Do I Have To Charge Sales Tax on Handmade Items?

If you are an Etsy seller, you may be wondering if you should be charging sales tax on your handmade items. While the answer may seem simple, it can be quite complex depending on your location and the location of your customers.

In this blog post, we’ll delve into the basics of sales tax on handmade items and provide you with helpful tips to ensure you are compliant with the law.

State Taxes for Handmade Sellers

As a business, you will need to collect sales tax whenever you make a sale to a customer who resides in a state where you have a “physical presence”.

This physical presence is what is commonly referred to as a Nexus. This will most likely be the state you reside in for most craft entrepreneurs that work from home. If however you own warehouses, attend craft fairs across state borders or hire employees in other states, you may have more than one Nexus to collect taxes for.

For example, if you live in Florida, your Nexus is Florida and you’ll be required to collect sales tax from your customers based in Florida.

As another example, say you live in South Carolina and you store your goods in a warehouse just over the border in North Carolina. Then you hire your brother in Virginia to work for you. It may be that you will have nexus in all three of those states.

Once you have determined your nexus, you’ll want to read up on the sales tax requirements for this state. You’ll also need to ensure that you have registered to charge sales tax - it is unlawful to collect sales tax without first registering for a permit. Be sure not to skip this step.

Tip: Etsy provides useful instructions that will lead you through the process of determining nexus and creating your sales tax settings for your listings.

How to calculate your sales taxes

State sales tax can be calculated by tallying all tax collected in all of the states in which you have nexus.

How to file your state taxes

As this is a state level tax, rules and ways of collecting this tax will differ. Contact your state tax representative for details.

Penalties

Don’t forget that some states require what’s called a “zero return,” which is for those sellers that didn’t collect any sales tax. If you don’t file one of these, you could be hit with a fee or penalty.

Annual Income Taxes for Handmade Sellers

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.

Penalties

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.

Quarterly Estimated Taxes

The US tax system operates using a “pay-as-you-go” model. This means that taxes should be paid as you earn money, rather than at the end of the year as a big lump sum.

For employees, this is usually arranged by the employer as a deduction before you receive your pay-check so you don’t really need to worry too much about the finer detail. For self-employed people however, this means you’ll need to be estimating the tax you are likely to pay based on your revenue and expenses within the quarter.

The IRS expects all businesses that are likely to owe more than $1000 in taxes over the course of a financial year to file estimated taxes each and every quarter.

When are my quarterly taxes due?

Quarterly taxes are due four times a year for specific periods (“payment periods”):

The IRS says: If the due date for making an estimated tax payment falls on a Saturday, Sunday, or legal holiday, the payment will be on time if you make it on the next day that’s not a Saturday, Sunday, or legal holiday.

Tip: Use a calendar app to set alerts for your quarterly tax - both for the due date itself, but also at least 3 weeks beforehand so you have time to get your numbers together.

How do I calculate my quarterly taxes?

The important thing to keep in mind is that your quarterly tax liability is considered an estimate rather than an exact amount. If you don’t have a good idea of your revenue and expenses this year to determine this number, your easiest option is to look at how much you owed last year and pay the same amount.

Whilst this is the easiest option, it isn’t often the best option. If your business is in a big growth phase, or sales are slipping a little lately then you may be overpaying or underpaying significantly.

Overpaying means unnecessarily tying up your revenue with the tax office until the end of the tax year - your money is going to sit in the big IRS piggybank until they eventually give it back to you at the end of the year as a refund. Given this is money you can’t touch or use to invest in your business this may not be a great strategy.

Underpaying your estimated tax has it’s own set of problems: the most obvious being that you’ll be getting a nasty unexpected tax bill come April.

It’s therefore wise to try and estimate your estimate tax as accurately as possible to prevent these situations. If you are using bookkeeping software like Craftybase to track your revenue and expenses, then you’ll firstly want to be looking to obtain your raw numbers from here.

Essentially, you’ll be looking to establish your expected adjusted gross income, taxable income, deductions and credits for the year.

There are typically three steps required to calculate your quarterly estimate.

Step 1: Estimated Income Taxes Owed To calculate this, you’ll need to multiply your total taxable income by the percentage indicated by your tax bracket for the year. This calculation results in your estimated income tax for the year.

Your tax bracket changes yearly, so ensure that you are referring to the latest rates - you’ll find this schedule in your Form 1040-ES.

Step 2: Estimated Self Employment Taxes If you are liable to pay self-employment tax, you’ll also need to calculate this number.

Take your taxable income and multiply by 92.35% to arrive at your self-employment taxable income. Next, multiply this number by 15.3% to generate your self-employment tax rate.

Step 3: Quarterly Tax Payment To calculate how much is due for the quarter, add together your income tax and self-employment tax estimates above, then divide this number by 4.

If you are calculating your estimated taxes for the first year, it is strongly recommended to run your numbers by a CPA before submitting.

How to file

This tax is filed using Form 1040-ES can be filed by mail or electronically.

To file by mail:

1. Complete and print form 1040-ES
2. Fill out the accompanying voucher
3. Write a check for the amount you have estimated
4. Send it to your nearest IRS address (as per the form).

To file electronically:

Use the Electronic Federal Tax Payment System (EFTPS).

Tip: Once enrolled to EFTPS, you can create automatic debits for regular payments. If your tax liabilities are constant this can be a great time saver.

Penalties

The key is to ensure that youIf you don’t pay for 4 consecutive quarters, you’ll pay approximately 3% annual interest on what amount you have underpaid. This will be calculated as part of your annual tax return.

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.