Taxes can be a daunting subject for many affiliate marketers. With varying regulations, numerous deductions, and the fear of audits, it’s easy to feel overwhelmed. However, understanding taxes is crucial to maximizing your earnings and ensuring your business stays compliant.
While taxes may seem complicated, understanding your obligations and taking advantage of deductions can significantly benefit your affiliate marketing business. By keeping accurate records, staying informed, and seeking professional advice when needed, you can simplify the tax process and maximize your earnings. Remember, paying taxes is a part of running a successful business, and with the right approach, you can navigate this aspect with ease and confidence.
As the old saying goes, it’s not what you make, it’s what you keep. This is as true in affiliate marketing as it is in the rest of the business world. In this chapter, we want to make sure you’re familiar with your tax obligations and the great tax-saving opportunities available to you. But first, we’ll look at setting up your affiliate business.
Keep in mind that setting up a business isn’t that difficult, and there are resources that can help you. Of course, you can consult with a tax professional or certified public accountant (CPA), but there are free resources as well. Go to the Small Business Administration (www.sba.gov) in your area and ask for a free consultation with a SCORE advisor. SCORE is the Corps of Retired Executives (www.score.org).
This guide will break down the essentials of taxes for affiliate marketers, helping you navigate this complex landscape with confidence.
Preparing Your Business for Taxes
Before we get into paying and filing taxes, we need to talk about your affiliate marketing business as a legal entity. After you’ve worked on your business all year and done a good job of record keeping, it’s time to do your taxes. It’s good to schedule them before April 15th.
The Simplest Business Structure: You!
The simplest way to file your taxes is as an individual – technically, as an independent contractor. This is also known as a “1099” business, as that form is used to report a payment to a person who is not an employee (employees report their earnings via the W2 form).
Many people think that to start a business, you need to fill out a lot of paperwork and register as a corporation and jump through a lot of hoops just to hang up an “open for business” sign. Not so! As far as the IRS is concerned, you can own a business as long as you have a legal name, a tax ID number (like your Social Security number), and you’re serious about making money. (Just don’t forget to pay them (the IRS) their share when you start making a nice profit.)
With this status, you’re 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
In addition to using your name as a business title (see the section above), 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’s also known as filing a “Fictitious Business 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 a DBA? First, some state or local jurisdictions may require it (depending on the type of business it is). Also, a DBA is a marketing option; it helps you sell what you offer. For example, if you have an affiliate marketing business in the computer niche and operate in that market as “Computers Parts and Accessories,” you will have an easier time looking professional than if you are John Smith, for example, of course, without wanting to offend people who go by this first and last name.
How to Register a DBA and Open a Business Bank Account
Also, when you formalize your business name as a DBA, you can take that registration form to your bank and open a business account so you can accept payments, transfer funds, get loans, etc. under your business name.
DBA registration is usually done at the county level or at the state level. You can call or visit your county government’s main office building or state capitol to register. Of course, doing an online search helps, too.
The Small Business Administration (SBA) keeps track of all the states and their DBA filing requirements. You can learn more at their website, www.sba.gov. Additionally, if 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 typically charge less and still offer some of the basic services a small business needs.
After you get your DBA, you must also get a tax identification number for it. Tax identification 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 scope of this post and the initial simplicity of affiliate marketing, sole proprietorship status, with or without a DBA, is good enough for most beginners. However, if your business is doing well, you should consider moving to a more formal structure, such as a corporation or a limited liability company (LLC). We believe that these are excellent business structures and that one of them may be ideal for you, given a variety of factors, such as personal considerations, tax laws, liability concerns, etc.
To help beginners weigh the pros and cons of incorporating versus other forms of legal business structures, visit the Small Business Administration site at www.sba.gov and the Service Corps of Retired Executives (SCORE) at www.score.org for more help and information.
How to Manage Taxes on Affiliate Marketing Commissions
In the first year or two of affiliate marketing, you’ll either have a net loss or a net gain, so you need to know how to manage it:
- If you have a net loss (your total expenses are greater than your total income), that loss is at least beneficial from a tax standpoint, as the loss reduces your taxable income, which in turn reduces your tax liability.
- When you have a net gain (the main goal, right?), you need to be aware of the taxes you need to pay.
Federal Income Taxes
When you make a net gain in your affiliate marketing business, this becomes a taxable event (that event takes place on April 15). Fortunately, if you made a small gain, the income tax won’t bankrupt you. Plus, other tax benefits come into play that help shield, offset, or even eliminate potential federal income tax.
Let’s say, for example, that your business’s net profit was $3,000, that was your only income, and you’re single. The standard deduction for example for 2019 was $12,200 (if filing single) and $24,400 (if filing married filing jointly). Since the standard deduction is larger than your business income, there is no federal income tax for that year. But there will likely be a self-employment tax on the $3,000 net profit.
