There’s an old saying “in this world nothing can be said to be certain, except death and taxes”. While the former can be put off with exercise and a healthy diet, the latter can’t be avoided quite as easily. The United States has a number of tax laws on the Federal, State, and Local levels that WordPress theme and plugin developers need to be aware of. This post will talk about the tax implications of things like outsourcing work, incorporating your business, and sales taxes.
As a former accountant who has made the transition into WordPress plugin development, I’m familiar with how complicated the tax issues that developers face can be. I’ve even developed a plugin to assist with 1099-MISC reporting for affiliates and multi-vendor marketplaces called WP1099. As a freelancer, and small business owner, I know how difficult it is to keep track of ever-changing tax laws, so this cheat sheet was written to help you understand what you need to do to stay compliant with the tax authorities.
Incorporating Your Business
Many people with a WordPress theme or plugin business consider the job a “side-job” and tend to treat it as such. Unfortunately, these side-jobs take real money from real customers. That can mean your side-job can end up putting yourself in legal trouble if something goes wrong with a customer.
The best way to protect your personal assets is to incorporate your business. This isn’t a difficult process, and in many states, it is fairly inexpensive to do.
Incorporating creates a legal entity that is separate from the individual(s) who created it. With this legal designation, the business owner(s) are generally protected from personal liability from the company’s debts. This means that if your company gets sued, your personal assets (your house, car, retirement accounts, etc.) can’t be attached to the lawsuit.
Corporation or LLC?
Corporations and Limited Liability Companies (LLC’s) both offer their owners personal liability protection described earlier. They each have their pros and cons, so it is important to choose the right legal entity type for your business.
LLC’s provide several advantages that benefit new businesses. An LLC protects business owners from personal liability for the actions of the LLC. They also have no formal management structure, or formal meeting requirements like a corporation has. Additionally, taxes are paid on the business owner’s personal tax return, which avoids “double taxation” that corporations pay.
Corporations, on the other hand, are taxed as separate entities, which creates what’s called double taxation. This means that they pay tax on their profits through their corporate tax return. Then the owners pay tax on the share of the profits that are distributed to them on their personal tax return.
The choice between a corporation and an LLC is going to depend on a number of factors. Generally, though, freelancers and “solopreneurs” will want to choose an LLC. If you are uncertain what the best legal entity is for your business, contact a business law attorney in your area.
In every solopreneur’s career, there comes a time when you become overwhelmed with the amount of work you have to do. Running a business is a much different animal than being employed. As a business owner, you wear all the hats until you can afford to hire someone to do some of the work for you.
Running a business is a much different animal than being employed. As a business owner, you wear all the hats until you can afford to hire someone to do some of the work for you.Tweet
But what does it mean to hire someone? Are they employees, or are they contractors?
According to the IRS, you need to examine the relationship between the worker and the business to determine if they are an independent contractor or an employee.
There are three categories that need to be looked at.
- Behavioral Control: Can a business direct and control what work is done and the manner that it is done in?
- Financial Control: This includes how the business pays the worker. As well as whether or not the worker is able to make their services available to a wider market.
- Relationship: Are there written contracts describing the relationship between the business and worker? Does the business provide the employee with benefits like insurance, pension, vacation, or sick pay? Is the relationship considered permanent, or temporary?
All of these are considered when determining if a worker is an employee or an independent contractor. And any one of them can cause the worker to be classified as an employee.
So what’s the big deal, right? An employee, contractor, what difference does it make?
The difference is if a worker is considered an employee, the business (also known as the employer) is responsible for things like payroll taxes, workers compensation in the event of an on-the-job injury, and other similar matters like health insurance.
Whereas an independent contractor is responsible for paying their own taxes, which are referred to as self-employment taxes. An independent contractor is also responsible for their own insurance. This includes health insurance, long-term disability insurance, as well as business liability insurance that would be used in the event that a legal dispute arises in the course of doing business.
