Don’t Forget the Taxes!: Tax Notes for Etsy Shop or Small Business

While we’re working on getting our days and nights figured out, I’ve got another great guest post for you!  Today’s wisdom comes from Mark, the Bare Budget Guy!

Just recently I was scanning my bank activity (one of my favorite go-to activities when I am procrastinating something), and I came across a $7.00 Etsy charge.

“Why the heck am I being charged by Etsy?” I wondered. I’ve heard about it here and there for years, but I never expected that it would make its way into my life in the form of an expense on my bank statement! My wife told me she had indeed ordered some teaching aids.

That led me to finally go and see what it was all about. I was aware of the basic Etsy premise, but as I explored the site for a few minutes, I quickly realized the money-making potential it had for us “normal” people—people who several years ago never would have considered having a small business.

In fact, I went back and read Stephanie’s Earning on Etsy Series and became a full-blown believer. By following a few simple steps and with some effort, you can make money. If you are reading this post, I think I can safely assume that a few hundred extra bucks a month is not chump change to you either.

Just Start!

Have you been considering starting a business, even if it’s something small on the side? If not, start considering it! There are plenty of opportunities out there. I was just recently thinking of all the people close to me who do something on the side and was surprised at how common it seems to be these days.

• Wife: private violin studio
• Wife’s brother: freelance graphic design
• Brother’s wife: freelance graphic design
• Wife’s close friend: Etsy store
• Personal friend: Sells a custom scripture outlining system

This is just a small sample, and there is more potential here than you may realize. The income from these businesses ranges from a couple thousand a year to more than $30K.

Something to remember when you start making money

As you start making some money on the side, you will eventually have to face the tax implications of having a small business.  Some people who are new to this learn some lessons the hard way. I know I did.

One summer during college I did door to door sales as an independent contractor (which for tax purposes, is essentially the same as having a small business). When tax time came, I was surprised to find that I owed a several-hundred-dollar penalty to our friends at the IRS because I had not made estimated tax payments. How was I supposed to know I had to make estimated payments!? This happens to hundreds of thousands of people every year.

Recently, I had to break the bad news to a new tax client that she owed $20K (including penalties) after not having paid any taxes during the first full year of her self-employment. Don’t put your CPA in that position. You’ll make him or her feel like a jerk!

The infamous estimated payment

Estimated tax is the method used to pay tax on income that is not subject to withholding, whether it is from your business, rental income, gains from the sale of assets, prizes, or awards.

The IRS has a fairly simple explanation here detailing who needs to pay, how to pay, deadlines, etc. Half the battle is just being aware that you may have to make payments yourself since you don’t have an employer withholding taxes for you throughout the year.

If you or your spouse is also employed elsewhere, there is a way to avoid estimated payments. For example, rather than going to the trouble of making estimated payments for my wife’s violin studio, we just have my employer withhold a little more from my paycheck. That way we are both covered, and we don’t have to put in any extra effort.

It’s not all bad! The beloved deduction

Yes, you may be more aware of the IRS in your life, but the advantages of having a small business far outweigh any drawbacks in my view. You may be eligible for a host of deductions that were not previously available to you such as the home office deduction, meals and entertainment, travel, interest, subscriptions, etc. Ever since my wife started teaching violin a few years ago, I find myself frequently asking her if her purchases are for her studio or it they’re personal.

Generally, you cannot deduct personal, living, or family expenses to offset your business income. However, if you have an expense for something that is used partly for business and partly for personal purposes, divide the total cost between the business and personal parts. You can deduct the business part.

There is a room on the main floor of our house that is designated as “the teaching room.” We purchased a large rug for the room to create a better teaching atmosphere (i.e. to keep the violins from breaking when the 5-year-olds drop them on the floor during group class). Yes, it makes our house look better, but it’s not something we would have purchased were it not for the business. This is something I am completely comfortable deducting as a business expense.

It’s not always clear cut, and there are definitely people who take more aggressive tax positions with regard to their deductions. Just be aware of the purchases you make every day, and ask yourself if you could legitimately deduct any portion of it in your business. If you buy a new computer that you use 50% for family use and 50% for business, don’t forget to take advantage of that fact.

What about babysitting?

Can you deduct it? Finding childcare has been the main struggle for my wife in running her violin studio. It took about a year to find the best situation with a sitter coming to watch the kids during her teaching hours, and it’s by far the largest expense she incurs. Good thing she can write it off as a deduction, right? Wrong.

Unfortunately, babysitting or child care would not be considered an “ordinary and necessary” expense for running most businesses. But even though you can’t use child care expenses to directly offset your business income, you can likely take advantage of the child care tax credit on your personal return, which enables you to claim up to 35% of your annual child care costs.

Track your business income separately

This all presupposes that you are actually tracking your business financial activity. We have a separate bank account for my wife’s violin studio, so it’s easy to organize her income and expenses. I don’t have a separate account for my own side endeavors at this point. I just use mint.com and tag the transactions that are specific to my business, which enables me to easily isolate them.

In summary

• Think about what small business might make sense for you
• Track your business income
• Track your business expenses (and potential expenses)
• Don’t put off taxes until the end

Good luck with your business!

Mark is a proud husband, dad to 3 energetic little ones, CPA, and the man behind BareBudgetGuy.com where he discusses family, finance, and encourages others to bare their budgets. He enjoys reading random tax literature at odd hours of the night, roughhousing with his kids, eating chocolate chip cookies & watching movies with his wife, and of course, all things related to personal finance.