Federal Self-Employment Taxes
Most beginning entrepreneurs aren’t aware of federal self-employment taxes, but they should be aware of them. The self-employment (SE) tax, also known as “Social Security and Medicare taxes” or “FICA,” is a tax of up to 15.3 percent of your net taxable income for the business. This can be a hefty tax if you’re not familiar with it and aren’t prepared to pay it.
Let’s say, for example, that you had a good year in your affiliate marketing business and made a net profit of $10,000. The federal income tax may not be as burdensome since you’ll also have a standard deduction, a personal exemption, and possibly other deductions that could reduce taxable income, which would also reduce your potential federal income tax liability.
In the example above ($10,000 net income), your self-employment tax would be 15.3 percent of $10,000, or $1,530. Now, if you were prepared, you make quarterly estimated tax payments to reduce the financial pain. But what if you didn’t see it coming?
Self-employment taxes are reported on Schedule SE (Form 1040). For more information, check with your tax representative or visit www.irs.gov/pub/irs-pdf/f1040sse.pdf. Bottom line: When you see a profit coming up, ask your tax representative how to handle the tax liability—before you have to pay the amount.
State and Local Taxes
State and local taxes are typically no more complicated than federal taxes, but it’s easy to miss something. Seriously, unless you’re very diligent about paperwork, filing deadlines, etc., it’s probably a good idea to work with your tax representative given the complexity.
Most states have an economic development agency (or similar-sounding agency) that was created to encourage business development and try to make it as easy as possible to conduct business and deal with various state and local bureaucracies. The website www.usa.gov has a directory with links to the websites of all 50 state governments plus the territories. In turn, these websites typically have links or contact information for counties and municipalities.
Sales Taxes
As an affiliate earns income from affiliate-related commissions, you typically don’t encounter sales tax. But in the event that your affiliate marketing business expands and you become a merchant and start offering products (physical or digital), then you may have to deal with it.
Sales tax is usually collected by a state or local tax authority, and it is usually a percentage of the sale amount. If you sell a product that costs $100 and the sales tax is 7 percent, for example, then the consumer must be charged $107. You must then remit the sales tax amount (monthly or quarterly) to the appropriate tax authority. Keep in mind that you (your business) do not pay sales tax, but you are required to collect and remit it to the tax authorities.
One way to stay informed about sales tax and related issues is through places like associations that are often among the first to hear about pending rules and taxes affecting businesses. Two organizations that are among the first to see these changes on their radar are the National Mail Order Association (www.nmoa.org) and the Direct Marketing Association (www.thedma.org). Of course, your tax advisor or accountant should also be aware of pending changes.
Digging into Powerful Tax Deductions
As a general rule, expenses incurred on behalf of your business are tax deductible. The IRS notes that for an expense to be deductible, it must be “ordinary and necessary” for your business. While there are some gray areas here, we believe that you know your business as well as anyone else and deciding when an expense is ordinary and necessary in your business shouldn’t be a difficult decision. Of course, if you’re unsure, check with your tax advisor.
We realize that the heavy thought of paying taxes can make you feel a little on edge, but fear not! There is good news buried in the tax regulations. There are plenty of juicy tax deductions available to you, and the first one is right in your own home.
Home Office Expense Deduction
One of the most attractive deductions for home-based entrepreneurs is the home office deduction. It can easily be worth thousands of dollars to you, so take a close look at it. The beauty of this is that by using it you are 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 business owner must make a concerted effort to qualify for.
Keep in mind that there are literally millions of legitimate home-based businesses (whether you rent or own) that, yes, legitimately, claim the home office deduction. The IRS even tells you how to do it! Full details are in IRS Publication 587 (entitled “Business Use of Your Home”).
Here’s an example: Let’s say you are a renter, renting a four-bedroom apartment, and your monthly rent is $1,350. You use one of those rooms regularly and exclusively for your home-based business. Suppose you pay $150 per month in utilities. To complete this example, also assume that for this business, net income is $4,000 ($10,000 less $6,000 of regular, deductible business expenses). Note that for a home-based business, the home office deduction is calculated after regular income and expenses are calculated.
Maximizing Tax Savings with the Home Office Deduction: A Practical Example
Here’s how this example takes the home office deduction:
Total annual rent is $16,200 (12 × $1,350).
Total annual utilities is $1,800 (12 × $150).
The total annual rent and utilities is $18,000 ($16,200 plus $1,800).
Twenty-five percent of your living area is used for a home office (one room out of every four rooms; let’s assume the rooms are generally equal).
So, your home office deduction is $4,500, which is 25 percent of $18,000.
Remember that before you apply the home office deduction, you see that the business generated net income of $4,000 (from the previous paragraph).
Here’s the kicker: The $4,500 home office deduction totally offsets the $4,000 business income, and the business’s taxable net income is $0. Great!
