An Etsy 101 Series wouldn’t be complete without covering Etsy taxes and accounting. It’s an important business task to get right, but not everyone’s favorite topic for sure. Relax though, we’re not going too deep on these. After all, this is a crash course, and it’s just not feasible to cover the laws and idiosyncrasies of every state. Ready to crunch some numbers? Let’s dive in!
Before we begin
This article is a part of an Etsy 101 series specifically for new sellers on Etsy! If you just stumbled across this article and you’re unsure where to begin, we recommend you check out the first of the series, Everything You Need to Know Before You Start an Etsy Shop.
At Marmalead, we strive to offer real, practical advice for Etsy sellers right here on our blog and on our YouTube channel. The world of Etsy is constantly evolving, so if you have a question you can’t find an answer to, reach out to us at firstname.lastname@example.org.
Now back to Etsy taxe & accounting
While you’re cruising through all this information, realize a lot of the work is in the initial setup. Things like filing for incorporation and Employer Identification Number (EIN) are a one-time task.
Before we dive into the details, it’s crucial to understand, this is not tax or legal advice. The purpose of this article is to help paint a picture of what’s involved from the taxes and accounting side so you can navigate it better. Ultimately, you should take any specific questions to a trustworthy and knowledgeable professional. In general, professionals can be more effective at helping when you go to them with a base level of understanding. A benefit of this understanding is that you’ll be able to ask better questions! Millions of creative business owners just like you navigate these topics, so we’re confident you can too!
Since you’re learning about Etsy taxes, we assume you want to make an income
The first thing to discuss is your intent. We’re going to assume your intent is to make an income, making you a business for tax purposes. Although, there’s another designation where the IRS considers your endeavor to be a hobby. The “hobby loss” rule applies if you don’t make a profit for 3 out of 5 consecutive years. And if that happens, you can’t deduct your business losses anymore. Basically, the IRS wants to make sure you’re not pretending your hobby is a business just so you can deduct the losses from your other income.
Protect your identity, or nah?
Should you use your Social Security Number (SSN) for your business? You can, in most cases, if you want to. Many people choose to apply for an EIN, which is a social security number for a business. One of the reasons is preventing identity theft. If a business needs to send you 1099, for example, they’ll need either your SSN or EIN for that form. Your EIN is unlikely to be useful if the number somehow gets out. And your SSN is tied to your personal credit.
Which business entity are you?
The type of business entity for your shop is important and somewhat nuanced. The basic choices are sole proprietor which is just you, the individual, without a separate corporation or a Limited Liability Corporation (LLC).
An LLC is a popular choice because it creates a separation of liability between you and your business. It’s also simple to manage from a tax, accounting, and ongoing compliance perspective. They’re a pass-through entity, meaning your profit/loss from the business is taxed at your personal tax rate. Beyond this, you have C-Corporations and S-Corporations. If you’re looking at those, you’re getting more advanced 😬
Keep it on the books
While setting up your accounting, you may also see a question about being Cash or Accrual based. This is about your bookkeeping. Cash basis is most common for small businesses. While accrual is something you’ll see big corporations use. You need to know that cash basis records transactions as income and expenses when it’s received and spent, just like paper cash. Accrual is recorded as it’s earned or owed, like when invoicing.
What do I owe you?
Getting into the tax aspect, there are multiple levels to be aware of. As a matter of tax efficiency and overall planning, it helps to understand “what’s what” upfront. Federal, State (Income and Sales), and City. All of these may not apply to you since it depends on your state. Nevada, for instance, doesn’t have State and City income tax, so if you live there, you would only consider Federal Income and State Sales tax.
Federal Income Tax & Etsy Taxes
Federal Income Tax from your business will likely go on a Schedule C form with your personal taxes (Form 1040). That comes back to being a pass-through entity that you read about earlier. Tax-rate wise, your business income gets added to any other income, such as wage income (W2). Then taxes that are due follow the tax brackets to determine the amount owed.
Misunderstandings in Etsy taxes
Since this article is a simple introduction to these terms, let’s look at a commonly misunderstood component for tax calculation and the brackets. For example, being in the 22% bracket doesn’t mean you’re taxed at 22% from $1 all the way up to $85,525 (which is the 2020 upper level for single filers). The first $1 to $9,875 is actually taxed at 10%, then it moves to the next bracket of 12% for $9,876 to $40,125. Then the next dollar is taxed at 22%. In other words, earning that extra dollar to be in the next bracket doesn’t mean your entire income is taxed at the higher bracket.
Self-employment tax & Etsy taxes
Another type of Federal Tax is self-employment tax. When you work a W2 job, your employer pays half of this tax, and you pay the other half through a payroll deduction. When you’re self-employed, you pay both the employee and business side (although you’re not considered an employee). This comes to 15.3%. Its purpose is to fund Social Security and Medicare. It will go on your 1040 Schedule SE.
I have to remember all this?
It’s worth noting that everything we’ve talked about tax filing wise is covered in TurboTax. If you’ve used TurboTax for personal filing, it’s the same experience. You’ll just need to answer additional questions when you file since they didn’t apply to you previously.
Okay, when should I pay my Etsy taxes?
When you’re self-employed and not on a payroll, you’re not having earnings withheld from your paycheck for taxes either. The IRS, however, still wants to be paid more than once a year. You’ll likely need to make quarterly estimated payments due on 4/15, 6/15, 9/15, and 1/15. Basically, this is your expected tax bill for the year divided by four.
