While online stores can generate significant sales for businesses, they also have the potential to create major tax liabilities. To avoid surprises at tax time, eCommerce professionals need to understand exactly how their online stores can affect taxes – and conduct their tax planning accordingly.
eCommerce Tax Planning: Possible Tax Implications and How to Plan for Them
As stated, running an eCommerce business can provide an outstanding source of additional income. However, side income has tax implications business owners need to understand. For example, eCommerce sales tend to surge towards the end-of-year due to the holiday shopping seasons. Most small businesses file taxes at the end of the year, so this sales surge can disproportionately affect your tax liability. Your business can avoid fiscal conundrums like these by utilizing proper tax planning strategies.
In the following sections, we’ll outline five surprising ways your online store could affect your taxes. We hope this knowledge will help you avoid unnecessary headaches at tax time. Specifically, we’ll cover the following items:
- Additional Income Taxes
- Self-employment Taxes
- Quarterly Estimated Tax Payments
- Issuing 1099 Forms for Contractors
- Tracking Expenses and Income
1. Additional Income Taxes
For salaried employees, tax planning proves fairly simple. Most of the money they make is W2 income with the necesarry taxes already taken out.
Conversely, online stores and eCommerce professionals often have several sources of income. To make complicate matters further, most of it is untaxed 1099 income. As such, these business owners need make tax planning a priority. Each income stream contributes to their gross income, which subsequently increases your total tax bill.
Your need to combine your online store income with any other income (e.g. W2 wages, investment income, property rents, etc) during the tax planning process. For individual filers, the IRS views this aggregated – or gross – income as the starting point for determining taxable income. Income from all sources is added together, and then deductions and credits reduce that amount to determine exactly how much you need to actually pay in taxes.
eCommerce professionals should take the following steps to account for this additional income:
- Bookkeeping system: Every business should tracking their income and expenses. An organized bookkeeping system is essential for effective management and tax planning.
- Maximize tax credits and deductions: As a business, eCommerce professionals may deduct all of the necessary operating expenses of their online stores. Additionally, they should work with tax professionals to ensure all other business and personal deductions and credits are used to minimize their tax liability.
2. Self-Employment Taxes
Most eCommerce professionals organize their online businesses as sole proprietorships, the most common business form in the United States. For tax purposes, this means that you report your business income on Schedule C. And, the net earnings (income minus deductions) reported on Schedule C are subject to self-employment taxes.
For W2 employees, payroll taxes amount to 7.65% of earnings (up to a ceiling), as the employer pays the other 7.65%. Unfortunately for sole proprietors, they need to pay all of this payroll tax, which leads to this self-employment tax on net earnings at a rate of 15.3% (7.65% x 2).
For tax planning purposes, eCommerce professionals can take the following steps to assist with their self-employment taxes:
- Increase W2 withholdings: If you also receive W2 income, you can request an increase in payroll withholdings to offset your end-of-year self-employment tax payment.
- Know your adjustments: Individual business owners can deduct one half of their self-employment tax liability as an adjustment for AGI, which reduces their overall tax burden.
- Make estimated payments: We’ll address this in the next section, but these estimated payments allow you to spread your tax bill out over the year – rather than facing a surprise bill when you file your annual return.
3. Quarterly Estimated Tax Payments
If you run a profitable online store, you need to pay taxes on your income. Since most of your income is untaxed, you’re responsible for paying the IRS. If you don’t make timely payment, the IRS could fine your for underpayment.
In order to avoid underpayment penalties and a huge tax bill, you need to make quarterly payment based on your estimated tax bill. These down payments go towards your federal income and self-employment taxes. The IRS expects four payments a year, once every quarter. The quarterly estimated tax deadlines are listed in the infographic to the right.
From a tax planning perspective, the IRS understands this concern, and offers the following solution:
- Safe harbor rule: To avoid IRS underpayment penalties, eCommerce professionals should take their prior year’s total tax and divide it by four. By paying 100% of your prior year’s tax bill over the current year’s four quarters, the IRS will not impose an underpayment penalty, as they deem this a “safe harbor” for taxpayers.
4. Issuing 1099 Forms for Contractors
While not an issue for all eCommerce professionals, if your online store uses contractors (a.k.a. freelancers), you may have an additional administrative requirement regarding taxes. Specifically, if you pay any contractor more than $600 over the course of the year, you’ll need to file Form 1099-NEC (formerly 1099-MISC) with the IRS.
While this is an informational form only, meaning business owners don’t need to pay any taxes related to filing 1099-NEC, it is required. Furthermore, payments to contractors qualify as necessary business expenses, and you can deduct them in determining your business’s net earnings. However, if you fail to file a contractor’s 1099-NEC and still try to deduct those payments, you’ll likely trigger an IRS audit, something no business owner wants.
To ease the administrative burden of filing 1099-NECs, eCommerce professionals should keep W9s on file for every contractor they use regularly. The information on these forms will help you in completing 1099-NECs.
5. Tracking Expenses and Income
At the end of the day, effective tax planning hinges on accurately tracking your eCommerce business’s income and expenses. A failure to accurately track this info leads to one of the following two negative outcomes:
- Outcome 1: You over-report net earnings (either due to over-reporting income or under-reporting expenses). This means you unnecessarily pay the IRS more taxes than you need to pay, something no business wants to do.
- Outcome 2: You under-report net earnings (either due to under-reporting income or over-reporting expenses). This means that you have paid the IRS less than you actually owe. If done intentionally, this constitutes tax evasion and can lead to civil and criminal penalties. More frequently, eCommerce professionals underpay taxes due to an honest mistake, but this can still lead to A) an IRS audit, and B) underpayment penalties.
To avoid these mistakes, you need a solid accounting system that accurately tracks income and expenses. Implementing such a system often seems like an overwhelming challenge to new business owners, but it’s must-have. Failing to do so can have severe consequences on your business.
Fortunately, programs like Wave Apps offer eCommerce professionals free bookkeeping software that makes tracking business income and expenses far easier. Of note, though, due to specific IRS rules on when and how online stores can deduct the costs of inventory, make sure to have a tax professional review your inventory tracking system in whatever software you choose.
Professional Tax Planning from the eCommerce Experts
As you can see, eCommerce income can have major tax implications. But tax planning doesn’t have to be a hassle for up-and-coming eCommerce business. At Tax Hack, we specialize in making your tax life easier, so you can focus on business. Contact us now to set up a tax planning strategy session with one of our Tax Hack pros!
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