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Accounting when selling a small product line

adammil1

Titanium
Joined
Mar 12, 2001
Location
New Haven, CT
I have been producing a little product as a side hobby. Typically I sell maybe $2-3,000 a year thru PayPal. I am thinking about doing a bigger run of my widgets, hoping to maybe able to clear $10,000 in revenue with the product if made in bigger quantities but I don't see it getting much more than that given the limited market.

Now that the IRS is changing the rules on PayPal reporting its probably time to set things up more legitimately but last thing I want to do for such a small product line is kill myself with accounting fees.

What's the best way to handle tax reporting of a business like this? My wife is usually the one who files everything with turbotax so I have never done it. Ideally I would just file with turbotax and deduct expenses for tooling, materials against the cost of goods sold. Is it that simple or is there more to it?

I assume other expenses such as repairs to my CNC miling machine (which even though it's part of my hobby shop) would be fair game for deductions too so long as I use it to make my product right?

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Garwood

Diamond
Joined
Oct 10, 2009
Location
Oregon
For a lower dollar amount my approach would be to expense it out to where you make zero on the product. I would discuss it with a good accountant.

If the goal is pay the least taxes, approach it like that. If the goal is to fluff up your income for a loan or to sell the biz then you present it as such.

You could charge rent for the shop space, a portion of electricity, shop supplies is pretty vague, etc.
 

Doug

Diamond
Joined
Dec 16, 2002
Location
Pacific NW
Check into what PayPal has to offer, they have ways to help small businesses.

For the IRS it can be a simple as a filing a Schedule C.
 

Kalispel

Aluminum
Joined
Jan 27, 2021
Location
Ohio
The reporting limit for third party settlement companies like PayPal changed from $20,000 to $600 effective January 1st.

The accounting is not a big deal. You will now receive a 1099 recording the sales as income. It gets a little more messy to account for the cost of sales but it is not too difficult if you already have included your business in your tax filing. The IRS will not like the words Hobby and Deduction in the same memo.

Sales tax collection is the bigger headache. There is no uniform rule. Some states are getting aggressive with online sellers. Some states forgive up to $100k in revenue. You need to get some tools and help when you get big enough to catch the attention of state revenue folks. Platforms like Amazon or plugins for Shopify or Wix can manage it.
 

adammil1

Titanium
Joined
Mar 12, 2001
Location
New Haven, CT
The reporting limit for third party settlement companies like PayPal changed from $20,000 to $600 effective January 1st.

The accounting is not a big deal. You will now receive a 1099 recording the sales as income. It gets a little more messy to account for the cost of sales but it is not too difficult if you already have included your business in your tax filing. The IRS will not like the words Hobby and Deduction in the same memo.

Sales tax collection is the bigger headache. There is no uniform rule. Some states are getting aggressive with online sellers. Some states forgive up to $100k in revenue. You need to get some tools and help when you get big enough to catch the attention of state revenue folks. Platforms like Amazon or plugins for Shopify or Wix can manage it.

So how does that work if things go well I hope to sell about $10k worth of product this year. So PayPal will send me a 1099 saying they sent me $10K.

But after I buy supplies, pay a local machine shop for their turning work I will likely have to pay out closer to $4k. So the whole thing will probably net me about $6K for the year. Do I just write those off as expenses so I am only paying taxes on $6k? Do I just do it on my normal tax return? I know I am pretty green here.

While I am at it if I need to buy some tooling, and maybe even a new machine that I can justify as being used towards the project do those costs also get to be written down against the income?


I should also mention sales tax isn't really an issue. That's all handled up front thru the company who runs my online store.

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Kalispel

Aluminum
Joined
Jan 27, 2021
Location
Ohio
So how does that work if things go well I hope to sell about $10k worth of product this year. So PayPal will send me a 1099 saying they sent me $10K.

But after I buy supplies, pay a local machine shop for their turning work I will likely have to pay out closer to $4k. So the whole thing will probably net me about $6K for the year. Do I just write those off as expenses so I am only paying taxes on $6k? Do I just do it on my normal tax return? I know I am pretty green here.

While I am at it if I need to buy some tooling, and maybe even a new machine that I can justify as being used towards the project do those costs also get to be written down against the income?


I should also mention sales tax isn't really an issue. That's all handled up front thru the company who runs my online store.

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This new rule change is going to trip up a lot of folks. Unfortunately, the accounting and other administrative jobs are all part of having a business. You can and should deduct all of your costs. It is not difficult but it is tedious. Read IRS publication 535.

