Do You Have To Have an LLC to Sell On Etsy?

Uncategorized Apr 18, 2021

It finally happened.

You decided that it was time to start selling on Etsy or your own personal website!

Now, before we can get to celebrating, coming down the other side of the highway are all of the things you really wish you knew about sooner….

That’s right, I am talking about all of the not fun things about running a business, like paying taxes for your Etsy Shop, getting licenses and permits for an Etsy Shop, opening up bank accounts, and deciding if you need to be an LLC for your Etsy Store or not.

Or more simply, how to start an Etsy Shop. 

The right way...the "business way"...the REAL way to start an Etsy shop. 

In today’s article, I am going to go over some of the most important things that you should do when you open an Etsy Shop, including going over the major question I get…

Do I need to have an LLC to sell on Etsy?

Before we get into all of that though, let’s first go over whether or not you are in fact a business at all.

This is the first thing you want to do when you are starting out your Etsy Store...

Step 1. Decide if you are a business or a hobby.

When you first start out your Etsy Shop, there are actually two things you can be considered in the eyes of the IRS, one is that you are considered a business and the other is that you are considered a hobby. 

You see, there is a MAJOR difference in your tax consequences and your legal requirements depending or not if your Etsy Shop or Handmade Store operates as a business or as a hobby.

So, what is the difference between a hobby and a business?

It all comes down to what expenses and deductions you can take on your taxes. If you operate as a business you can take certain business deductions like travel, office supplies, rent and advertising. If you are operating as a hobby, you can ONLY deduct the actual materials, or cost of goods sold that you have, AND you can only deduct UP to the amount of income you have. Now in order to operate as a business and take advantage of the extra deductions, you will need to follow some requirements, so let’s go fully into step 1 of the process…

How do you decide if your Etsy Shop is a hobby or business?

To figure this out, let’s go over a couple common scenarios in which you WOULD be considered a business. If ANY of these sounds like you, then you ARE IN FACT a business and you are NOT a hobby.

  1. Are you trying to make a profit by starting your Etsy or Handmade Store? I am sure this is easy to answer. Ask yourself this one simple question: Am I doing this to make a profit? If you answered yes to this, then you are a business and NOT a hobby. Now, and this is important, whether or not you actually MAKE a profit IS NO DIFFERENCE, it is what your intention If you're intent is opening up an Etsy Shop for profit, it's a business, not a hobby.
  2. The second question to ask yourself is this. Are you actually MAKING a profit on your Etsy or Handmade Store? If you have made a profit in 3 of the last 5 years, meaning that you made more then you spent in 3 of the past 5 years, then you are IN FACT a business and NOT a hobby.
  3. The third question is this. Is your shop a partnership or LLC? If you've formed your Etsy Shop or Handmade Store as a partnership or LLC, you are 100% a business and NOT a hobby.

Now, these are the 3 easy questions to ask yourself, if you want to make sure you are 100% operating as a business and can take all of your business expenses and deductions let’s go over how the IRS decides if you are a business or a hobby. 

According to the IRS, here are the 9 factors for considering this a business and NOT a hobby

  1. Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
  1. Whether the time and effort you put into the activity indicate you intend to make it profitable.
  2. Whether you depend on income from the activity for your livelihood.
  3. Whether your losses are due to circumstances beyond your control (or are normal in the startup phase of your type of business).
  4. Whether you change your methods of operation in an attempt to improve profitability.
  5. Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.
  6. Whether you were successful in making a profit in similar activities in the past.
  7. Whether the activity makes a profit in some years and how much profit it makes.
  8. Whether you can expect to make a future profit from the appreciation of the assets used in the activity

If you answered yes to most of these questions then you are IN FACT a business and will need to treat it as such when you go to file your taxes. The way you treat a business for tax purposes is fairly straight forward and what you do is take ALL of your income and ALL of your business-related expenses and complete what is called a Schedule C. This Schedule C is what is commonly referred to as the “Profit and Loss from the Business”.

Now, if you answered NO to most of these questions and your intention is NOT to make a profit, then you will be treated as a hobby for tax purposes and how that works is like this…

You will take the total amount of gross receipts you have, or total “income” that you have for the year and then you can ONLY deduct the total “Cost of Goods Sold” you had.

