Business Entity and Taxation
Some marketers are under the impression that accepting payment through an online payment processor shields the income from mandatory reporting, which is not the case. Expect to pay taxes on your earned income, but understand that the applicable tax rate is influenced by your business entity. If you are a sole proprietorship, your business profit is taxed at individual income tax rates, and you will attach IRS Schedule C to your Form 1040. If you are registered as a C or an S-corporation, business profits are based on corporate rates, which are generally lower than individual rates. More deductions accrue to corporations that use Form 1120 to file their corporate tax returns.
Types of Taxes
No matter your home state, if you earn income of at least $400 during the tax year, you will have to file tax returns. For tax purposes, payments and sales receipts paid through PayPal and similar platforms are reported in the same way as all other income.
Federal Income Taxes
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Federal taxes are based on your total earnings for the tax year. Based on Internal Revenue Service guidelines, income taxes are pay-as-you-go, indicating that taxes are paid as income is earned, necessitating the collection of withholding taxes, which cover income, Social Security, and Medicare taxes. For online marketers, consider setting aside about 30 percent of your earned income to cover taxes.
Unless you live or operate in one of seven states that do not collect state income tax, you will have to pay state taxes. Furthermore, online marketers must collect and remit sales tax depending on meeting the nexus requirement, which means having sufficient physical presence in the state. If you operate out of Los Angeles, you collect sales tax from customers in Los Angeles. Tax nexus is defined by the revenue agency of each state, so make sure to clarify this issue with a tax professional.
Tax Documentation and Filing
Establish a system of tracking your inventory, costs and sales. Taxable income is net of sale price and cost of goods. Additionally, total customer refunds are netted out of total sales to find taxable income. Online marketers may find it convenient to use an app or a financial software, such as QuickBooks, Peachtree or the web-based Xero software, to track these numbers. Be aware of filing deadlines for different tax types especially because revenue agencies may require monthly or quarterly sales tax returns.
Impact of Section 6050W
IRS Code Section 6050W requires that payment processors report online marketers that have met both of these requirements:
– gross payment volume from sales of goods or services of $20,000 in one year
– 200 transactions for payment of goods or services sold in the same year
You will receive Form 1099-K from all of the payment processors you used if you meet both of the criteria. The IRS will have a copy, which means they will have the gross figures that include reimbursements, discounts and fees. If you are tracking these figures, your taxable income should be lower than reported. In comparison, Canadian tax laws simplify the process by collecting goods and services tax or harmonized sales tax from all online customers based in Canada – they also offer disability tax credit for any handicapped business owners or marketers.
Tax preparation is a complicated process, but having a tax professional you can turn to for advice ensures business tax compliance and a streamlined record-keeping process. Let me know if you think I missed anything in the comments!