How to Pay Taxes on Your Etsy Sales

Operating an Etsy shop, whether as a primary income source or a side venture, means navigating tax obligations. When you sell goods or services and generate income, the Internal Revenue Service (IRS) views this activity as a business. This classification carries specific responsibilities for reporting earnings and paying various taxes. Understanding these requirements helps ensure compliance and can prevent unexpected tax burdens.

Understanding Your Tax Responsibilities

Etsy sellers face two main types of federal taxes: federal income tax and self-employment tax. Federal income tax applies to all taxable income, similar to wages from a traditional job. Self-employment tax covers Social Security and Medicare taxes for individuals who work for themselves. This combined tax rate is 15.3% on net earnings from self-employment, with 12.4% allocated to Social Security and 2.9% to Medicare. For 2024, the Social Security portion applies to the first $168,600 of combined wages, tips, and net earnings.

You must pay self-employment tax if your net earnings from self-employment reach $400 or more. It is important to distinguish between a business and a hobby for tax purposes. An activity qualifies as a business if your primary purpose is for income or profit and you are involved in it with continuity and regularity. If your Etsy shop is considered a hobby, any income is still taxable, but associated expenses may not be deductible in the same way as business expenses. While this article focuses on federal income and self-employment taxes, sellers should also be aware that state and local sales taxes are separate obligations, often managed by Etsy itself for many transactions.

Keeping Accurate Records

Maintaining accurate financial records is fundamental for tax reporting and maximizing deductions. These records should document all income and business expenses. Income records include sales receipts from Etsy, shipping income, refunds, and payment processing fees.

Meticulous tracking of Cost of Goods Sold (COGS) is essential, encompassing direct costs of materials, labor, and packaging/shipping supplies. Other business expenses to record include:
Etsy listing and transaction fees
Advertising costs
Home office expenses (if applicable)
Internet and phone bills
Mileage for business-related travel
Professional development
Software subscriptions

Tools like spreadsheets, accounting software, or specialized apps can streamline this process, making it easier to categorize transactions and generate reports. Organized records are vital for tax compliance and provide a clear financial picture of your business’s performance.

Calculating Your Taxable Income and Deductions

After organizing your records, calculate your net profit, which forms the basis of your taxable income. This calculation begins with gross sales, subtracting returns, Cost of Goods Sold (COGS), and all other business expenses. The resulting figure represents your net profit or loss. For example, if your gross sales were $10,000, returns were $500, COGS was $3,000, and other business expenses totaled $2,000, your net profit would be $4,500 ($10,000 – $500 – $3,000 – $2,000).

Business expenses can reduce your taxable income, including Etsy fees, materials, supplies, shipping costs, and advertising. If you use a portion of your home exclusively and regularly for your business, you might qualify for the home office deduction, which can be calculated using either a simplified method (e.g., $5 per square foot, up to 300 square feet for a maximum $1,500 deduction) or by deducting a percentage of actual home expenses like rent, utilities, and insurance. Vehicle expenses for business, such as picking up inventory or dropping off packages, can also be deducted using the standard mileage rate (67 cents per mile for 2024). Bank fees and interest paid on business loans are also deductible.

After determining net earnings from self-employment, calculate your self-employment tax. This tax is computed on 92.35% of your net earnings from self-employment. For instance, if your net earnings are $10,000, the self-employment tax is calculated on $9,235. Self-employed individuals can deduct one-half of their self-employment taxes paid. This deduction helps offset the burden of paying both employer and employee portions of Social Security and Medicare taxes.

Reporting Your Income on Tax Forms

After calculating your net profit and self-employment tax, report these figures on specific IRS forms. As a sole proprietor, most Etsy sellers use Schedule C (Form 1040), Profit or Loss From Business. On Schedule C, report gross receipts, Cost of Goods Sold, and itemized business expenses to determine your net profit or loss.

The net profit from Schedule C is carried over to Schedule SE (Form 1040), Self-Employment Tax. This form calculates self-employment tax based on net earnings, ensuring Social Security and Medicare contributions are accounted for. You may also receive a Form 1099-K from Etsy or its payment processor if gross payments exceeded a certain threshold. For 2024, this threshold is $5,000. Even without a Form 1099-K, you must report all business income on Schedule C. Information from Schedule C and Schedule SE flows to your main income tax return, Form 1040, where it combines with other income or deductions. These forms can be obtained directly from the IRS website.

Making Your Tax Payments

As a self-employed individual, the IRS requires estimated tax payments throughout the year, rather than waiting until the annual tax filing deadline. Taxes are not withheld from Etsy income as they are from traditional employment wages. Estimated tax payments are due quarterly: April 15, June 15, September 15, and January 15 of the following year. If a due date falls on a weekend or holiday, the deadline shifts to the next business day.

Several convenient methods exist for making estimated tax payments to the IRS. IRS Direct Pay allows payments directly from your checking or savings account online. The Electronic Federal Tax Payment System (EFTPS) requires prior enrollment but allows scheduling payments up to a year in advance. Payments can also be made by mail with Form 1040-ES, or by check or money order. Additionally, you can pay by debit or credit card, though these options involve processing fees charged by third-party processors.

Pay enough estimated tax on time to avoid underpayment penalties. The IRS calculates penalties based on the amount of underpayment, the period it was underpaid, and prevailing interest rates. To avoid a penalty, pay at least 90% of the tax shown on your current year’s return or 100% of the tax shown on your prior year’s return, whichever is less. Any remaining tax liability after estimated payments is due by the annual tax filing deadline, typically April 15.