The difference between the “income” and “costs of goods sold” is what will be considered your taxable “hobby income” and this will be reported on Schedule 1, Line 8 of your 1040.

Let’s go over a hobby example

Let’s say you make blankets and you decide that you want to sell some of these “just for fun” AND let’s say that you did not make a profit in 3 of the last 5 years AND let’s say that you do not meet any of the 9 requirements above, if you are following along, this means you are a hobby, right?

So, since we are a hobby, we can only deduct what is called the cost of goods sold.

Now, we know in order to make blankets we need to purchase the cotton or fleece, or whatever material to make the actual blanket. The materials you purchased to make the blankets are what is considered your cost of goods sold.

The total amount of materials, or cost of goods sold we purchased to make the blanket is what we can deduct from the total amount of income we had.

So, let’s say you made $10,000 selling blankets and the material used to make the blankets is $4,500. But let’s also say you spent $400 on setting up a website, $250 on office supplies, $500 for studio space, $700 on advertising and $250 on gas. If you are a hobby, you can ONLY deduct the $4,500 and CAN NOT deduct ANY other expenses.

Now, when you go to fill out your tax form, on Schedule 1, Line 8 on the 1040, you will report $10,000 minus $4,500 or $5,500 of taxable income. You can NOT deduct the website, office supplies, studio space, advertising or gas as you are NOT a business and these are considered business expenses!

It is that easy, if you are a hobby, make sure you figure out the total amount of income you have and deduct the total amount of Cost of Goods Sold you have and report in on Schedule 1, Line 8, Form 1040.

If you are a business make sure you follow all 9 of the IRS requirements to “be a business” and make sure you take all of your income and ALL of your business-related expenses and report it on the Schedule C.

Now, at this point in the process, we know how to decide if we are a business or a hobby and we know the tax implications of both.

So, what’s next?

If you are a hobby, there actually is no next step, you can stop reading here and get back to having fun and making your blankets. All you need to do is report the total amount of income minus the total amount of cost of goods and file your taxes.

If however, you realize at this point that you are in fact a business there are still several things we will want to do and the next step, or step 2 in the process is deciding on what kind of business structure we will be…

Step 2. Decide If You Need to be an LLC or Sole Proprietor for My Etsy Shop   

The next thing you want to do when starting out is deciding how to set up an Etsy business. Now, a business needs to be  "structured". The structure is the way your business is organized in the eyes of the IRS and in the eyes of the law. It is really just telling the law and the IRS, hey, here is how I am set up.

The two most common “structures” for an Etsy Shop or Handmade Store are a Single Member LLC and a Sole Proprietorship.

A Sole Proprietorship for an Etsy Shop is an entity that is owned and run by one person and in which there is no legal distinction between the owner and the business entity. Meaning, you are the business and the business is you.

A Single Member LLC Etsy Store is a company that becomes its own legal entity. That means its owner is typically not held personally responsible for debts or if legal action is taken against the business

Let’s go over some of the advantages and disadvantages of both…

Here are the advantages of a Sole Proprietor

  1. You can do this instantly, without any money and easily, boom you’re a sole prop because you said so 
  2. You really do not report to ANYONE but yourself, no one really knows you exist 
  3. You do not need to pay unemployment tax

 

Here are the disadvantages of a Sole Proprietor

 

  1. You have UNLIMITED exposure to liabilities, so if you get sued, YOU are on the hook.
  2. You cannot SELL the business, because there IS no business 

 

Here are the advantages of being an LLC in most states

  1. As long as members do not pierce the corporate veil, they are not personally responsible for debts of the LLC
  2. Raising Capital or obtaining a Loan through the LLC
  3. More professional appearance

 

Here are the disadvantages of being an LLC in most states

  1. Some states charge extra fees for operating an LLC, looking at you California
  2. Increased paperwork like Articles of Organization or other state or local documents
  3. You need to follow strict guidelines as to NOT pierce the corporate veil

 

Now, if you noticed, the biggest advantage of being an LLC over a Sole Proprietorship is the amount of exposure you have to litigation friendly customers and the fact that you look more “professional”. The only real difference is that we are not “legally” separated from the business. Now, this can get confusing and here is how I like to break it down.

