By Cliff Ennico
“I started an online retail business earlier this year, and have generated so much income already that I know I’m going to get a Form 1099 from PayPal this year.
When do I need to sign my business up for federal and state taxes? I know I have to do this eventually but would prefer to hold off forming a limited liability company (LLC) until after January 1. What is the proper order in which this should be done?
Also, I’m planning to do this business with my spouse. Do I have to sign up as a partnership and file Form 1065 with the IRS each year?”
When you start a business and don’t form an LLC, corporation or other legal entity, you are what is called a “sole proprietorship”. The good news is that you started your business this year rather than last year, so you are (so far) not delinquent with any tax filings. You have time to set up your business the right way.
There are two types of taxes an online retailer has to keep track of: income taxes and sales taxes. You pay income taxes to the IRS and to your state tax authority (if your state has an income tax – some don’t). You pay sales taxes to your state tax authority only – as of now there is no federal sales tax.
Let’s take income taxes first. Even if you make only One Dollar of profit with your online selling activities, you are required to report your income from those activities to the IRS and pay income tax on that income at your individual tax rate. Most people do this by filing Schedule C as part of their individual federal income tax return (Form 1040), but you are not required to do that. You can choose instead to treat your online selling as a “hobby” and report your income as “hobby income” on line 21 of your Form 1040.
I strongly prefer that my online selling clients use Schedule C to report their income. That way, you can take all kinds of business related deductions to reduce your taxable income. If you have a day job and you incur a loss from your online selling, the loss can be used to offset income from your day job. Those are wonderful tax benefits you don’t get when you report your income form online selling as “hobby income”.
Your first Schedule C is due with your Form 1040 next April 15, and you can extend the filing date by up to six months. If you owe the IRS money, however, you have the pay the amount due by April 15 even if you request the six-month extension.
If you have more than $1,000 in tax liability for the current year (and it sounds as if you might – PayPal sends you Form 1099 only if you grossed more than $20,000 from more than 200 transactions), you are supposed to estimate and pay your federal and state income taxes in four (4) installments on April 15, June 15, September 15 and January 15. Since I am writing this column in November, you should make at least a partial payment of this year’s on January 15 to avoid interest, penalties and other charges you might incur if you wait until April 15 to pay the whole amount.
Because the sole owners of the business are you and your spouse, you probably will not need to file Form 1065 (the partnership information return) this year. If you plan to add new owners or investors down the road, however, you will need to start filing Form 1065 once they are on board, and it will be easier for you to do that if you start filing now.
Also consider whether or not your spouse should be a partner in your business – if he or she is not rolling up their sleeves and slogging through the trenches with you every day, there is no tax or other advantage to making him or her your business partner. You might actually be better off as the sole business owner, as that way (1) you can transfer assets into your spouse’s name to protect them from lawsuits and (2) you may – depending on your state law – come out ahead if you and your spouse get divorced. Give that some thought.
Now for sales taxes. You should have registered with your state tax authority to pay sales tax when you started this business, and you should definitely do so now. Keep in mind that you pay sales tax only on “in-state sales” (sales to people who live in the same state you do). Total your in-state sales to date and, if the amount of tax is relatively small (it probably will be), pay it as a lump sum when your next sales tax return is due, most likely at the end of the current calendar quarter.
Cliff Ennico (email@example.com) is a syndicated columnist, author and host of the PBS television series ‘Money Hunt’. This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com. COPYRIGHT 2015 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE, INC. @.