In February of 2008, just as the recession deepened, Rob Kalin, the founder and CEO of Etsy.com, the Brooklyn-based online market place for handmade goods, showed the audience of the Martha Stewart Show some of the big sellers on this site. Among them: a “sock money soap popsicle” and knitted pussy willows. "Anyone here — if you're in school or out of school, at any age — you can start a business from home," he told the audience.
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Lots of people have done just that. Etsy says more than $314 million dollars in goods were sold on the site in 2010 up from $87.5 million in 2008. In addition to big sites like Etsy, eBay, and Craigslist, there are plenty of newcomers, such as Zazzle.com, Artfire.com, and Cafepress.com that allow people to turn a DIY hobby into a business.
Not surprisingly, the Internal Revenue Service is figuring out ways to get its fair share. If you’re using an online auction site to unload old baby clothes or unwanted furniture for less than what you originally paid, relax, the IRS probably isn’t interested. But it’s a different story if you are handling a large number of online transactions, and selling items for more than your cost. Depending on the details, the IRS may consider your proceeds to be income and come after you for taxes. Just like anyone who is self-employed, if your business earns more than $400 in annual net profits, you’ll need to play self-employment tax.
But fiscal planning can be a little trickier for online sellers, because they typically have lower expenses and higher profit margins than traditional retailers. That means should your tea cozies made from vintage quilts suddenly be featured on Etsy’s homepage, you could wind up with an unexpected windfall. “The self-employment tax can really trip people up,” says Bob Meighan, a certified public accountant and vice president of TurboTax. Last year, that was 13.3 percent of your business income – but down from 15.3 percent in 2010. “What you’re doing is paying into Social Security and Medicare for yourself,” he adds. That can be a big bite from a small revenue stream.
And beginning this year, companies that process payments are required to send 1099-K statements to taxpayers who annually sell more than $20,000 worth of goods and have more than 200 transactions on sites such as Etsy or eBay. Most online sellers, of course, don’t do that kind of volume, but all small businesses must report their income and expenses to the IRS. Many online sellers don’t realize that many of the fees they pay to Ebay and Paypal are deductible, as are their materials costs and shipping expenses.
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“The biggest mistake [Etsy sellers make] is not becoming knowledgeable about the tax law before starting their business,” according to JJMFinance, an Etsy store that provides tax services to other Etsy sellers. “Every Etsy seller should have a bookkeeping system that they feel comfortable using the moment they start spending or receiving their first revenues.”
Even if you have no intention of growing your online sales business into a Fortune 500 company, it’s still a good idea to keep good financial records just in case Uncle Sam comes calling. Options vary from a basic Excel spreadsheet to full-blown accounting software like Quickbooks. Most tax prep software, such as TurboTax or TaxAct, also can help you determine what is and isn’t a business expense.
Here’s an even cheaper option. Consider these free iPhone and iPad apps to make your bookkeeping — and next year’s taxes — a little easier. All are available at the Apple store.
This mobile app allows you to track payments from your customers, send and pay invoices and is great for keeping an eye on shipping expenses and sales patterns.
2. Expense Tracker
Expense Tracker makes it easy to digitally add and categorize receipts using your phone, helping you keep business and personal expenses separate. Should you ever want to incorporate, file a small business return or even just answer an inquiry from your accountant, you’ll have the numbers at your fingertips.
3. Quickbooks ConnectTracker
If you’re already using Intuit’s Quickbooks 2011 to keep your records, including payroll and accounts payable, Connect will sync all that information with your phone. Ebay sellers can manage their customer database and inventories, send invoices and generate receipts from their iPhones.
4. United States Post Office
Nothing wrecks a small business on Etsy and Ebay faster than slow shipping. With this app, not only can you track delivery also look up zip codes, find post-offices and calculate postage.
A no-brainer if you sell goods on Ebay. Post items, keep track of auctions and get current sales updates. The barcode scanner allows you to check your pricing against competitors. You can even share the news of your auctions on Facebook and Twitter.
A version of this story originally ran on April 12, 2011.
CORRECTION March 20, 2012: This piece incorrectly stated that taxpayers must file the 1099-K form, but it's companies like PayPal that are required to send the 1099-K statements to taxpayers.