If you need more help deciding and want to know how to do it in YOUR state, I recommend checking out my "Get Legit Kit". It is a 50 page guide that breaks this stuff down to a science. It literally has every single state mapped out on exactly how to set up an LLC and a Sole Proprietor in YOUR state. Check it out below. 

Grab The Get Legit Kit Here!

 

To think about it simply, think about it like this, when it comes to deciding on being a Single Member LLC or staying as a Sole Proprietorship, there are two sides the one side is the Tax Side and the other side is the Legal Side.

Let’s go over these two.

The Tax Side

In the eyes of the IRS, it DOES NOT MATTER if you register your Etsy Shop or Handmade Store as Single Member LLC or not. If we have not set up an LLC, then we are considered a Sole Proprietorship. A Sole Proprietorship is STILL a business and can STILL take ALL business deductions and expenses. You will be taxed the same exact way whether you decide to form a Single Member LLC or you operate as a sole proprietorship. A sole proprietorship can still do the same things as an LLC for tax purposes. There is actually NO difference AT ALL between a sole proprietor and an LLC. A sole proprietor can still take expenses, can still take deductions and will actually be required to file the same exact forms (Schedule C) as an LLC.

The Legal Side

To start off, I am not a lawyer and, in my opinion, I would CERTAINLY consult with a lawyer. What I am about to say is for informational purposes only and should not be considered legal advice. 

With that said, here is what I believe is an easy explanation. When you set up a Single Member LLC, you set up a corporation and a separate entity from yourself. There is you THE PERSON and there is you THE BUSINESS. There are now two separate entities in the eyes of the law. I know it can be confusing because according to the IRS a Single Member LLC and a Sole Prop are taxed the same, BUT in the eyes of the law they are separate. If you can think about it like that and that the IRS has one set of eyes and the law has another, then you will understand this concept.

Now, when deciding to be a Single Member LLC, you must do something which is called “protecting the corporate veil”

A corporate veil is “a legal concept that separates the personality of a corporation from the personalities of its shareholders, and protects them from being personally liable for the company's debts and other obligations.”

So, in plain English you can understand, this means you are legally "free" from your business.

So how does that happen? What does it mean to be legally free from your business?

Let’s go over an example

Let's say your name is Mary and you sell under Mary, as a single person, a single entity or as I said above, a sole proprietor. Let’s say you never set up any LLC to establish yourself as a separate entity.  And now let's say I get a faulty product and my head blows up. I know this is very unlikely, but hey, things happen. So now, headless, I want to sue you and I want to sue you for everything you have!

If you never set up a Single Member LLC, I can take everything you have AS A PERSON, I can take your personal house, I can take your personal car, I can whatever the court allows me.

Now let's say though that you were smart and DID set yourself up as a Single Member LLC. When I go to sue you, I can ONLY take whatever your LLC has. And since Mary’s LLC does not own the house and does not own the car, I cannot touch any of these things.

Now, and this is important, I cannot touch any of her personal assets as long as she does not “pierce the corporate veil”. What this means is there are cases in certain states where an LLC and a person will be considered the same thing and if your LLC gets sued your personal assets can be taken. This will happen if you “pierce the corporate veil”, or simply, you and your LLC are acting as one in the same and a court can not tell that you are “separate” or “legally free” from the LLC. So how does this happen? How do you “pierce the corporate veil”

Here are the most common ways you can “pierce the corporate veil”.

  1. You mix personal and business funds ALL of the time, from time to time it happens, but if you consistently pay for your rent or mortgage out of your business bank account it can be said that you and your business are not separated
  2. Failing to keep accurate records for the LLC
  3. You commit fraud, a big no no in the eyes of the law AND the IRS. I would never recommend committing fraud 😊
  4. Using business assets for personal use, without any type of proper documentation

Now, how can we avoid piercing the corporate veil?

Well, in the next step we will go over probably the easiest way to avoid piercing the corporate veil which is opening up a separate business bank account and avoiding comingling business and personal expenses.

But before we get into that, let’s just wrap up this section on Business Structures.

Wrap Up on Business Structures

Again, I am not a lawyer and I would recommend consulting with a business lawyer before doing anything major, however, in my opinion it always makes sense to register your business as an LLC. It makes you look more professional; it gives you more protection and it will allow you to operate like a real business.

