As an experienced accountant who has worked in public accounting and has run multiple online businesses, including Etsy shops and websites, I have a lot of experience to share with small business owners, especially those in the e-commerce space. In this post, I’m going to outline the important details you need to consider when you launch your online business so that you don’t run into trouble down the road.
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What Does the IRS Consider a Business?
Many people start selling online without considering the financial, legal, or regulatory ramifications. They may think that their business is just a hobby, and therefore the income doesn’t need to be reported, but the IRS actually requires all income to be reported, whether business or hobby income. As soon as you start making money, the IRS wants to know about it. However, it’s important to make a hobby/business determination. To determine if you are operating as a business, the IRS has a list of questions you can ask. We will talk about the most important questions to ask yourself next.
Key Questions to Ask Yourself
As you assess whether your activity is a business, ask yourself 1) whether your activity is carried out in a business-like manner and 2) whether the time and effort put into the activity indicate a plan to make a profit. If your answer to any of these questions is yes, then you are a business. Most people who sell online are in fact a business.
If you determine that you are a business, then it’s important to register your business. In 2023, Etsy and other online selling platforms will be required to issue a 1099-K for shops earning $600 or more. A 1099-K is a tax form that outlines how much money you made on a platform. When they issue a 1099-K to you, they also send a copy to the IRS so that the IRS knows how much money you earned. Even if you don’t receive a 1099 from Etsy, or earn less than $600, you still need to report your income to the IRS. This is why it’s important to go ahead and register as a business when you start making sales–you will be prepared when you receive a 1099-K at year end.
Choosing a Business Formation
The next step in starting your online business is choosing a business formation. There are two main types: sole proprietorship and single-member LLC. A sole proprietorship is where you and the business are one and the same. This structure is the easiest to form and has very little paperwork and low fees.
On the other hand, a single-member LLC is a separate entity from yourself and offers some legal protection, although it varies by state. It’s important to keep in mind that these two business entity types are taxed in exactly the same way by the IRS, so there’s no tax advantage in choosing one over the other.
Registering Your Business with the State
Once you have chosen your business formation, you need to register your business with your state. Since business formation happens at the state level, every state is different in terms of the forms they require, the cost of formation, and the licenses you may need. The most difficult part of business formation is navigating the different requirements of each state, but you can find help from services that specialize in business registration.
There is no advance registration required with the IRS. However, when you file your Schedule C with the IRS at year-end (more on that later) just check the box that says you are a new business.
Understanding Business Taxes and Bookkeeping
As you start your business, one of the things you need to consider is how to manage your taxes and finances. In this post, I’ll cover the basics of business taxes, bookkeeping, and how to keep your finances organized.
Sole proprietorships and LLCs are considered “pass-through” entities, meaning that they do not file a separate tax return. Instead, the sales and profits of the business are combined with your personal tax return and reported on Schedule C, an additional form that gets added to the 1040 (the regular personal tax return you file every year).
Filing Schedule C is relatively straightforward, especially if you have been keeping track of your business finances throughout the year, and if you’re using a tax program like TurboTax, it will simply ask you for specific numbers, calculate the taxes, and then you’re done.
One common question when it comes to business taxes is how to handle estimated taxes. The goal is to avoid owing the IRS more than $1,000 when you file your taxes at the end of the year. A good starting point for estimating your taxes is the self-employment tax of 15.3%, but it’s important to keep in mind that you may owe more than that. Many business owners set aside 25-30% for estimated taxes. The IRS makes it easy to pay your estimated taxes through their website, and you can adjust your payments based on how much you owe or are refunded at the end of the year.
To file your taxes at year-end, you need to know your numbers, and that’s where bookkeeping comes in. Keeping accurate and organized records of your business finances is essential for tax purposes, but it also helps you stay on top of your cash flow and makes running your business easier. My favorite tool for bookkeeping is QuickBooks Online Simple Start. It’s what I use in my business and with my bookkeeping clients.
One of the most important things to do when it comes to your business finances is to open separate accounts for your business. Keeping your business and personal finances separate is not only best practice, but it’s also required by the IRS. There are many options available, including free checking accounts with Relay and credit cards with Capital One.
The goal of bookkeeping is not just to prepare for taxes, but to keep track of your business finances throughout the year. By keeping organized records of your income and expenses, you can make informed decisions about your business to improve profitability.
When you’re first starting, bookkeeping can seem intimidating, but it’s not as bad as it sounds. If you need help getting started, check out my YouTube channel, where I share tutorials that walk you through the process of setting up your bookkeeping. I have videos for Etsy sellers, Shopify sellers, eBay sellers, bloggers, and more.
In addition, I’ve created an easy-to-use Etsy Bookkeeping Made Simple spreadsheet for new Etsy sellers who aren’t ready for a program like QuickBooks Online. If your business has grown and you need help handling your bookkeeping, check out my done-for-you bookkeeping services.
Time To Get To Work
Starting a business is an exciting undertaking that comes with many responsibilities. By making sure you cover all the areas I mentioned in this post, you can minimize stress and ensure that your business stays on the right track. It’s much easier to lay a solid foundation as you get started than to have to go back and fix oversights when the stakes are higher.