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©2023 Charles Plesums
Austin Texas USA
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Before we get started, the disclaimer. Remember that I am not qualified (licensed) to give tax or legal advice, but am only sharing my interpretation of the advice I have received, which I believe is legal and honorable, and probably applies to others as well as me.
If you are young and starting a business that you hope will grow and support you, there may be other web sites that are better, but since you are here, I do have some specific hints for a growing business, in addition to the general advice here. Most of the advice on this page is for a one person "business" that doesn't want to grow - often operated by a retired person or someone approaching retirement, like myself.
Countless people have told me that they can't sell the furniture other crafts they make because they haven't set up a business, or they haven't completed the paperwork establishing their corporation (Legal Zoom suggesting everyone needs their service, in my opinion, is wrong). The big thing is that you do not have to "set up a business" to get started. Nobody expects an artist to set up a business to sell a painting.
In fact, there are good reasons to NOT set up a business - do not incorporate, create a LLC, or file a DBA (Doing Business As...). Your parents gave you the business name - "John Doe" or in my case, "Charles Plesums." I am not doing business under an assumed name (although if I just use "Plesums" without "Charles" or if I use "Charlie Plesums", or Plesums Furniture, those are assumed business names). The assumed name may trigger franchise fees or taxes that don't apply to an individual selling something they made.
Should you incorporate? I decided not for me. If I had a business with many employees and a product failed, it would be hard or impossible to determine who was at fault. The most a customer can do is sue the company, so a corporate structure would be good to isolate the business finances from my personal savings. As an individual craftsman, if a product fails, the lawyers know who they can blame, so a corporate structure doesn't provide much protection. Having a corporate structure when you don't really need it does help support your friendly lawyer and accountant - please help them send their kids to college!
You should hope that you will make enough money that you will need to pay taxes! Report what you sell on Schedule C of your 1040 personal income tax. Schedule C is really simple... if you sell something (even as a kid with a hobby), you should always have recorded the revenue there. You can deduct the cost of materials (supplies) used to make what you sell on schedule C as well. Warren Buffet, one of the world's richest people, started with a paper route, filed his newspaper income on Schedule C, and deducted the cost of his bicycle as a necessary business expense.
Do you need insurance? For my business there are a couple main concerns: product liability and contractor liability.
Are you a business or a hobby? The usual federal test to distinguish between a business and a hobby is that a business explicitly tries to make a profit, and is actually profitable at least once every 7 years. If a business loses money one year, it can deduct the loss in one year from their profits the following year(s). If you are only a hobby, any losses one year cannot be used to offset profits in future years.
In general, the machines and tools you buy to conduct your business can be deducted from your profits. In some cases, business property is taxed, while personal property is not, so some people own their machinery personally, and loan or lease it to the business. Of course, that means that they may have to pay sales tax on the equipment, as an individual buyer, rather than taking the exemption from sales tax that may apply to a business purchasing manufacturing equipment. If your craft is both a business and a hobby, you can deduct the portion of the machinery related to the "business" (if half the time you make things for yourself, and the other half of the time you make things to sell, then half of the cost of the equipment can be deducted).
If the business owns machinery or inventory, it is often subject to additional taxes such as property tax. Therefore I avoid keeping any inventory... I order just the materials I need for a specific project. See the separate discussion on cash basis accounting. For tax purposes the leftovers from one project can have zero value, even though I may not want to discard them. I even own the machines personally (yes, I paid sales tax on them).
If a portion of your home is used for business, that portion can be deducted as a business expense. Sounds great... but be careful. If you use the guest room as your office, but if you occasionally have a guest, it is contaminated, no longer used exclusively for business, and is no longer deductible. My garage is dedicated as my shop, but I don't know if I could prove it was never used for household functions. Accountants tell me that deducting a portion of your home as a business often will trigger a tax audit. I don't figure the tax savings from the "business use of your home" deduction is worth the accounting or the risk of a tax hassle.
Cash or Accrual? You do have to keep careful financial records, no matter how big or small your business. Since I do not have inventory, I can choose to operate on a "cash basis" rather than "accrual." On a cash basis, all materials received are "used" the instant I pay for them (no inventory), and nothing is sold until I am paid (no accounts receivable). If you buy material in December, and deliver the product in January, that project will look like a loss in the earlier year. Sounds silly, but it is perfectly legal, and quite simple.
Accounting Software: I use the basic "Personal" Quicken, not the more expensive and complex Quicken for business or Quick Books. (They can help you if you have complex billing, inventory, etc., but they are not necessary for a solo craftsman.) Microsoft Money was similar but has been discontinued. If you keep precise financial records, you don't even need a special bank account - but if you aren't certain about your bookkeeping precision, a separate bank account may help you track business income and expenses.
Do you have to "do" sales tax? In Texas, yes. You even have to do it if you have more than two days of garage sales in a year. You have to do it if you sell your work at a craft fair. If you don't collect sales tax, and are caught, you have to pay the sales tax (and probably a fortune in penalties and interest), and you can bet your customer isn't going to volunteer to pay the sales tax later.
This site (layout and contents) is ©2008-2023 by Charles A. Plesums. The material is free for personal use. Questions? contact us.