Example of an Employee Relationship
A worker may be considered an employee if you’ve hired them at a set salary (or hourly rate), you provide them with employee benefits, have the ability to dictate how they work (where they must work from, hours they must be available, the equipment they must use, etc.).
For example, Sally is hired by ABC Co., which designs websites for clients as a lead web designer. Her salary is $50,000 per year, and she is expected to work from the corporate headquarters Monday-Friday each week between the hours of 9 AM-5 PM. Sally will also get a new laptop and software from ABC Co. that she must use for all company work. She gets two weeks paid vacation per year, receives health insurance, and retirement savings matching.
Sally is considered an employee.
Example of an Independent Contractor Relationship
Let’s use the same example, with a few modifications.
ABC Co.’s lead web designer was out on maternity leave, and one of their major clients had a design update that needed to get done within the next two weeks. ABC Co. asked Sally to do the project for $1,500. Sally can do the work whenever and wherever she wants on her own laptop, as long as the job is done within two weeks. ABC Co. has no objections to Sally taking on other clients during the same time period if she wants to. After the project is complete, ABC Co. has no obligation to provide any additional work to Sally.
Sally is considered an independent contractor.
Types of Independent Contractors
You may typically find the following types of workers in an independent contractor relationship with another business.
- Temporary workers that you might use for a one-off job. For example, a graphic designer to create your company’s logo and letterhead.
- Affiliates are considered independent contractors because there usually aren’t any rules as to when or where they need to work, and their only pay is generated when they bring in business. A salaried salesperson, on the other hand, might be considered an employee.
- Vendors in online marketplaces like ThemeForest, CodeCanyon, or other similar sites.
As a business, you’re not responsible for paying an independent contractor’s payroll taxes. However, you are responsible for reporting the income they’ve earned from you to the IRS if they’ve made over a certain amount on Form 1099-MISC. In most cases, that amount is $600, however, it could be as little as $10.
Wait, $10? I thought only payments over $600 were required on a 1099-MISC?
Generally, any royalty payments totaling over $10 for the year need to be reported, while most other payments need to total $600 or more. Payments are considered royalties when you pay another person for their intellectual property. For example, when you sell a theme on ThemeForest, ThemeForest is selling your intellectual property on your behalf. The money they pay you are considered royalties. As long as you earn $10 or more during the year, ThemeForest will be sending you a 1099-MISC.
In order to report earnings on a 1099-MISC, you will need to collect the worker’s information on an IRS form W-9. It’s always advisable to request this information when the contractor begins doing work for you. The IRS requires that you have this information on file before making payments that exceed the minimum threshold. If the contractor refuses to provide the information, the business is required to withhold 28% of the payments and submit it to the IRS.
This isn’t fun for either party, so it is best to make sure your contractors provide the W-9 information up front to avoid the unpleasant situation of having a lighter-than-expected check come through.
If the contractor is not based in the US, you will need a W-8BEN as documentation that they do not require a 1099-MISC.
To make things a little easier if you’re hiring a corporation, you’re not responsible for reporting their income on a 1099-MISC. However, a W-9 will identify the type of legal entity that you are working with, so it’s important to get the form filled out from each worker.
1099-MISC reporting is a topic that could warrant its own blog post (or a series of blog posts).
As an employer with employees, you are required to withhold payroll taxes from each paycheck.
The basic formula for an employee’s paycheck looks something like:
- Gross pay for the pay period (salary or hourly rate x hours worked)
- Less required payroll tax deductions
- Less voluntary payroll tax deductions
By law, employers must withhold the following taxes:
- Federal income tax. The amount to be withheld varies based on the amount that the employee earns. See Publication 15 for more details.
- Social Security tax. The total amount is 12.4% (6.2% for the employer and 6.2% for the employee).
- Medicare tax. The total amount is 2.9% (1.45% for the employer and 1.45% for the employee).
- State income tax. The amount varies by state, so check with your local state taxation authorities.
- Local taxes. Cities, counties, and other local governments may have additional income taxes that need to be withheld. Again, check with your local government for more information.
