For most people (myself included), internet marketing begins as a side project. You work on your websites and whatnot on weekends and after you get home from your “9 to 5″ job. At first, you don’t earn a lot, but if you stick with it, you slowly but surely begin generating real income.
Some people hit it big very quickly and others fade out just as quickly as they faded in. If you stick with it, you will eventually reach a point where you have to begin treating your internet marketing activities as a real business.
Today, I’m going to show you exactly how to do that.
A Quick Disclaimer
As you know, I’m a CPA by trade, so I have a fair amount of education and experience when it comes to things like business, taxes, etc. Despite this fact, it’s nearly impossible to give advice that applies to all people. Therefore, although I will be making suggestions in this article, you should not take any of it as “official” tax or legal advice. You’re always better off consulting with a CPA one-on-one so that you can get advice that applies to your specific situation.
In addition, some of the information below will be legal in nature – I am not a lawyer. If you are facing legal questions or uncertainty, you should consult with an attorney and not solely rely on what I’ve written here.
One final note – any tax or legal information I present below is intended for U.S. residents/citizens (as this is where my knowledge base resides). If you live/work in another country, some of this may not apply to you. Either way though, the general principles should be fairly universal.
Why You Should Care About This
When it comes to the administrative side of business – accounting, taxes, business structure, etc. – a lot of people like to turn their heads the other way. After all, you want to focus on making money and growing the business, not dealing with annoying paperwork.
When you’re small and just starting out, this attitude is okay. It’s not ideal, but you won’t likely get yourself into too much trouble. As you grow, however, transactions become more frequent, and things can become more complex.
Not only do you need to be aware of your legal requirements, such as filing taxes, but as a business owner, you want to have a firm grasp on your company’s financial health. If you aren’t properly keeping track of everything, you could be missing opportunities (or failing to identify problems). Even if you hire someone to take care of all of this, it still behooves you to understand it.
First Things First: Maintain Good Records
Before you run off to come up with a clever company name, you need to set up the foundation for your business’s activity. All of that begins with good record keeping. Without this, you’re going to be lost, especially when it comes to taxes.
When you keep track of and organize all the transactions of your business, preparing your tax forms becomes much easier. Furthermore, you can evaluate the different segments of your business effectively. Is website X profitable? What are my biggest costs? Are there areas where I can reduce costs and improve profitability? All of the answers can be found in the numbers, but without them, you can easily miss a lot of things.
You’re may be thinking, “Well, Eric, this is easy for you. You’re an accountant. I’m terrible with numbers.” You’re right, this is easier for me, but that doesn’t mean it’s impossible for you.
There are no ninja accounting tricks to learn. It’s really as simple as this: When you receive a payment, you record it as income. When you spend money on something related to your business, record an expense (and make sure to classify properly it so you remember what it was for).
Where to Maintain Your Accounting Records
How and where you do this recording can vary. Here are some options:
- Outright.com – I list this first because it’s free. Outright allows you to maintain your accounting records online, and it’s fairly simple to use. I’d recommend this for businesses that are just starting out and don’t require anything too complex.
- Microsoft Excel (or other spreadsheet software) – I’ve seen a lot of very small businesses or freelancers use Excel to maintain their accounting records. It works, as Excel is pretty versatile, but if you’re not organized, this isn’t going to force you to be organized. It’s easy for a spreadsheet to get messy, and if you’re not careful, you can inadvertently screw up your records.
- QuickBooks – For small businesses with growing complexity, QuickBooks seems to be the default choice. It’s not cheap, and it takes some learning, but it’s powerful. You can generate different types of financial reports, handle payroll (if you ever hire people), create invoices, and a lot more. Basically, you can manage the entire financial side of your business, even if it gets complex. This is what I have my clients use in most cases.
Taxes: They Suck, But We’d Be Fools to Ignore Them
Taxes are always a hot topic. They’re a necessary evil. And as much as I hate to admit it, the complexity of the U.S. tax system is one of the reasons I have extremely high job security.
This is probably one of the only areas of life that affects almost everyone, yet few people have a complete understanding of it as it pertains to them and their businesses. I’m an experienced CPA, and there is a LOT about taxes that I still don’t completely know and have to learn.
It would literally take me hundreds of hours to write a guide that covers everything you need to know about taxes, but I wanted to hit on some key points and dispel some myths that may be floating around out there.
Common Myths About Taxes
- Myth: If I’m making money online, the government doesn’t see it, so I don’t need to report the income on my tax return.
- Fact: I’m not sure how many people actually believe this, but I do think many people feel they can get away without reporting online income. The fact of the matter is, it’s income, just like your W-2 from your day job. You are legally required to report it and pay tax on it (if applicable). Many companies, like Google, will issue you a Form 1099-MISC for the income you earned (on AdSense, for example). This is also being reported to the government.
- Myth: If I’m working from home, I can just deduct everything related to my home expenses and argue that it’s all related to my business.
