paying taxes on April 15th. Depending on how much you sell and how much you earn on these and other commercial sites, the IRS tax code clearly differentiates types of sellers. Selling a few personal items that sell for less than the purchase price is a nondeductible hobby loss. This means that sellers that only have a few transactions and they sell items for less than the purchase price, don’t have to pay any taxes. Low volume casual sellers typically don’t make a profit, and any income is not taxable like at a garage sale. When you are a collector or investor of valuable items that you sell for more than the purchase price (e.g. coin collection), each transaction is handled as a capital gain or loss. If you are a regular hobbyist seller then all your earnings are taxed as ordinary income with no deductions. The IRS classifies a hobby as a not for profit endeavor. In past years those who sold as a hobby were able to itemize their expenses, but as of 2018 this deduction is eliminated. In order to be classified as a business you must be profitable. If you are struggling to distinguish between being classified as a business or a hobby, answer each of the following 9 questions:
Answer The Following 9 Questions:
- Is the activity being carried out in a businesslike fashion (i.e. accurate books and records)?
- Is the individual investing enough time and effort into the business for it to be profitable?
- Does the taxpayer depend on the income from the activity as a means of support?
- Are your losses due to conditions beyond your control (i.e. startup costs)?
- Do you alter your methods of operation when necessary to improve profitability?
- Do you have the knowledge needed to operate the business, or are you seeking professional guidance to improve performance?
- Have you been successful with making a profit with similar activities?
- Do you have a positive history of profits with respect to the activity? (For most businesses turning a profit at least 3 of the last 5 years is necessary)
- Do you plan on making a profit from the appreciation of assets used in the activity?
If most of your answers to these questions are yes, then consider yourself a business and take advantage of all the deductions in this blog that pertain to your business.
Selling items from the comfort of your home is convenient and cheaper than renting out a business space. A deduction is available to homeowners and renters who use their home as their principal place of business. You can use the simplified method to deduct $5 per square foot of your home or apartment that is used exclusively for business up to $1,500! This is typically the preferred method because it requires less substantiation than the actual expense method. The actual expense method can create a large deduction based on the business portion of home expenses such as interest, taxes, utilities, insurance, repairs and depreciation. If your business is not profitable, this deduction will not decrease your profits below zero and won’t benefit you in such a tax year. Even though the home office deduction is often relatively small, it establishes a business location that can qualify you for significantly more mileage.
Self-employed online sellers often put significant miles on their personal vehicle by driving to purchase supplies, going to the post office, and out of town exhibitions and conferences. It’s important to record all business miles driven for these activities on a physical log, or a mile tracking app. In 2019 the standard mileage rate is 58 cents per business mile which is up from 54.5 cents in 2018. In addition to miles driven, there are additional expenses that should be recorded and deducted. These expenses include parking fees, toll fees, and business percentage of interest and taxes paid on your vehicle. While there is an alternative method to represent actual expenses, it is unlikely to benefit someone making money through online sales.
Advertising
Advertising expenses are deductible to the extent that they are ordinary and necessary. When you pay to increase sales through channels such as social media ads, sponsored ads, email marketing software, or a website, you can deduct the full amount paid in the current tax year. If you are advertising the startup of your business, these startup costs must be claimed in the year that they are paid. Charitable donations to non-profit organizations are deductible if they are used to secure promotional advertising for the business. There are expenses that are no longer deductible including entertainment with business associates, personal expenses related to your business, and research and development costs. Although entertainment deductions have been eliminated, 50% of business meals are still deductible.
It’s important to deduct legal and professional fees including advice from professionals such as attorneys and accountants, or when hiring out specific deals, transactions, or yearly taxes. You will likely incur regular business expenses such as merchant processing fees, credit card fees, bank fees, licenses, insurance and storage costs. Any of these or similar expenses paid to manage your online selling business are fully deductible. Business gifts up to $25 per person are deductible if the gift is given as part of a business relationship. Communication expenses generally include cell phone, internet, aircard, and video chat platform fees. Only business use portion of these expenses can be deducted, so it’s important to subtract the personal use percentage from the total.
The IRS allows a deduction for office expenses and supplies purchased that are ordinary and necessary for the specific trade or business. Some office expenses specific to online sellers include the purchase of a tablet, laptop, computer accessories, paper, toner, printer, pens, notepad, logbook, computer software, cloud storage and selling apps. Some necessary supplies that you will likely purchase include a camera, film, lighting, tripods, packaging materials, and other shipping supplies. These and other reasonable costs are deductible if the items were purchased during the tax year and used for business purposes. There are inventory rules for sellers who produce, purchase, or sell merchandise in their business and carry unsold goods at the end of the tax year. Generally, you must record your starting inventory, new purchases, ending inventory and cost of goods sold. The purpose of this method of reporting is so that you only deduct the inventory items sold, and not those being stored for a future date.
Unlike wages, income from self-employment is not subject to automatic withholding amounts set aside each time you are paid. It is common for self-employed individual to owe a significant amount in taxes if no money is set aside to take care of the taxes due. The IRS imposes an additional tax called an underpayment penalty to encourage taxpayers not to wait until April 15th. You have the option to make quarterly estimated payments to keep pace with what you expect to owe at the end of the year. Consulting with a tax profession in regards to the estimated payment amounts would be beneficial so you can make the correct payments through direct bank account debit, credit/debit card (fees apply), same day wire (bank fees apply), mailing a check or money order, and cash (at an IRS retail partner). Below are the due dates for quarterly payments.
- Quarter 1 (Jan 1 to Mar 31). Due date is April 15th
- Quarter 2 (April 1 to May 31). Due date is June 15th
- Quarter 3 (June 1 to Aug 31). Due date is September 15th
- Quarter 4 (Sept 1 to Dec 31). Due date is January 15th **of the following year**
There’s plenty to consider when running an e-Commerce business but using the information in this guide and consulting with a tax professional at Molen & Associates will put you on the right path to success!
Austin Long
Tax Advisor
