Different opportunities exist for individuals to make money online. One such possibility includes selling goods from other vendors as an "associate" salesperson. For instance, you might work for XYZ industries during the day, but you might maintain a Website that sells books or posters at night. You know that you won't become a millionaire with that night job, but you enjoy the pocket change anyway. The IRS, however, wants everyone to report every red penny that falls from heaven, so you must report the income you make from that Website (usually as "other income" on line 21 of the 1040 form) .

In the previous article, I offered a link to the IRS that defines the difference between a business and a hobby. If you feel that your income from this Website venture is so minute that it doesn't consitute a business, then the IRS states that, "You may be entitled to certain hobby deductions, but only up to the amount of income reported for each hobby." In other words, you can deduct the amount you pay for server space to host that Website, but that cost cannot exceed the profit that you made. However, other limitations exist as well?

For instance, if you decide to quit that day job and concentrate on the Website revenue, you have then created a business. If you're too nervous to attempt that jump into virtual reality, the IRS still wants your attention with this statement: "An activity is presumed carried on for profit if it produced a profit in at least 3 of the last 5 tax years, including the current year." How do you know if you've created a profit from that Website? Easy - you have a profit when the gross income from an activity exceeds your deductions.

So, if you enjoy those monthly/quarterly checks as an associate salesperson, then you might question whether you really intend to make a profit with that site over the next three to five years. If you do, then you may need to add yourself to the ranks of the self-employed (even if you remain employed fulltime at XYZ), because although the goods you sell belong to someone else, you have created a space in that organization as an independent contractor.

Additionally, the business that you represent may send you a Form 1099 if you meet a certain mark in their payment schedule. In other words, if you make only $25 - $100 per year, you might fly under the radar for a year or two. But, if you begin to make more than $100 per year or if you continue this activity for three years or more, you and the IRS probably will receive the 1099. You just need to report the income printed on that form and in most cases that 1099 income belongs on a Schedule C because you probably will want to deduct your business expenses from that income to reduce tax payments. In this case, I would suggest that you read last week's article about self-employment taxes and gear up for the future.

The second virtual income scenario involves a person who sells goods online, but the goods come from the warehouse in the back yard instead from an unseen entity. In this case, you are definitely self-employed rather than an independent contractor. Here's an example of how an online business like this can be built inadvertently, just in case you wondered how you ever landed in this position (this comes from personal experience):

Say that your teenage daughter makes money when she sells her handmade earrings to her friends. As a parent you are proud of her accomplishments, and you suggest that perhaps she can sell her earrings online. You both look for an online venue, choose one, and the sales begin. Before you know it, this venture has developed into a cottage industry.

Now, several issues are attached to the above scenario. First, your child needs a Social Security card, because that child may need to file a tax return to report income. Secondly, an income tax return must be filed by that child if she is a dependent and her earned income exceeds $5,000. See the IRS earned income filing requirements for child dependents to estimate where you stand in this case. Think about this: at $20 per pair of earrings, your daughter only needs to sell 250 pairs to meet $5,000. But, also remember that costs for selling and shipping those earrings can be deducted from this business.

If you're interested in more information about how a child files a tax return, be sure to read the entire page attached to that link in the previous paragraph. If you intend to make this earring business your business and hire your child as an employee, that presents a different scenario altogether. In addition, that child could hire you and that's another can of worms. For more information about these processes, visit the IRS page on family employment. You may want to consult a financial planner, as those individuals may have more detailed information about how to make tax and business decisions which feel right for your family.

The third and final scenario for virtual income comes from the service sector. In this case, you might sell your graphic capabilities, writing, tax preparation, or other services (like Web accessibility consultation) to people in local or international markets. You might believe that this sort of business could be quite profitable, as your overhead is limited, and your hours are your own. And, you would be correct, especially if you are successful with sales. The only problem with limited overhead is that deductions are difficult to find. And, your hours may be your own, but your business may swell into a monster that eats into your non-business hours.

In addition, if you offer your services to businesses located outside your residential state, you may owe more state taxes than you care to pay. Next week I'll demonstrate how state taxes can snack on the monetary contents within your wallet when you create income from certain online ventures.

Until Then,
Linda Goin