I am sure it is rare that you will be sued as an Etsy or Handmade Store, but something that may happen is you get in over your head with some loans or debts that are actually for the business. If the bank or lender starts to worry about the status of the loan or debt, they could potentially come after you personally if you do not have a separate entity set up.

So, know that we know the legal and tax consequences and the advantages and disadvantages of a Sole Proprietor and Single Member LLC, the next step in the process is opening up a separate or business bank account. If you remember from up above, opening up a separate or business bank account will help you protect the corporate veil if you are an LLC and if you are a sole proprietor it will make your life SO MUCH easier when it comes to separating out your personal and business expenses. So, let’s move on to step 3..

Now again, if you want to know how to do this in YOUR state specifically, I recommend checking out my "Get Legit Kit"

 

Step 3. Open a Separate or Business Bank Account for my Etsy Shop

 

Once you register as an LLC or decide to stay as a Sole Proprietor the next thing you would want to do is open up a business or separate bank account. While this is not a legal requirement to open a separate bank account there are reasons it is important, the first being is will make your life so much easier…here’s why…

 

#1 Reason to Open a Business or Separate Bank Account

Imagine your own personal bank statement, maybe it’s 5 pages long every month: now imagine you start selling and buying items for your Etsy or Handmade Store, maybe it jumps to 10 pages a month and the number of transactions you have start to make your head spin.

Now imagine, it is April 1st and you know you need to go through almost 120 pages of bank statements just to figure out what was personal vs what was business for your taxes.

If your personal and business transactions are all in one place, the amount of time and energy to do this will make you want to just wing it. From my experience, it will take about 15-20 hours JUST to go through a personal account and “pull out” the business transactions and you will certainly miss some business expenses in there and you may even put in some personal expenses.  

Now, if you have a separate account for your business transactions, you have a clean records and transactions at the end of the year to complete your tax return since everything is one place.

 

#2 Reason to Open a Business or Separate Bank Account

The second reason it is important to have a business bank account is to prove that this is not a hobby. If you want to take all of the business expenses you can, you may need to prove that you are not a hobby to the IRS and a really easy way to prove you are not a hobby is opening up a separate business bank account. It will make you look professional and that you are in fact trying to operate as a true business.  

#3 Reason to Open a Business or Separate Bank Account

The third reason it is important to have a business bank account is a clear audit history. No one likes to hear this word, but it DOES happen. While it may never happen to YOU, YOUR business may actually be audited by the IRS. If that does happen, it will make both them and you happy that there is a clear line between your business and you the person due to you have a clear record of things in your business bank account.

#4 Reason to Open a Business or Separate Bank Account

The fourth reason is to ensure you are not “piercing the corporate veil”. If you remember from up above, a really easy way to separate yourself and the business is by establishing VERY clear lines between the two. An easy way to establish this line is to open a separate bank account and AVOID co-mingling as much as possible.

#5 Reason to Open a Business or Separate Bank Account

The fifth and maybe most important reason to open a separate bank account is to establish yourself as a professional. You'll need a business bank account to accept bank card transactions on your sales, which means you'll have to get a business bank account first. 

If you keep your business finances separate from your personal finances, it shows the IRS and the law that you are being professional and that you have dedicated time and energy to making this business profitable, which will protect you both from a tax perspective and a legal one as well.

Finally, once you find a bank that you like, they will be more willing to extend a line of credit to your business, offer a business credit card or even give you a loan down the road when you need one.  

So, to wrap up Step 3, we know the reasons it is important to open up a separate bank account which are it makes our life easier. It proves we are not a hobby. It gives us a clear audit history. It ensures we are not piercing the corporate veil and finally it gives us a professional edge.

So now we completed step 3, if you are following along, Step 1, we decided if we were a hobby or a business. Step 2 we decided what kind of business structure we want to be and in Step 3 we went over why we want to get a business bank account.

The last step deals with the more regulatory side of things like obtaining licenses and permits.

Step 4. What Kind of Licenses and Permits Do Etsy Shops Need?