- Fact: The home office deduction is actually an area that the IRS highly scrutinizes, and it’s one deduction that will increase your chances of being audited (so you should definitely make sure to do it right). In general, you can only deduct expenses that specifically relate to your business operations. If you have a home office that is exclusively used for work, you can deduct a portion of your general home expenses (such as rent or utilities) based on the % of total square feet your home office uses. Read more here, from the IRS.
- Myth: I don’t make enough money to be audited, so I don’t need to worry about properly reporting income. The IRS has bigger fish to fry.
- Fact: It is true that higher income individuals and businesses have a higher chance of being audited, because logically, the IRS stands to gain more by finding a mistake. However, that doesn’t mean everyone else is in the clear. In 2011, if you filed an individual tax return and reported business activity (on Schedule C), the audit rate for those who earned between $25,000 and $100,000 was 2.9%. For total income under $25,000, the rate was 1.3%. There are a lot more statistics that you can find in the IRS’s report here (see page 22).
Other Important Points
- As soon as things begin to get complicated, I highly recommend hiring a CPA to take care of your taxes (and I’m not just saying that because I am one). It’s not worth the stress of doing it yourself if you don’t have a full understanding of what you’re doing. CPA’s don’t have to be expensive – to prepare a basic tax return for someone with self-employment income (like an internet marketer) could cost as little as $150. And this expense is tax deductible.
- Pay estimated taxes quarterly if you’re making a significant amount of money from your internet marketing activities. What’s considered significant? It depends, but I would say if you’re pulling in at least a few hundred dollars per month in addition to your day job, you should be paying estimated taxes each quarter to avoid penalties and interest when you actually file your tax return. You can read the guidelines for estimated taxes here.
- I recently wrote a guest post at Murlu.com, which you can read here. Basically, I answered several questions about taxes as they apply to freelancers and other individuals who have their own businesses (which all applies to internet marketers).
Formally Organizing Your Business: The Final Step to Make Your Business “Official”
Once you’re up and running, keeping good accounting records, and making sure you have your tax filing obligations under control, you should strongly consider formally organizing your business into a legal entity.
There are several entity choices (and I’m not going to go into all of them), but the most common choice is the LLC (Limited Liability Company).
When you’re the only owner of the business (i.e. you have no partners), you and the LLC are viewed as one and the same, from a tax perspective. In other words, even with the LLC, you will still be reporting your income and expenses on Schedule C, within your Form 1040.
Why create an LLC then? Here are some benefits:
- Your liability is limited (gee, I wonder where they got the name from) – Provided you maintain your LLC as a separate entity from yourself (i.e. it has its own bank account, you don’t mix together personal funds with business funds, etc.), anyone who sues you can’t come after your personal assets. They can only go after the assets of the business. Remember, I’m not a lawyer, so this is just a very general explanation of “limited liability.”
- Use your LLC’s tax ID for tax reporting purposes instead of your Social Security number. Do you ever get a little bit uncomfortable when you have to provide your name, SSN, and other very sensitive information to various websites? Sites like Google AdSense are likely safe, but there are more questionable ones out there that have affiliate programs that require your tax information. If you have an LLC, you can simply provide the LLC’s information instead of your own.
- Bonus reason: If you’ve been banned from Google AdSense, you are allowed to set up a new account if it’s for a separate legal entity (i.e. your LLC).
How to Set Up an LLC
To set up an LLC, I used LegalZoom (aff link). It was really easy and took about 15 minutes.
They will walk you through all the steps, but here are some key things to be prepared for:
1) You will need a business name. Whatever you choose, make sure you’re willing to stick with it, because you won’t be able to easily change it.
2) LegalZoom has a few different packages – go with the Economy one. It’s a bit less expensive, and contains the essentials.
3) Once your LLC has officially been created (it takes several days), make sure to apply for an EIN with the IRS if you went with the Economy package. Because LegalZoom doesn’t do this for you in the Economy package, you have to do it yourself. It’s very easy and you can apply for it online in about 5 minutes here: http://www.irs.gov/businesses/small/article/0,,id=102767,00.html (click APPLY ONLINE NOW).
4) It’s easiest to set up the LLC in the state you reside. Otherwise, you have to pay LegalZoom to be your “registered agent” in the state you choose, if it’s one where you don’t live (or don’t know someone there who can be your “registered agent”). There are benefits to organizing in certain states (Nevada and Delaware are very popular for legal reasons), but that’s beyond the scope of this article.
5) If you have questions, just ask. They have support representatives ready and willing to help you through the process. It seems complicated, but once you finish, you’ll be surprised at how easy and simple it is.
A Few Last Notes
Once you’ve done everything above, you should set up a bank account for your business. It’s important to keep your business funds separate from your personal ones. Yes, you can transfer money in and out as necessary, but you should keep track of these transfers.
In general, when you receive income related to the business, it should go into the business bank account. When you incur expenses, it should come out of the business account. This will make it a lot easier to manage your accounting as well (because personal and business transactions are not mixed together).
Whew – this post is finally over! I know I threw a lot at you here, so please feel free to ask questions in the comments or send me an e-mail. I’d be happy to help as best as I can.
Also, if you found this article to be a valuable resource, I’d greatly appreciate you sharing it on Facebook, Twitter, and wherever else you like to share things. Thanks!