Voluntary payroll deductions include things that the employee has agreed to have deducted from their paycheck. This can include:
- Life and health insurance premiums.
- Retirement plan contributions.
- Employee stock purchase plans.
- Union dues, and other similar job-related expenses.
Similar to 1099-MISC reporting requirements, payroll taxes is a topic in and of itself. For many businesses, it may make a lot of sense to hire an accountant or payroll agency to handle the calculations for you. Just learning the ever-changing rules can be enough of a distraction from your business that it keeps you from getting the work done that you need to do to stay in business.
Just learning the ever-changing rules can be enough of a distraction from your business that it keeps you from getting the work done that you need to do to stay in business.Tweet
When working on your theme or plugin business, it’s easy to use your personal bank account for any business-related income and expenses. However, it’s important that you set up a separate bank account that is only used for business purposes.
All of your income should be deposited into this account, and any expenses you have related to your business should be paid out of the account.
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It is OK to put personal money into, and eventually pay yourself out of the business account. Actually, that’s pretty common. When a business gets started, it will need money so the owner will typically deposit money into the business account. This is called an owner investment.
When you eventually need to take money out of the business, it’s a good idea to put the funds directly into your personal account. This is called an owner’s draw. So, in this case, you’ll pay yourself ($2,000), rather than paying directly for an item ($7.39 for a coffee at Starbucks).
When you avoid using your business account to pay for personal items directly, it makes life so much easier when it is time to do your taxes. At tax time you will know that the expenses and income in your business account are only for business purposes. There’s no need to hunt around dozens of other personal transactions in your bank statement when reconciling your books.
Your business will likely sell a product or service to your customers. In many cases, there are sales taxes that you have to collect as well.
In the United States, there is no sales tax on the federal level that applies nationwide. The downside to this is that the sales taxes we have to collect vary from state to state, and in some cases from city to city.
To further complicate things, each local sales tax applies to different things. For example, in some areas services are not taxable, while digital products are. Each jurisdiction can charge different sales tax rates on different classes of items, so just because something is taxable, doesn’t mean that it is taxed at the same rate as everything else.
For more information on sales tax rates, visit the Sales Tax Institute’s website, or your local tax authority.
Just because you might be a US-based business, doesn’t mean that other countries aren’t going to tax the sales you make in their jurisdictions.
The European Union charges a Value Added Tax (VAT) to most sales that are made in the EU.
But wait, I don’t sell in the EU I’m located in America!
Technically, as a supplier of digital products to customers in the EU, your business is responsible for charging VAT and submitting it to the individual governments. The VAT isn’t a simple flat percentage though, as each country has its own rate and their own tax authority that you need to submit to.
If you are a B2B operation, you may not need to collect VAT as it becomes the buyer’s responsibility to pay the VAT. However, you will need to collect and verify the customer’s VAT number to make sure they aren’t an individual who is trying to avoid paying the tax with a bogus VAT number.
The VAT isn’t a simple flat percentage, as each country has its own rate and their own tax authority that you need to submit to.Tweet
Just like sales taxes and 1099-MISC reporting, EU VAT is a complicated topic that could require its own series of blog posts. Just know that it is your responsibility to file and pay VAT to the appropriate European tax authorities. However, using a solution like Freemius to sell your WordPress products frees you from that liability by handling it for your business.
Taxes are hard
There’s a saying “if you think hiring a professional is expensive, wait until you hire an amateur”. I think that saying is especially applicable when deciding whether or not to take care of business tax related matters on your own. There are penalties for failing to file or withhold enough money. If that wasn’t enough to scare someone into hiring a professional tax accountant, you should also know that the tax rules change all the time. So, even if you have a good grasp on what your business is responsible for this year, chances are good that next year will bring about a whole new set of changes.
If you are uncertain about what your business is responsible for from a tax perspective, my recommendation would be to hire a CPA or tax accountant to help guide you down the right path.