Ok, so a common question I get a lot is whether or not you need business license or permits for an Etsy Shop or Handmade Store and while it is not always the easiest question to answer, here are some common guidelines and tips for you…

Here are the four most common licenses and permits you will need to operate as a business 

#1 Basic Business Operating Permit

A basic business operating permit which is a permit that allows you to operate your business within the local government's geographical jurisdiction, so very simply this is a license within your local government, whether it be a county, city or state. The license requirements for operating a business vary by state and by city, so your best bet is to contact your local Small Business Administration office to ask what permits are required in your city. For Etsy and Handmade Stores, the licensing requirements are usually minimal, and the application costs are usually between $50 and $100 (although this varies by city and state).

#2 Employer Identification Number (EIN)

AN EIN #. An EIN# or Employer Identification number is a special number that is set up by the IRS themselves and this is how you will report your income and loss to the IRS. You will use this number on your schedule C. IF you are operating as a sole proprietor, then you DO NOT need to obtain an EIN and you can just use your SSN to file and pay your taxes. If you formed an LLC or Partnership then you must obtain an EIN #. With an EIN# you will look more legitimate

#3 Home Occupation Permit

The third most common permit you will need is what is called a Home Occupation Permit.  If you're operating your business out of your home, you may be required to get a Home Occupation Permit. For most Etsy and Handmade Stores, this isn't much of an issue, but if you're making your products out of your home (as many Etsy Shops and Handmade Stores do), you might need this permit. I would recommend reaching out to your local SBA or even City Hall.

#4 Sales Tax or Sellers Permit

The final permit or license you will need is a Sales Tax Permit. I will have an entire article related to sales tax later, but for now, let’s just briefly talk about it. Once you register as a business and since you are selling products online at a minimum you NEED to and MUST register your business in the state to collect sales tax. Briefly, this is actually a relatively easy process and it something that intimidates a lot of Etsy and Handmade Stores but in short, at a minimum register to collect sales tax in the state in which you operate. For example, I live in Pennsylvania and to register for sales tax in my state all I need to do go to google and type in “Register for Pennsylvania Sales Tax”, from here I walk through their forms and steps in order to receive a “Sales Tax Number”. This number is VERY important to keep hold of. So now every time I make a sale in Pennsylvania and collect sales tax, I can report this BACK to the state under my state ID number and keep them off my back. Again, I will go over an entire article on Sales Tax later, but for now, just make sure you register to collect sales tax for the state in which you operate!

Now, this one is probably the MOST requested question I get outside of "do I need an LLC to start my Etsy Shop". 

The seller's permits and sales tax licenses will vary VERY much by state, so I saved you the time and have linked here my "Get Legit Kit" which goes over YOUR state and if you need a seller's permit and more importantly, if you do HOW to actually file a sales tax form for your Etsy shop. Grab it below here. 

Grab the Get Legit Kit Here

Alright, so this is a brief breakdown of the different kind of licenses and permits you will need to operate as a real legitimate business. Very briefly, these are a

  1. Basic Operating Permit for my Etsy Business,
  2. EIN # for my Etsy Business,
  3. Home Occupation Permit
  4. Sales Tax or Sellers Permit for my Etsy Business.

The Basic Operating Permit and Home Occupation Permit can be obtained by contacting your local state, county or city SBA office. The EIN # can be obtained by registering your LLC with the IRS and your sales tax or sellers permit can be obtained by a quick google search on your specific state. In my experience dealing with all three of these government offices or administrations is actually a relatively easy process and they are super helpful when it comes to telling you exactly what you need and even will walk through with you step by step.

Conclusion

If you followed these four steps, at this point you are operating as a real, legitimate Etsy business and have met all of the requirements of the federal, state and local governments and should have no worries or issues when it comes to proving yourself as a true, legitimate business. Just to recap, the four steps to setting up your Etsy or Handmade Business are

  1. Deciding if you are a business or hobby
  2. Deciding what kind of business structure is best
  3. Opening up a business or separate bank account
  4. Obtaining the appropriate licenses and permits for the federal, state and local governments

If you followed all of these steps, the next thing you will want to make sure is you are keeping accurate books and records. Now, this is my specialty and is something you can check out here.  I have an Etsy QuickBooks Tutorial and an Etsy QuickBooks Course. It goes over how to do Etsy QuickBooks and How to Do Etsy QuickBooks Self Employed

Also, if you want some free stuff, click on the "free stuff" on my website :) 

Until next time…

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