Tax Considerations for Online Income
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As the year is drawing to a close, it’s important to remember that Dec. 31st is generally the last day you have to significantly impact your taxes for the year. One of the great things about making a few bucks online is that you have some options to reduce your tax bill through some smart management of your cash that you’ve earned through the year.
First, once you make more than $600 from Squidoo or any other affiliate program they will send you and the IRS a 1099 form at the beginning of next year, telling both you and the government how much money you earned. Yes, you owe taxes on this money!
Now, you are taxed on profit not on gross income. Therefore, many companies spend some cash at the end of the year on things they may need in the coming year in order to put the cost towards their total expenses, thus reducing their profit and their tax burden on April 15th.
If you haven’t done any accounting during the year to track your profits and costs, now is the time to do it. If you don’t know how much money you’ve made, it’s very difficult to predict how much you will owe in taxes.
As an example, if you made $1,000 during the year and spent $200 on hosting, domain names, and other expenses, you have $800 in profit. From that, you will need to make sure you have enough to pay taxes. I’ve found that opening a separate account within your business bank accounts specifically for tax witholding is the easiest way to do it. In this example, if you are in the 25% tax bracket you should withold at least $320 (40%) of your profits. Why 40%? Well, since you are self employed, it is your responsibility to pay your own FICA and Medicare taxes which add up to about 15% of your earnings on top of your normal tax bracket.
40% witheld? Ouch! Yep, that’s the way it works.
There is hope though. You can do things like open a retirement account to ’shelter’ some of your online income. You could also spend some profit on business related expenses like new computers or software and reduce your tax bill that way.
For example, if you opened a SEP IRA and bought a $600 computer with your profits you are then looking at a potential tax bill of:
$1000 income
-$200 Hosting
-$600 Computer Expense
-$50 SEP IRA contribution
$150 * 40% = $60
Now, instead of paying $320 in taxes on $800 in profit, you have bought a new computer to help you make more money, opened a retirement account, and reduced your tax bill to $60. Pretty cool, huh?
I am not a tax or accounting professional and these numbers are just used for illustrative purposes. You should definitely seek advice from someone that knows what they are talking about (that’s an expense as well, by the way 
) .
However, Hurry up! The year is almost out!
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Comments
Great advice as always Joe! Also a good reminder to keep track of your business expenses when you’re self employed.
Very good advice. Generally, you can make that IRA contribution anytime before April 15th and it is allowed to be claimed on last year’s tax form. We calculate our taxes and then increase our IRA contribution to reduce the portion that we owe. We have to pay it out anyway, so better to pay it to ourselves than to Uncle Sam, don’t you think?
Great post Captain! For anyone reading this post after 12/31, it’s too late to buy supplies or equipment to reduce your taxes, but you still have time to contribute to an IRA or SEP IRA (you have until April 15). Btw, I am a tax pro who specializes in online businesses.
Great point. When I first started freelancing, I was stunned by how big the tax cut out was, but if you’re smart about it, you can buy the things you need (and usually want), save for retirement, and keep the govt from seizing 40%. Great post!
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Excellent advice, Captain. Folks, this is a business like any other. Make sure to include it in your tax figuring for the end of the year. Companies like Squidoo are required by law to report your earnings.