As the old adage goes, it’s not what you make, it’s what you keep. It’s just as true with affiliate marketing as it is with the rest of the business world.
In this article, we want to make sure that you’re familiar with both your tax obligations and the great tax-saving opportunities available to you.
Keep in mind that setting up a business isn’t that difficult and there are resources to help you. Of course, you can consult with a tax professional or certified public accountant (CPA), but there are free resources too. Go to the Small Business Administration in your area and ask for a free consultation with a SCORE counselor. SCORE is the Service Corps of Retired Executives.
Table of Contents
Setting Up Your Business for Taxes
Before we get to paying and reporting taxes, we need to cover your affiliate marketing business as a legal entity. After you have worked on your business all year round and have done a good job of record-keeping (hopefully!), it’s time to do your taxes. It’s good to time them before April 15 and after an extensive root canal (just kidding on that last part!).
The simplest business structure: You!
The simplest way to report your taxes is as an individual — technically, as an independent contractor. This is also referred to as being a “1099” business since that form is used to report a payout to an individual who isn’t an employee (employees report their earnings through the W2 form).
Many people think that to go into business, you need to complete lots of paperwork and you must register yourself as a corporation and jump through lots of hoops just to hang an “open for business” sign. Not so! As far as the Internal Revenue Service (IRS) is concerned, you can be in business as long as you have a legal name, have a tax ID number (like your Social Security number), and are serious about making big bucks. (Just don’t forget to pay them their share when you start making some good profits.)
Under this status, you are a sole proprietorship, and you report this activity (income and expenses along with net profit/loss) on Schedule C, which is attached to your Form 1040.
The second simplest business structure: The DBA
Beyond using your name as a business title (see the previous section), you’ll find that it makes a lot of sense to register a business name. At this point, you’re still a sole proprietor, but with a business name, you can do more.
Registering a business name is also called registering a “DBA,” which stands for “Doing Business As.” It is also referred to as filing a “Fictitious Name” certificate or registration. Either way, it’s there for you to claim a name for your business under which you can conduct your business activities.
Why do a DBA? For one, some state or local jurisdictions may require it (depending on what kind of business it is). Also, a DBA is a marketing choice; it helps you in selling what you offer. For example, if you have an affiliate marketing business in the medical niche and operate in that market as “Medical Marketing Associates,” you’ll have an easier time looking professional than if you are “Irwin Poopinschmutz” (no offense to Mrs. Poopinschmutz).
In addition, when you formalize your business name as a DBA, you can take that registration form to your bank and open a business account so that you can accept payments, wire funds, get loans, and so forth with your business name.
DBA registration is typically done at either the county level or the state level. You can call or visit the county government main office building or the state capital about registering. Of course, doing an online search also helps.
The Small Business Administration (SBA) keeps track of all the states and their DBA filing requirements. You can find out more at their website, www.sba.gov. In addition, should you get a DBA and then need a bank account, we recommend that you consider opening your new business checking account at a credit union because they usually charge less yet still have some of the basic services a small business needs.
After you get your DBA, you should get a tax ID number for it as well. Tax ID numbers are issued by the IRS, and you can get one for your DBA with Form SS-4, “Application for Employer Identification Number” (you can download this form at www.irs.gov/pub/irs-pdf/fss4.pdf).
The next level: LLCs, corporations, and partnerships
Given the initial simplicity of affiliate marketing, the sole proprietorship status, with or without a DBA, is good enough for most beginners. However, if your business does very well, you should then consider upgrading to a more formal structure such as a corporation or limited liability company (LLC).
We think these are great business structures, and one of them may be great for you given a variety of factors such as personal considerations, tax laws, liability concerns, and so on.
Handling Taxes on Affiliate Marketing Commissions
In your first year or two of affiliate marketing, you’ll have either a net loss or a net profit (duh!), so you need to know how that gets handled:
- If you have a net loss (your total expenses are greater than your total income), that loss is at least beneficial from a tax point of view since the loss reduces your taxable income, which in turn reduces your tax liability.
- When you have a net profit (the whole goal, right?), you should be aware of any taxes that are due. The following sections cover the most obvious ones you should be ready for.
1. Federal income taxes
Well, someone’s gotta pay for the deficits! Anyway, when you generate a net profit in your affiliate marketing business, this does become a taxable event (ugh … that event takes place on April 15). Fortunately, if you made a small profit, the income tax won’t break you. In addition, other tax benefits kick in which help shield, offset, or even wipe out the potential federal income tax.
