Don’t get me wrong … the extra money is great! But if you’re accustomed to the simple process of doing your taxes on your own, things are about to change!
Not only will you have some fun, new IRS forms and worksheets to fill out, you’ll also have some new taxes you owe or – worse – penalties to pay! But on the bright side there will also be some new, pretty good opportunities for you to dodge some of those taxes and save even more for retirement than you were before.
I know it’s not just me that has had some questions about how exactly you’re suppose to handle your online income when it comes to your taxes. The reason I know this is because I’ve received a wonderful suggestion for my friend ARB over at Angry Retail Banker to write a blog post about how I’ve been dealing with this new reality for the past few years.
Well, I’m no tax expert (and certainly not a tax professional). But for my own personal situation, I do work with a professional tax advisor and can share a few tips or two for someone looking to figure out what steps to take next.
To LLC or Not?
One of the first questions ARB wanted to know was whether or not I had ever took action to form an LLC for my online business.
The short answer is “no”, I haven’t.
I’ve thought long and hard about that same question. I’ve done quite a bit of research and got advice from a number of pros in the business. And, to sum it up, quite frankly they all tell me the same thing: From a financial perspective, there really isn’t a whole lot of benefit.
Now, that’s not to say that there’s anything wrong with an LLC. But you have to remember – an LLC is designed protect you in legal matters. If you believe you will ever be sued or accused of something, then an LLC will really help. In my case, the sad reality is that I am a semi-anonymous blogger with a pretty low audience. I don’t really produce anything or sell any products, and I don’t provide any tangible services.
Also, when I write articles, they are they don’t really contain anything any specific investment advice. Usually they are mostly generalizations about good (or sometimes bad) experiences that I have had, and I’m always very careful to mention that what worked for me may not work for everyone. And if that’s not enough, there’s also a giant disclaimer at the bottom of every single one of my websites that appears on every page. So all-in-all, my risks are pretty low.
I’m sure at some point if I ever end up actually doing financial coaching, speaking events, and working one-on-one with people on a regular basis, then perhaps that would be the right time to form an LLC. But for now, I feel I’m good.
I don’t exactly have anything against forming an LLC, it’s just at the moment every professional that I’ve talked to has said I’m not really in a spot where I need one exactly.
Okay, so no LLC. But what about the money itself? Should you open a separate bank account? Should you keep your online earnings separate from your other personal finances?
Again, it doesn’t really matter. It’s all in how you report your money.
To be honest, I have never really done much in the way of separating my business income from my regular finances. I simply let all of our income filter into my PayPal account (since that’s where most of it comes to anyways), and then from there, I transfer it into my regular accounts.
One thing I could do a better job of is to filter the money into my investment accounts. I unfortunately find myself sometimes needing that money for everyday things like splurges or big-ticket purchases around the house. Hey, I’m only human, right?
Watch Out for Tax Penalties! Make Early Payments
One thing you do have to be very mindful of is that now if you have online income coming in, that money has NOT yet been taxed. That’s a lot different than when you work at your job and the taxes are just taken out automatically.
Here’s the kicker: If you make too much money on the side (that doesn’t get taxed throughout the year like your employment income), then the IRS will penalize you because you paid too little into your taxes for the year.
I know … I found out the hard way!
The solution: You have to make “early payments” into the IRS throughout the year so that you don’t risk paying too little into the system.
Although that sounds like a pain, again, you’re already basically doing this with your employment check anyways. The difference is that the responsibility is on you to figure out how much and what to do.
Fortunately, there is an easy way to handle this. And again, it’s working with a real tax professional (versus trying to do it yourself and screwing it all up).
Every year, my tax professional and I calculate how much I estimate to make throughout the year, and then he sets up how much extra I need to pay into my taxes for the year so that I don’t risk any penalties.
If I end up paying too much in, no big deal! I just simply get a refund for the year. If I make more money than I anticipated, then we can adjust one of my quarterly payments to cover it. Either way, I’m covered!
The Incredible SEP IRA
One of the best things of course with working with the tax professional is that you get to find out all the little tricks there are when it comes to filing your online income as a business.
By far and large, my favorite trick to use (that is also perfectly legal) is taking a portion of my online income and paying myself a SEP IRA for retirement.
For anyone who wants to know a lot more about what us up areas, you can read about it on my post here. Basically, a SEP IRA is money you got to pay to yourself as an employer (since online income is technically self employment income) for the purpose of retirement, just like how your employer would to a 401(k) or other plan.
From a practical standpoint, what that means is that you can effectively lower the amount of taxes you have to pay for the year and save more for retirement! That’s a huge win-win for you!
By doing this over the last three years, I’ve been able to save anywhere I’ve been able to save an extra $3,000 to $4000 each year. And that’s on top of what I’m already saving in my 401(k), 403(b), and other IRA’s.
Keep in mind that’s $3,000 to $4,000 that I did NOT have to pay taxes on. And at my effective tax rate, that means I save myself paying the IRS almost $1,000 each time. So, I get to save money and not have to pay taxes? Sign me up!
You’re a Business – Track Your Finances Like One!
In order for you and your tax professional to have the absolute best chance of success, I strongly, strongly encourage you to keep accurate records of every transaction that happens with your online income throughout the year. You don’t need anything fancy. Just a simple ledger in MS Excel will do fine.
Every time you receive affiliate income or someone pays you in Paypal for a post, write it down. Every time you hire a freelancer or renew your domain, write it down. What your accountant will be looking for at the end of the year as a summary of all the expenses and all the sources of income that you had throughout the year. As a professional, they have a legal responsibility to make sure that what you’re claiming and what the representing is true and honest. So the easier you make that on them by doing your work throughout the year and keeping an extremely accurate book of records, the better the two of you will be.
As I mentioned, I’m sure that at some point in the future I will rethink and probably act on forming an LLC. There is absolutely nothing wrong with setting one up, and have a legal standpoint, it probably is a smarter way to go. However at this level of my on my blog and business development, it’s not a make it or break it type thing.
As long as you can keep good accurate records of your business transactions, and are willing to shell out the money for a good tax professional advice, then you should have absolutely no worries about how to handle your online income.
I highly, highly encourage anyone that has the ability to take advantage of the SEP IRA. I can’t stress this enough, you get to pay yourself instead of the IRS. Save more money, and pay less taxes. I’m not sure how much better it gets than this!
Readers, how do you handle your own my business and come when it comes time for taxes? What advice would you give to newer bloggers who are starting to make a little bit of money, and need help figuring out how to best handle it?
Featured image courtesy of Flickr | Neubie