Ah, spring. It’s the time when flowers bloom, snow fades and Mother Nature comes alive again. It’s also the time when Uncle Sam becomes a very vivid image in our minds as the annual income-tax deadline looms.
You may find yourself in full tax mode right now, hunting down receipts, tallying expenses, totaling sales, and basically doing what you can to let Uncle Sam know how you did in 2011. This year, you may also find yourself dealing with the IRS’ new 1099K form, which payment processors mailed out to sellers who reached certain sales minimums.
We know it can seem overwhelming. To help, we talked to two experts to get their insights and break down just what you need to know as you file your taxes, because April 17—the last day to file without an extension—is just around the corner.
Basics of small-business tax reportingYou are required to report your gross income when you pay income taxes, but you pay tax only on your net income
If you’re a newer seller, you may be wondering exactly what you need to report on your tax return. Steven Aldrich, CEO of Outright.com, a bookkeeping tool for small businesses, says you always need to report your sales. “There is no minimum threshold,” he notes.
So, if you didn’t find a 1099K in your mailbox, that doesn’t mean you’re off the hook.
Cliff Ennico, author of “The eBay Sellers’ Tax and Legal Answers Book,” explains that online sellers are required to pay two types of taxes based on their sales: income taxes (federal and sometimes state) and sales taxes in most states.
“You are required to report all of your gross income when you pay income taxes, but you pay tax only on your net income—gross income minus certain deductions and credits,” he notes. “If your state has a sales tax, you are required to report your gross sales, but you pay sales tax only on your in-state sales (sales to residents of the same state you are in).”
Sorting out the 1099K
Now let’s talk 1099K forms. This is the first year sellers on eBay, Etsy, Amazon and other online venues received these forms. They are an attempt to close the “tax gap,” which Outright’s Aldrich defines as the difference between what taxpayers report on their taxes and the total they should report.
Credit card and payment processors like Amazon and PayPal began sending out these forms in January to sellers who had $20,000 or more processed through their payment processing services and at least 200 online transactions. If you listed on multiple platforms during 2011 and met those requirements, or used various payment processors, you may have received more than one of these forms, Aldrich continues.
“We’ve been in the thick of the 1099K discussions,” he says. “We’ve told our customers not to panic. All you need to do is run your business the way you have been. You want to be profitable. You want to pay taxes. You just don’t want to pay more than you have to.”
1099K forms show you how much third parties processed for you during 2011. Payment processors send out two copies of each of these forms. One goes to sellers who qualify. The other goes to the IRS—and yes, the federal tax agency will compare what you report in your tax return to what’s reported on the 1099K it receives.
This new form has caused some worry among online sellers, Aldrich says, because the total noted on the 1099K form may not match merchants’ sales totals. You see, these forms reflect the gross dollar amount processed. They do not take into account fees or expenses sellers may have had during the year.
You want to be profitable. You want to pay taxes. You just don’t want to pay more than you have to
“The concern [sellers] had was, ‘Is someone going to come knocking on my door and ask me to verify the total I have?’” he says. “Then the IRS came out with a statement and said, ‘We won’t expect you to validate that number. We just want a fair number.’”
If you receive a 1099K form, you’ll want to enter zero on line 1-A of your tax return. Below that, on line 1-B, you’ll enter the amount you have on record as your annual sales. Remember, this total may be different form the total on the 1099K form, and that’s OK. Just make sure you have the documentation to verify your deductions.
Reducing your tax liability
Deductions are a great way to minimize the amount you have to pay the IRS, but again, you should have the receipts to back them up. If you’re unsure what you can deduct, read on for a few tips, just keep in mind that this is not a comprehensive list. There may be more deductions you can enlist than what we’ve noted.
We encourage you to consult a tax professional to make sure you find all of the deductions that apply to you, and to make sure you don’t accidently deduct something you shouldn’t.
Supplies: You couldn’t do business without supplies, so it only makes sense that you’re able to deduct these. The word “supplies” is very broad—and it can be even broader if you make the items you sell. For instance, any online seller can claim the cost of packing peanuts, envelopes, boxes, tape and postage as a deduction. But if you also make the goods you offer—let’s say if you’re a dressmaker or a jewelry maker—you can claim the amount you spend on cloth or beads as a write-off. You can even write off the cost of the pins you used to hold your garment in place as you stitched it together.
If you’re a painter, you can write off the paints you used in 2011 and the canvases you painted on. If you’re a card maker, you can write off the paper, glitter and ink you used, and so on.
Mileage: Mileage is another expense you can put down as a deduction. We know the trips to the post office to drop off shipments, or to the store to pick up inventory may seem short but, after 12 months, they add up, Aldrich reminds us. So keep track of how much you drive for your business and what you spend on gas.
“It’s a good deduction,” he says, “Just make sure you have the documentation to back it up.”
If you forgot to do that during 2011, don’t worry. You can start keeping track of your receipts now for next year’s tax season.
Operating costs: Don’t forget to note any listing fees—including upgrade charges—as well as final value, payment processing, shipping insurance and image hosting fees. After hundreds, or thousands of listings, a few dollars here and a few more there can really add up. Be sure to also note subscription fees you pay to third parties to list or save your items.Set aside one hour a month to organize invoices, sales receipts and other documentation
Advertising costs: You can also write off what you spent advertising your business. This includes a variety of things, from advertising on Google AdWords, to what you spent on new business cards, to a new logo design. You can also deduct expenses if, let’s say, you paid someone to write content for you, Aldrich adds.
Tax preparation costs: And don’t forget to note what you spend on a CPA, tax-prep service or tax-prep software package. You can even note the cost of bookkeeping software like Outright.
Filing for an extension
Now, if you’re feeling overwhelmed, and you need more time to get everything in order, you can file for an extension. This will give you until Oct. 15 to file your taxes, Outright notes in its Commerce Tax Guide. However, you should still get an estimate of what, if anything, you’ll owe the IRS when you do file taxes in October, Aldrich continues.
That’s because payments are still due in April, whether you file then or not. If you wait until October to pay what you owe Uncle Sam, you’ll have to pay interest, too. According to the IRS, the interest rate is the federal short-term rate (currently 0.19 percent) plus 3 percent.
We’ll leave you with a little advice from our experts. Aldrich suggests that as you go through the tax process this year, make notes to remind yourself next year of what worked and what didn’t when you did your taxes.
“Taxes come every year. It’s going to happen again in 12 months, so think about what will make your experience the best possible,” he says.
Ennico says giving yourself plenty of time is the key to a good tax experience. And staying organized throughout the year will help reduce your stress level when that time comes around again.
“Don’t wait until next January to start pulling together all of your business records,” he advises. “Create a file folder with manila folders for each deduction expense you claim on your tax return. Then set aside one hour a month to ‘feed’ each folder with invoices, sales receipts and other documentation for that deductible expense. That way your books will be up to date by December.”