Say, for example, that your net profit in your business was $2,800, that was your only income, and you are single. The standard deduction for 2019 is $12,200 (filing single) and $24,400 (married filing jointly). Since the standard deduction is greater than your business income, there is no federal income tax for 2019. But there will be likely a self-employment tax on the net profit of $2,800 (see the next section).
2. Federal self-employment taxes
Federal self-employment taxes are missed by most beginning entrepreneurs, but they need to anticipate them. The self-employment (SE) tax, which is also referred to as “Social Security and Medicare taxes” or “FICA,” is a tax up to 15.3 percent of your net taxable business income. This can be a hefty tax if you are not aware of it and prepared to pay it.
Say, for example, that you had a good year in your affiliate marketing business and you earned a net profit of $10,000 (great job!). The federal income tax may not be that onerous since you’ll also have a standard deduction, a personal exemption, and possibly other deductions that could lower the taxable income, which would also lower your potential federal income tax liability. (We cover tax deductions later in this article.) But how about the federal self-employment tax?
In the preceding example ($10,000 net income), your SE tax would be 15.3 percent of $10,000, or a whopping $1,530. Now, if you were prepared, you make quarterly estimated tax payments to lower the financial pain. But what if you didn’t see it coming? That’s right — ouch!
3. State and local taxes
State and local taxes are usually not more complicated that federal taxes, but it’s easy to miss something. Seriously, unless you are very diligent with the paperwork, filing deadlines, and so on, it’s probably a good idea to work with your tax person given the complexity.
Most states have an economic development agency (or similar-sounding agency) that is set up to encourage business development and attempt to make it as easy as possible to conduct business and deal with various state and local bureaucracies. The website at www.usa.gov has a directory with links to the 50 state government websites plus the territories. In turn, these websites usually have links or contact information to counties and municipalities.
4. Sales tax
Since an affiliate marketer earns an income from affiliate-related commissions, sales tax is usually not encountered. But in the event your affiliate marketing business does expand into becoming a merchant and goes into offering products (physical or digital), then you may have to deal with it.
A sales tax is typically levied by a state or local tax authority, and it is usually a percentage of the sale amount. If you sell a product that is $10 and the sales tax is 7 percent, for example, then the consumer should be charged $10.70. You then must submit the sales tax amount (monthly or quarterly) to the relevant tax authority. Keep in mind that you (your business) does not pay the sales tax, but you’re required to collect it and send it in to the sales tax authorities.
One way to keep informed about sales taxes and related issues is through venues such as associations that are usually among the first to find out about pending rules and taxes that affect businesses.
As a general rule of thumb, expenses incurred on behalf of your business are tax-deductible. The IRS makes the general point that an expense, to be deductible, must be “ordinary and necessary” for your business. Although there is some gray area here, we think you know your business as well as anyone else, and deciding where an expense is ordinary and necessary in your business shouldn’t be a tough decision. Of course, if you aren’t sure, ask your tax person.
We realize that the burdensome thought of paying taxes may have you inching toward the ledge — but fear not! There is good news buried in the tax regulations. Plenty of juicy tax deductions are available for you, and the first one is right in your own home.
Deducting home office expenses
One of the most attractive deductions for home-based entrepreneurs is the home office deduction. It is easily worth thousands of dollars for you, so take a close look at it. The great thing about it is that using it is like effectively turning some of your business income into tax-free income!
The home office deduction is a special deduction and one that every home-based entrepreneur should make a concerted effort to qualify for. I don’t prepare taxes anymore, but when I did, I was surprised how many folks didn’t take the home office deduction because they either didn’t know they could take it or were discouraged by an overly conservative tax preparer. Yeeesh!
Keep in mind that there are literally millions of legitimate home businesses that — yes, legitimately — claim the home office deduction. The IRS even tells you how to do it! The full details are in IRS Publication 587 (titled “Business Use of Your Home”). Here is a quick review: If you use a portion of your home (whether you rent or own a house or condo) regularly and exclusively for your home business, you can deduct that portion as a home office deduction.
Here’s an example: Say that you are a renter, you rent a four-room apartment, and your monthly rent is $1,000. You use one of those rooms regularly and exclusively for your home business. Assume that you pay $150 per month in utilities. To fill out this example, also assume that in this business the net income is $3,000 ($10,000 less $7,000 of regular, deductible business expenses). Keep in mind that for a home-based business, the home office deduction is calculated after regular income and expenses are calculated.