Publication 535 (2020), Business Expenses | Internal Revenue Service

Programs like TurboTax can create the tax filings. You need to document your actual costs, enter the information correctly and file the documents away in case you need to defend your claims.

The accountant suggestion is a good idea even if you only use them for guidance.

It is also inexpensive and easy to create a Limited Liability Company (LLC) to provide some legal protection should your business encounter a problem. You can do this yourself pretty easily or pay a lawyer a to do it. An individual LLC is a pass through entity so it does not change your individual tax liability.

If you are uncomfortable or uncertain the best approach is to seek professional help.
 

Ries

Diamond
Joined
Mar 15, 2004
Location
Edison Washington USA
I am not totally up to date on this, because I became a corporation 20 years ago- but, for a long time, I filed a schedule C self employed, as part of my personal return. I did all the taxes myself, and it was no big deal. In my state, you need a state business license, again, easy and cheap. For part of the time, I lived in a city that required a city biz license too. Some places dont require one, some do.
But the bookkeeping was pretty simple- I used to do it on yellow legal pads, in the 70s.
Keep a list of purchases.
Keep a list of income.
fill out the schedule C, in turbotax.
Pay a tiny bit of taxes- if you take in 10k, and have expenses, it will probably only be a few hundred bucks.

I always found that an LLC was more money time and hassle to give you a very minimal legal protection- all my income, assets, and accounts were in my personal name, and no lawyer would spend more than five minutes penetrating an LLC if I was sued, as I had to use my personal financials to get a bank account, credit, net 30 with suppliers, and so on, even if I had an LLC.

If you have a separate business location, and you clearly not the same thing financially as an LLC (ie partners, employees, and so on) then an LLC may be worth it, but in most cases, you are the business, and an LLC wont change that.
 

gustafson

Diamond
Joined
Sep 4, 2002
Location
People's Republic
YOu file as a sole proprietor on a schedule C

https://www.irs.gov/pub/irs-pdf/f1040sc.pdf

On the schedule C you list your income and expenses.
Part of your electric bell, cell phone, internet access
Stock, tools, supplies
bank fees paypal fees
If you have capital equipment, you can choose to depreciate it over a number of years on another form

It is not that complicated

Get quickbooks or quicken or another computer software so everytime you write a check or pay something it has an expense account tied to it that goes right on your Sched C
Paypal is a bank account for purposes of software

You should get a business bank account to keep things separate
 

standardparts

Diamond
Joined
Mar 26, 2019
What CarbideBob posted:

"We all hate to pay outside help but get an accountant and maybe a tax lawyer."

Establish a relationship with an accountant. Usually pay a retainer for advice and council. The accountant will know if an when an attorney is needed. Good tax accountants can access/interact with IRS data legally which speeds resolution of issues.

The time saved doing book work, paying for software to do the numbers, along with the stress of wondering if your 'accounting' is correct is better spent making parts. Get an accountant.
 

Mebfab

Diamond
Joined
Jun 7, 2003
Location
Mebane North Carolina USA
Local community college most likely has a small business center. Your issue is exactly part of the mission. Until recently (maybe still do) they had grant money to cover costs to help you out if you hired an outside company to do a consult.

But they will be able to give you advice. If nothing else they can help narrow down the amount of questions you pay someone to answer. The one local to me is pretty good. Too far for you.
 

Kalispel

Aluminum
Joined
Jan 27, 2021
Location
Ohio
The "Limited" part of Limited Liability Company means what it says.

It is not bulletproof protection. It can be breached.
It declares the company is distinct from your person.
It puts creditors and customers on notice when dealing with an LLC.
It provides personal protection from your employees' actions.

The schedule C comments are right on target.
An Individual or a Single-Member LLC filer both use Schedule C

Publication 535 outlines the rules for deductions.
Publication 535 (2020), Business Expenses | Internal Revenue Service

A business structure is simple and easy to create.
It is a one-time event. Get an EIN and file a charter.
The ongoing accounting burden is also minimal.
 

Radar987

Cast Iron
Joined
Dec 30, 2011
Location
CA
Just be aware that the slightest misstep in tax reporting will likely land you in prison, even if it's accidental. Most of us here on Practical Machinist have done hard time. It's just part of doing business here in America.

I hope you didn't buy any of that. The IRS' penalty for unpaid tax is to pay the unpaid tax, plus 10%. So if you screw up your math and owe them $300, you're going to pay them $330. That's IF you get audited.

Don't pay thousands hiring an accountant or lawyer to avoid a potential, but unlikely, $30 tax penalty.