In the last step, note that the $4,000 of business income is cash in your pocket, and the $4,500 home office deduction makes it tax-free. The cool thing about this is that regardless of whether you had the home business or not, you were still going to pay rent and utilities. But now that you have a home business, that home office deduction becomes a powerful tax benefit.
Here’s one more point. In the last step, only $4,000 of the total $4,500 home office deduction was used (only $4,000 was needed). Unfortunately, you can’t use that $500 portion to realize a tax loss. However, you can carry it forward to use in a later year. Great!
There’s more to the home office deduction than our simple example, but we think you get a good idea of the tax benefits. For more information, check out IRS Publication 587 at www.irs.gov/pub/irs-pdf/p587.pdf.
We Break Down the Most Common Affiliate Deductions
Here is a list of the most common tax-deductible expenses that most affiliates typically face in their day-to-day business activities:
- Computer software and business-related applications
- Internet connection costs and Internet-related expenses
- Web design and programming fees
- Office supplies
- Business use of phones and other communication devices
- Advertising, marketing, and promotion costs
- Payments to other affiliates, sub-affiliates, and resellers
- Professional fees (legal, tax, etc.)
- Business publications (online and offline)
- Fees for business-related microtasks (creating a blog or website)
- Postage and shipping costs
- Business membership program fees
See other Common Business Deductions
In addition to the above list of common tax-deductible affiliate expenses, here are other expenses that are generally tax-deductible:
- Business use of Automobiles
- Business-related mileage, tolls, and parking expenses
- Business travel
- Business meals
- Business conferences and educational activities
- Salaries, wages, and other compensation to employees
- Payments to independent contractors
- Costs related to business tax preparation
- Small office tools and equipment used for your business
- Supplies to create crafts to resell
Of course, talk to your tax representative about other possible deductible expenses. For more details on business expenses, visit IRS Publication 535 (Business Expenses) at www.irs.gov/pub/irs-pdf/p535.pdf.
Keeping Good Records
Keeping good records is just as important as getting an annual checkup and eating healthy. When it comes time to report your business activity on your tax return, your recordkeeping system will be invaluable.
Of course, you should keep good records and always ask for a receipt (or a digital record from PayPal). With more and more transactions being done online, receipts are quickly becoming more digital than paper. Keeping receipts will soon go from a collection of messy manila folders and shoe boxes to something as simple as a flash drive (or a file folder on your computer’s hard drive).
In any case, you should be aware of the IRS’s supporting documentation requirements and recordkeeping guidelines. For more details on this, get IRS Publication 583 titled “Starting a Business and Keeping Records” (found at www.irs.gov/pub/irs-pdf/p583.pdf).
Researching the Tax Benefits of Pensions
Whether you run a craft business from your kitchen table or are launching a multinational corporation that spans the globe from your home office, you have real power to build wealth with your business. Even if you run a home-based business, you can set up a pension plan that has more power than a run-of-the-mill IRA (individual retirement account).
For example, there is the SEP-IRA (simplified individual retirement plan for employees). A small business can set it up and have the ability to save up to $56,000 (the 2019 limit) per year. Did you know you can even make your own 401k? There is also the Keogh Plan, the Solo 401(k), and other pension plans.
This topic is too complex to cover in this post adequately, but we mention it here to pique your curiosity and hopefully make you understand that even micro-entrepreneurs have options they can take advantage of now or in the near future that will help them build wealth in the long run, all driven by the positive decision to start their own business.
You can learn more about IRS small business pension plans by getting Publication 560 (“Small Business Retirement Plans”) at www.irs.gov/pub/irs-pdf/p560.pdf.
Review of Resources to Help You With Your Taxes
The amazing thing about the sections above is that we barely scratched the surface, but if you take it step by step with the tips above and the resources below, you should be fine. Don’t try to cover it all at once. Taxes are known to cause nervous breakdowns, so take your time. You have the whole year to familiarize yourself with the topic.
Check out the following IRS guides (all easily downloadable from www.irs.gov/publications):
- Publication 17 – Gives a good overview of Form 1040 and includes references to Schedule C as well
- Publication 334 – IRS Small Business Tax Guide
- Publication 463 – Helps you understand travel and entertainment deductions, as well as automobile 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 obtaining a tax identification number
- Publication 587 – Walks you through setting up your home office and how to take advantage of the home office deduction; Also includes information on Form 8829
- Publication 946: All About Depreciation and Amortization
Paul Mladjenovic’s courses on taxes for affiliate marketers include the following:
- How to Make Any Expense Tax Deductible (www.ravingcapitalist.com/home/how-to-make-any-expense-tax-deductible)
- Home Office Tax Kit (www.ravingcapitalist.com/home/home-office-tax-kit)
Some websites we think are good include the following:
- TaxMama (www.taxmama.com)
- J.K. Lasser (www.jklasser.com)