For a U.S. based affiliate marketer, the taxes on affiliate marketers can be daunting and time consuming to navigate. Many affiliate marketers fail to understand what the taxes on affiliate marketers are, and how to pay them in a legal and compliant manner. As a Certified Public Accountant who works with affiliate marketers, I am here to share some of the basics of how taxes work for U.S. based affiliate marketers.
Earnings Classifications for Affiliate Marketers
The first step in understanding taxes for affiliate marketers is to understand how affiliate marketers are paid, and how that differs from the way most Americans are paid. As an affiliate marketer, you are paid as what is known as a “1099 Contractor” for tax purposes. This differs than say, a cashier at a grocery store, who is most likely treated as a “W-2 Employee”. The key difference here is that contractors do not have any taxes withheld from their income by their employer (in this case, the affiliate network who writes your check), whereas the W-2 employee at a grocery store has the employee portion of payroll taxes withheld (Medicare and Social Security taxes, which amount to 7.65%), and another portion withheld for estimated federal and state income taxes, respectively. Although it may seem favorable that 1099 Contractors don’t have these taxes withheld from their checks, they still inevitably do owe taxes on their earnings. They are required to pay both the employer and employee portions of the Medicare and Social Security taxes in the form of a 15.3% “Self Employment Tax” and are required, in some cases, to make estimated tax payments to the IRS for their federal and state income taxes. Paying the self employment tax and estimated taxes to the IRS is the most common misconception or oversight amongst affiliate marketers, and often leads to year end surprises. To add an additional wrinkle, there is a common misunderstanding with respect to how taxes work for affiliate marketers operating as a sole proprietorship, LLC, or C-Corporation– which we will discuss next.
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Entity Type (or lackthereof) Matters…Sometimes
If affiliate marketing is simply a “side hustle” or something you do for fun in addition to a full time job, you most likely haven’t filed any paperwork to form a legal entity for your business. If so, you are deemed as operating a Sole Proprietorship for tax purposes, with all income from your affiliate marketing activities flowing through to your personal tax return on your Schedule C. This effectively means that any earnings from affiliate marketing are treated as earnings by you as an individual, and you’ll pay taxes on these earnings on your personal tax return.
If you filed paperwork and formed a Limited Liability Company (an “LLC”), there could be some additional tax ramifications to be aware of. If your LLC is a single member LLC (meaning, only one owner), then you are taxed the same as a Sole Proprietorship with all earnings from affiliate marketing flowing through to your personal tax returns. However, if there are multiple members (owners) of your LLC, you’ll be required to file an informational return (Form 1065) with the IRS to report all earnings from the LLC. In addition, you’ll be required to furnish a Schedule K-1 to all owners of the LLC, which they then use to report their earnings from the partnership on their personal tax returns. The final wrinkle is if the LLC has made an S-Corporation election, you’ll be required to file Form 1120S and furnish a Schedule K-1 to each owner, once again indicating their pro-rata share of the entity’s earnings. The S-Corp election can be a powerful tax savings strategy, and one that I recommend in many circumstances, but is one that you should consult a CPA on before making the election.
The final tax treatment to consider is if you formed a C-Corporation for your affiliate marketing activities. If you did so, you’re required to file Form 1120 with the IRS to report earnings, and the entity pays taxes on those earnings. This is important for two main reasons. First, corporate tax rates are different than personal tax rates. Second, a C-Corporation can introduce the notion of “double taxation” by which the earnings of the company are effectively taxed at the entity level (corporate tax rates) and then again at the owner level (personal tax rates) in the event that dividends are distributed to owners. This is generally the least favorable entity type for affiliate marketers, but there are some instances where it could make sense.
Deductions for Affiliate Marketers
As an affiliate marketer, you are essentially operating your own business, which opens you up to some potential tax savings in the form of deductions. Some common deductions for affiliate marketers are things like hosting fees for websites, content creation fees (i.e. Photoshop, video creation software, etc.) and equipment purchases. What deductions allow you to do is essentially lower your amount of taxable income. As a basic example, say you earned $1,000 in 2016 from affiliate marketing. However, in order to earn that $1,000, you spent $350 on eligible expenses such as hosting fees and landing page creation. This reduces your total taxable income to $650, which can be substantial from a tax savings standpoint. To find out more about what types of expenses are deductible for tax purposes, make sure to speak with your CPA before year end, and document all eligible expenses in a clean and organized manner.
While the world of affiliate marketing can be especially lucrative for some, there are a variety of issues related to the taxes on affiliate marketers that you need to be aware of. It is crucial that you make sure you are staying compliant with the IRS and properly planning for your tax obligations to avoid any nasty year end surprises. Make sure to talk to your CPA about proper tax planning techniques, and explore some of the tax savings deductions and strategies that may help you save come tax time!
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