What's the best way to handle tax reporting of a business like this? My wife is usually the one who files everything with turbotax so I have never done it. Ideally I would just file with turbotax and deduct expenses for tooling, materials against the cost of goods sold. Is it that simple or is there more to it?

Have her buy Turbotax Home and Business and play around with it. File as a sole proprietorship.

Apply deductions liberally. Anything and everything related to your business is tax deductible, including stuff you bought years ago. You just can't deduct the same thing twice.
 

Mebfab

Diamond
Joined
Jun 7, 2003
Location
Mebane North Carolina USA
You should be more worried about the state tax office then the feds in my experience. The irs and income tax issues are nothing compared to the state sales and use dept. They can cause a lot of problems, a lot of fines. And are 100% on the lookout for the little guy. Big companies are not an easy mark.
 

wheels17

Stainless
Joined
May 10, 2012
Location
Pittsford, NY
No doubt about needing professional help, but there used to be a middle ground of "Hobby Expenses" in the tax code. This is old, from 2017:


Five Things to Remember about Hobby Income and Expenses | Internal Revenue Service

This is more recent, from 2020:


Not-for-Profit Activities
If you do not carry on your business or invest-
ment activity to make a profit, you cannot use a
loss from the activity to offset other income. Ac-
tivities you do as a hobby, or mainly for sport or
recreation, are often not entered into for profit.
The limit on not-for-profit losses applies to
individuals, partnerships, estates, trusts, and S
corporations. It does not apply to corporations
other than S corporations.
In determining whether you are carrying on
an activity for profit, several factors are taken
into account. No one factor alone is decisive.
Among the factors to consider are whether:
• You carry on the activity in a businesslike
manner,
• The time and effort you put into the activity
indicate you intend to make it profitable,
• You depend on the income for your liveli-
hood,
• Your losses are due to circumstances be-
yond your control (or are normal in the
start-up phase of your type of business),
• You change your methods of operation in
an attempt to improve profitability,
• You (or your advisors) have the knowledge
needed to carry on the activity as a suc-
cessful business,
• You were successful in making a profit in
similar activities in the past,
• The activity makes a profit in some years,
and
• You can expect to make a future profit from
the appreciation of the assets used in the
activity.
Presumption of profit. An activity is pre-
sumed carried on for profit if it produced a profit
in at least 3 of the last 5 tax years, including the
current year. Activities that consist primarily of
breeding, training, showing, or racing horses
are presumed carried on for profit if they pro-
duced a profit in at least 2 of the last 7 tax
years, including the current year. The activity
must be substantially the same for each year
within this period. You have a profit when the
gross income from an activity exceeds the de-
ductions
 

AndyF

Stainless
Joined
Nov 3, 2003
Location
Phelps, NY, USA
... Don't pay thousands hiring an accountant or lawyer to avoid a potential, but unlikely, $30 tax penalty...

I agree on the ratio, but it is a good idea to pay a few hundred for an education. One hour with someone who knows the rules definitely beats many hours spent reading and trying to figure out the rules.
 

Doug

Diamond
Joined
Dec 16, 2002
Location
Pacific NW
Turbo Tax was my friend for years. In later years we did need an accountant.

After things had been going well for the business for the first few years I decided to take a free SBA course on taxation related to small business operations. I figured being a total amateur in accounting they would be able to teach me some money saving tax tricks. What it turned out to be was an 8 hour infomercial for the local accounting and legal groups. If I had followed their advice, mostly hire us, I would been bled dry and likely never got the business off the ground.

My point is, small business accounting like the OP needs to know is just not that complicated. But it might get to be more complicated than it's worth getting involved in for the net income on $10K of sales. The new PayPal rules, and maybe soon eBay and CL. And by law states are trying to require sellers to collect sales tax if the buyer's state has a sales tax, that itself could take the fun out of the business.
 

Bill D

Diamond
Joined
Apr 1, 2004
Location
Modesto, CA USA
Be aware about the pitfalls of claiming part of your house as a tax dodge shop/office. When you sell the house it can get interesting how that affects your taxes on the profits and ability to shelter the profits by buying another house with the money.
Same deal with a car used part time for the shop when. you sell it or trade it in.
Bill D
 

CITIZEN F16

Titanium
Joined
May 2, 2021
Be aware about the pitfalls of claiming part of your house as a tax dodge shop/office. When you sell the house it can get interesting how that affects your taxes on the profits and ability to shelter the profits by buying another house with the money.
Same deal with a car used part time for the shop when. you sell it or trade it in.
Bill D

The car issue is solved by taking the mileage deduction.
 








 
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