For the most part, online businesses are required to comply with the same rules and regulations of traditional small businesses. When it comes to taxes, however, several additional issues come into play. Check out this quick guide to find out what all business owners in the e-commerce world should know.
Internet Tax Freedom Act
The Internet Tax Freedom Act aims to protect the Internet's commercial, educational, and informational potential. For online businesses, this legislation spells out what is and is not allowed - clearing up all rumors about how e-commerce is taxed. It's important for these businesses owners to know their rights and responsibilities when tax time comes around each year.
What's Allowed: The Act does NOT exempt e-commerce sales from being subject to business income tax. These sales are held to the same income tax standards of sales made from traditional brick-and-mortar or mail-order sales. Online businesses are liable for income tax, self-employment tax, employment tax, and excise tax.
What's Not Allowed: The Act prohibits implementing Internet-only taxes. Basically, no taxes can be required of online businesses that are not required of other businesses. Taxes that would be in violation of this legislation include an Internet access tax, multiple e-commerce tax, bit tax, bandwidth tax, and email tax. If you do not have a physical presence in a state, which many online business do not, you are not required to collect sales taxes from customers in that state. Each state defines 'physical presence' differently - to determine whether or not your business qualifies as a physical presence, contact your state's revenue agency.
Employees vs. Independent Contractors
Similar to traditional small business owners, when an online business requires additional operating help, owners are required to classify workers. For tax purposes, workers can be classified as either an employee or an independent contractor - and both have their benefits and drawbacks.
To avoid federal penalties, it's important for business owners to understand how to accurately classify their workers. To make a classification, assess what work is required of that person and how that work will be completed.
Employee: You, as the owner, control the answers to both these issues. As their employer you tell them what needs to be done and how it needs to be done.
Independent Contractor: You, as the owner, control what needs to be done but not how. These workers are required to complete as certain project but how and when (within a set time frame) it is completed is up to their discretion.
For more information on classifying you workers, check out the IRS Guide to Independent Contracts (Self-Employed) or Employee?. If you need further assistance classifying a worker, IRS Form SS-8 can be filed for an official review and determination of a worker's status.
Reporting Paid Wages
Tax laws require that online businesses report how much all workers were paid throughout the year. Business owners must report these depending on their classification:
Employees: Business owners are required to pay Social Security, Medicare, and unemployment for all persons classified as employees. Regardless of the length of employment, a W-2 Form must be filed for each employee. If your business has employees, check out Forms and Associated Taxes for Employees.
Independent Contractors: Business owners are NOT required to pay Social Security, Medicare, or unemployment for persons classified as independent contractors. Owners generally file IRS Form-1099 for independent contractors. If your online business works with independent contractors, check out Forms and Associated Taxes for Independent Contractors.
Home-Based Online Businesses
Although not all home-based businesses utilize e-commerce, most online businesses are home-based. If you run a business out of your home you may qualify for tax deductions. Be sure to understand what requirements must be met before making any deductions.
What's Required: To be eligible for any home-based deductions, the area in your home where you operate your online business must me used 'exclusively' and 'regularly' for business. In addition to this requirement, your home must be your business's principal place of business, a regular meeting place to deal with customers, or a separate structure used in connection with your business. Read more about home-based deduction eligibility.
What Deductions Apply: If you meet each of the requirements for a home-based business, your online business can make certain tax deductions. The first step in determining your deductions is to compute the percentage of your home that is used for your business. This percentage can then be used to proportionately deduct property taxes, utility expenses, insurances costs, mortgage or rent, maintenance fees, and other home costs. For more information, read 'How to Claim the Tax Deduction for Business Use of Your Home.'