Annual income tax is (as the name implies) due on a yearly basis and is basically a tax on the income you have made in the past calendar year.
Any sales of products and services in the year need to be declared as “self-employment income”. You will ultimately owe taxes on the net profit of your business. This is the total amount you have made, minus all allowable business expenses.
Your Annual Income Tax needs to be calculated from the previous calendar year and is due in mid April (the exact date varies from year to year depending on weekends and holidays).
How to calculate
If you have a “pass-through” business structure, you’ll be filing your business’ tax return alongside your own personal one as an additional Schedule on Form 1040.
As a business that manufactures handmade products, you most likely will have significant material inventory. You’ll thus be needing to filing a “Schedule C” - otherwise known as its full title: Form 1040 Schedule C: Profit or Loss From Business (Sole Proprietorship)
This form allows you to report your revenue, expenses and cost of goods sold (COGS). If you haven’t filled out a Schedule C before, it can understandably look quite daunting. The IRS provides 18 pages of accompanying documentation which can be really helpful for the finer technical details, however for a much simpler breakdown see our blog post: Tips on completing a Schedule C for your small business.
The form comprises of 5 sections which we will briefly cover to get a feel for things:
Part I: This section is for your total sale revenue, your cost of goods sold and your gross profit.
Part II: This part allows you to claim expense deductions against set categories. An important note is that these expenses are your indirect ones (i.e. not related to the cost of production)
Part III: This section asks for your value of total raw material inventory at start and end of year to derive your Cost of Goods Sold. In order to obtain these numbers, you’ll need to be tracking your inventory using either a perpetual system (like Craftybase) or a periodic system (like Excel) and then entering the numbers here that your system generates.
Part IV: This is the area in which you can detail vehicle related information that will be used to calculate any allowable deductions.
Part V: This section is for any expenses that do not fall into the above three sections.
How to file
The Schedule C form can be filed online using software like TurboTax or eFile. Read more about options for filing your returns online for free.
IMPORTANT: It is strongly recommended to engage the services of an accountant to assist in lodging your business tax returns - especially if this is your first year of operation. Keep in mind that accountancy fees and software can be fully deducted as a business expense.
If you don’t file by the April deadline, you can incur “failure to file” penalties of 5% of the balance owed per month that it remains unpaid. This rises up to a maximum fine of 25% of the balance.
This penalty can be waived at the discretion of the IRS, however remember you have the burden of proof to establish why you missed the deadline. If you file on time but don’t pay the full amount owed, this can result in a penalty of 0.5% of the unpaid balance per month.
Please note that tax laws change frequently. This information is for educational and informational purposes only should not be construed as tax or legal advice. Please consult a licensed financial expert in your area with specific questions or concerns.