Here is how this example takes the home office deduction:
- Total annual rent is $12,000 (12 × $1,000).
- Total annual utilities are $1,800 (12 × $150).
- The annual total for both rent and utilities is $13,800 ($12,000 plus $1,800).
- Twenty-five percent of your living area is used for a home office (one room out of four rooms — assume the rooms are generally equal).
- Therefore, your home office deduction is $3,450, which is 25 percent of $13,800.
- Remember that before you apply the home office deduction, you see that the business made a net income of $3,000 (from the earlier paragraph).
- Here is the good stuff: The home office deduction of $3,450 totally offsets the business income of $3,000, and the net taxable income from the business is $0. Cool!
In Step 7, keep in mind that the $3,000 of business income is cash in your pocket and the home office deduction of $3,450 makes it tax-free. The interesting point about this is that whether you had the home business or not, you were still going to pay the rent and utilities anyway. But now that you have a home business, that home office deduction becomes a powerful tax benefit.
Here’s one more point. In Step 7, only $3,000 of the total home office deduction of $3,450 was used (only $3,000 was needed). Unfortunately, you can’t use that $450 portion to give you a tax loss. However, it can be carried forward to be used in a later year. Sweet!
Looking at the most common affiliate deductions
Here is a list of the most common tax-deductible expenses that most affiliate marketers typically come across in their daily business activities:
- Computer software and business-related apps
- Internet connection costs and related internet expenses
- Web design and web programmer fees
- Office supplies
- Business use of telephone and other communication devices
- Advertising, marketing, and promotional costs
- Payments to other affiliates, sub-affiliates, and resellers
- Professional fees (legal, tax, and so forth)
- Business publications (online and offline)
- Fees for business-related micro-tasks (setting up a blog or website)
- Postage and shipping costs
- Business membership program fees
Checking out other common business deductions
In addition to the prior list of common tax-deductible expenses for affiliate marketers, here are other expenses that are generally tax-deductible:
- Business use of auto
- Business-related mileage, tolls, and parking expenses
- Business travel
- Business meals
- Business conferences and educational programs
- Salaries, wages, and other compensation to employees
- Payments to independent contractors
- Costs related to preparing business taxes
- Small tools and office equipment used for your business
- Supplies for creating arts and crafts for resale purposes
Researching Pension Tax Benefits
Whether you’re doing an arts and crafts business from your kitchen table or launching a multinational corporation stretching across the globe … uh … from your home office, you have real power to build wealth with your business. Even as a home-based business, you can set up a pension plan that has more power than a garden-variety IRA (Individual Retirement Account).
For example, there is the SEP-IRA (Simplified Employee Pension Individual Retirement Arrangement). A small business can set this up and have the ability to sock away up to $56,000 (the 2019 limit) per year. Did you know that you can even do your own 401k? There’s also the Keogh Plan, the Solo 401(k), and other pension plans.
This topic is too involved to cover in this article adequately, but we mention it here to pique your curiosity and hopefully make you realize that even micro-entrepreneurs have options they can take advantage of either now or in the near future that will help build long-term wealth — all triggered by the positive decision to start their own business.
You can find out more about small business pension plans from the IRS by getting Publication 560 (“Retirement Plans for Small Business”) at www.irs.gov/pub/irs-pdf/p560.pdf.
Reviewing Resources to Help You with Your Taxes
The amazing thing about the preceding sections is that we barely scratch the surface (yikes!), but if you take it step-by-step with the earlier tips and the following resources, you should be okay. Don’t try to cram it all in at once. Taxes have been known to cause mental breakdowns and alcoholic binges, so take your time. You have all year round to get familiar with the topic.
Check out the following guides from the IRS (all easily downloadable from www.irs.gov/publications):
- Publication 17: Gives you a nice overview of Form 1040 and includes references to Schedule C as well
- Publication 334: The IRS’s small business tax guide
- Publication 463: Helps you understand travel and entertainment deductions as well as auto expenses and business gifts
- Publication 535: Covers the general world of business expenses
- Publication 583: For taxpayers starting a business; also includes information on record-keeping and getting a Tax ID number
- Publication 587: Guides you in how to set up your home office and how to take the home office deduction; also includes information on Form 8829
- Publication 946: All about depreciation and amortization