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Do you have to pay taxes on an online business? While the simple answer is yes, understanding the reason is more complicated. This is because there is more than one type of tax online businesses must consider. Both self-employment tax and retail tax can come into play depending on the law and IRS regulations. There is also the possibility of having to pay for corporate tax – again, depending on the situation. Let’s go over the three taxes in question.
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Retail sales tax is a state collected tax. If your online business sells a taxable item you must collect tax from customers who reside in your state. This law stems from the direct mail/mail order trade and was adapted to Internet trade.
This law requires retail tax collected from customers where you have a physical location in any given state. If you don’t have a physical location in a state, you don’t collect tax from that state. The Supreme Court ruled this into law with their decision in the 1992 Quill v. North Dakota case when that state attempted to collect retail tax from Quill, a mail order business with no physical presence in the state.
Quill v. North Dakota applies to all businesses in the United States but not outside the United States. If your online business ships internationally, it would be liable for foreign taxes from other countries; this is the main reason most businesses either do not sell internationally or they set up a separate entity for individual countries.
To collect retail sales tax many online businesses rely on software that automates the process. When the customer enters their address this signals to the software if tax is required. If retail tax is required it is simply added onto the total cost. For the program to determine the correct tax rate, you must manually enter that when you first set up the software.
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Self-employment tax is a tax paid by persons who reach a minimum limit of income before an estimated tax is required. This limit is $400 in net income (after taxes) according to the IRS. This tax is required from anyone who operates any type of business for any year of self-employment. This is actually the same tax employers pay into Social Security, Medicaid and FICA. While having your business pay you as an employee may be the simpler way to collect the tax, it also is the more expensive method since you are using an accountant.
To calculate this tax, you use the current rate (15.3 percent of net earnings in 2010) as a percentage. Net earnings include combined wages, tips and net earnings. Quarterly payments are sent to the IRS and placed in escrow until taxes are filed. These payments can be sent directly by the business or you can set yourself up as an employee of the business with an accountant handling the taxes like an employer would. At the end of the year, you would file Schedule SE along with your Form 1040. If the amount calculated on Schedule SE is less than the amount paid in, you get money back; if the amount is less, you are required to send a check for the difference.
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Do you have to pay taxes on an online business if you are a corporation? Again this depends on what the business is. If you have a retail operation online, you are subject to retail sales tax. If you are a service business this does not apply – but, instead of self-employment tax you are subject to corporate taxes.
Corporate taxes can vary widely depending on the type of corporation. An LLC (limited liability corporation) does not have the same tax rate or qualifications as a full C Corporation or a smaller S Corporation. If you are a partnership you may be required to pay corporate tax and self-employment tax per each individual in the partnership.
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In order to determine if you must pay tax, and which tax, there is a quick checklist you can run through to provide answers.
- Do you sell physical items online such as shirts, books or other physical stock? If so you are subject to your states retail sales tax law (this includes eBay and Amazon sales).
- Are you going to make over $400 in net revenue this year? If so you are subject to self-employment tax.
- Are you a sole proprietor or a corporation? Even if you are an LLC with one member you must still list as a corporation.
- If you are in a partnership, is the partnership a corporation or simply a partnership? This determines if you must pay both self-employment tax and corporate tax.
Even if you have no online website the IRS will still consider you an online business if you earn over $400 in online revenue. This happens to many freelance writers and others who derive their income from the Internet. Once you are over the threshold you are considered a business – even if it is not your sole or dominant income.
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Images Credit: William A. Swan
U.S. Small Business Administration: Collecting Sales Taxes Over the Internet
Nevada Corporate Planners: Online Sales Taxes
IRS: Tax Topic 306
IRS: Article on Self-Employment Tax