What if my business is steadily growing, and I don’t know how much I’ll owe? This is more common than not. To avoid a penalty for underpaying, there’s a solution. Pay at least 90% of the tax for the current year. This doesn’t really help if the business is growing and you don’t know what 90% will be. Or 100% of the tax shown on the return for the prior year, whichever is smaller. In other words, if your total tax bill for last year was $5,000, paying $5,000 in estimated payments will avoid a penalty even if your bill this year is much higher. You’ll still have to pay the difference, of course. And anything you overpay gets refunded.
Here’s to the state
If you live in one of the 42 states with an income tax, you’re already filing a return with them. Just like the Federal Return, your business income/loss will be added to the return. This is where the pass-through entity helps simplify things. If you chose a different type, you’d have to do a separate Federal and State return just for the business, and then the papers really pile up.
But what about state sales tax?
The laws around Sales Tax are always changing. And in recent years, the popularity of ecommerce has made states more ambitious about collecting it. It used to be you just had to collect Sales Tax in the State/County where you had something called nexus (for our definition, that means you have business operations there, employees or a warehouse, for example). For most of us though, that will be just our home state.
You’ll also want to check the laws in your state to see whether or not what you’re selling requires you to collect Sales Tax. If so, you’ll need to register to collect and remit Sales Tax. It’s a monthly thing. However, lower volumes are often able to pay quarterly. Some states also have thresholds where you don’t have to register and collect Sales Tax until you reach a certain sales dollar figure.
But wait, there’s more! In most states, Etsy as a marketplace is now collecting Sales Tax based on where the buyer is located without you doing anything at all. For these sales that take place in your home state, you don’t have to report these sales, only say they were made through Etsy.
Combining those two pieces of information, it’s worth looking at your specific State’s laws to see if selling exclusively on Etsy where they’re collecting Sales Tax requires you to do anything at all.
Their slice of the pie
By now, you’re catching the theme that every level of government wants a piece of your income. Your County is different because they’re likely getting their revenue from your property taxes, not income taxes. So that brings us to City taxes. This can be straightforward where the form just asks for numbers straight off your 1040. However, if you live in one city and your business is based in another, both cities want a return and you’ll need to calculate what’s owed to each. Often the city you live in will give you some level of credit for the taxes you’re paying to the other city.
So now we know how to pay our Etsy taxes, let’s look at accounting
Accounting for your business means keeping a record of what happened financially over the course of the year. This is called bookkeeping. A popular solution is Quickbooks, and Etsy even has a partnership with them. You enter an expense (supplies that you purchased, for example), and it stores that information in the proper accounting format. It will also generate financial reports like balance sheets and income statements. And both of these are important for understanding the health of your business.
System and Routine
The biggest favor you can do for yourself with accounting is to have a system and a routine. It’s so much easier to do your bookkeeping when you can still remember the details. That’s the ideal time to record the details, so you no longer need to remember them! The beginning of the following month is a good time to knock out a month of bookkeeping. I recommend putting it on your calendar or make it a recurring To-Do List item.
Bookkeeping doesn’t need to be tedious. It’s just putting transactions into general categories like expenses for supplies, marketing, or equipment (e.g., camera). An easy way to start is to take all your receipts from the prior month and start entering them. Then match all those transactions to your bank and credit card statements. Mark them off as you go because when you have extra transactions on your statements, you’ll want to add those too.
Where’s that receipt?
Ideally, you hold onto receipts if you ever need to look back and show proof of the transaction. Don’t stress about keeping receipts for small transactions. Even during an audit, the IRS receipt requirements are $75 or more. For the receipts you do keep, they say to hold onto them for three years. If you buy many of your supplies online, just put the email receipt in a folder where you can search it out if you ever need it. For paper receipts, grab a shoebox and load it up. Mark it by year so you know when you can throw them out.
Business expenses to claim on your Etsy taxes
Just like keeping your house going, there are a lot of expenses to running a business. You should account for every expense to have the most accurate picture of how your business is doing.
- Buying stamps? Postage expense.
- Use a phone? Phone expense.
- Bought a course to learn something business-related? Education expense.
- Use Marmalead? Software expense.
Quickbooks will have standard account names and you’ll just need to choose the most fitting one for your transactions.
The Income Statement is the most important report you can generate for your business. It tells you what money is coming in, where it’s going out, and how much you’re keeping as profit. Sometimes little expenses like frequent supply purchases add up to more than you’d expect. The Income Statement is a useful place to see that.
The Income Statement looks something like this:
Sales Revenue $100,000
Cost of Goods Sold (COGS) $40,000
Gross Profit $60,000
Equipment Expense $2,000
Total Expenses $8,000
NET INCOME $52,000
Wrapping up Etsy taxes
See, that wasn’t so bad, was it? Wrapping your head around Etsy taxes and accounting isn’t as hard as you think, but it does take a little research. The good news is, there are many free or relatively inexpensive programs out there that you can use to help you keep track of everything throughout the year. And again, don’t be afraid to consult with a professional on this subject. It could very well save you time and headaches in the future.
Interested in more things you should know before you start an Etsy shop? Do you know what similar product listings sell for on Etsy, or are you flying blind? Not only is it important to know the price of your competition, here’s how to price your products to beat them.
To read through the next article in this series, check back next week!