Friday, April 29, 2011

Attention Online Sellers: How to Avoid Tax Trouble

In February of 2008, just as the recession deepened, Rob Kalin, the founder and CEO of Etsy.com, the Brooklyn-based online market place for handmade goods, showed the audience of the Martha Stewart Show some of the big sellers on this site. Among them: a “sock money soap popsicle” and knitted pussy willows. "Anyone here — if you're in school or out of school, at any age — you can start a business from home," he told the audience. 
Lots of people have done just that. Etsy says more than $314 million dollars in goods were sold on the site last year up from $87.5 million in 2008. In addition to big sites like Etsy, Ebay, and Craigslist, there are plenty of newcomers, such as Zazzle.com, Artfire.com, and  Cafepress.com that allow people to turn a DIY hobby into a business.

Not surprisingly, the Internal Revenue Service is figuring out ways to get its fair share. If you’re using an online auction site to unload old baby clothes or unwanted furniture for less than what you originally paid, relax, the IRS probably isn’t interested. But it’s a different story if you are handling a large number of online transactions,  and selling items for more than your cost. Depending on the details, the IRS may consider your proceeds to be income and come after you for taxes. Just like anyone who is self-employed, if your business earns more than $400 in annual net profits, you’ll need to play self-employment tax. 
But fiscal planning can be a little trickier for online sellers, because they typically have lower expenses and higher profit margins than traditional retailers. That means should your tea cozies made from vintage quilts suddenly be featured on Etsy’s homepage, you could wind up with an unexpected windfall. The self-employment tax can really trip people up. Last year, that was 15.3 percent of your business income. What you’re doing is paying into Social Security and Medicare for yourself. That can be a big bite from a small revenue stream.
And beginning in 2012, taxpayers who annually sell more than $20,000 worth of goods and have more than 200 transactions on sites like Etsy or Ebay will be required to send the IRS a new form, the 1099 K.  Most online sellers, of course, don’t do that kind of volume, but all small businesses must report their income and expenses to the IRS. Many online sellers don’t realize that many of the fees they pay to Ebay and Paypal are deductible, as are their materials costs and shipping expenses.
The biggest mistake [Etsy sellers make] is not becoming knowledgeable about the tax law before starting their business. Every Etsy seller should have a bookkeeping system that they feel comfortable using the moment they start spending or receiving their first revenues.
Even if you have no intention of growing your online sales business into a Fortune 500 company, it’s still a good idea to keep good financial records just in case Uncle Sam comes calling. Options vary from a basic Excel spreadsheet to full-blown accounting software like Quickbooks.