Mike Cane pointed me to this unhappy tale about the IRS sending an unexpected tax bill to the creator of the Online Etymology Dictionary related to their Google Ad revenues:
First the warning: If you have a Web site, and you ever put Google ads on it, and you ever made a penny off those ads, congratulations! The Internal Revenue Service owns you.
According to the IRS you are a private contractor employed by Google; you are a business; and you will have to pay business taxes and the rates that go along with them. Doesn't matter how big you are, how long ago you put those ads there, or whether you made $20 or $20,000 off them.
Did you know that? I didn't. I had to start putting Google ads on etymonline in 2005, because people kept ripping the entire content at one gulp and it was crashing the servers. Some of you regulars might even remember that time. The only solution was to rent more expensive servers, and the only way I could afford that was to minimally monetize the site with the smallest possible ads.
I had been declaring that ad revenue as "extra income" and dutifully paying my taxes on it. Suddenly last year the IRS informed me I owed them scads of money that I didn't have. Link to "Cancel Christmas"
What I gleaned from the story (and subsequently confirmed with the author) is that the web site creator reported the Google Ad payments as income but did not treat them as self-employment income. If you are an independent contractor or operate a business as a sole proprietor, you are not only subject to income tax but also to self-employment tax. Self Employment tax is the equivalent of the FICA and Medicare taxes that are withheld from wages. When you are an employee, your employer pays half of the tax, but when you are self-employed, you must pay both halves. The tax rate is 15.3% on the first $106,800 and 2.9% of anything over that amount.
Self-employment tax is imposed on your net business income, not gross. What may have happened in this case is that the author reported the Google Ad payments as "other income" on page one of Form 1040 and did not file Schedule C, which is where you report net income from a business. Had the author reported the Google Ad revenue on Schedule C, he would have been entitled to reduce the amount subject to both income tax and self-employment tax by allowable deductions, such as the payments to the web host, which is supposedly what the Google Ad money went to pay for.
It may be that the web site creator can still file amended returns for 2007 through 2009 and reduce the assessed amount. Generally, the statute of limitation runs three years from the date you file your tax return. The taxpayer does not have to merely accept the tax assessment in a situation like this. In my opinion, the next step would be to submit amended returns to the IRS moving the income to Schedule C and reporting the business expenses that offset the revenue. It may be that by doing so, the assessment can be reduced to zero. The IRS will take into account additional facts or a change in the way that items are reported, but they need you to provide them with the additional information in a format that they can accept. That is where your CPA, tax attorney or enrolled agent can provide valuable assistance.
Mike Cane writes on his blog:
The decree would be: IRS calculates the monetary value of using a free site and taxes us based on that use. There are “in-kind” taxes that could easily be contorted to make this happen. The IRS could rule we’re obtaining taxable value in a way that makes us allwind up owing them something.
Or: They could decree that since WordPress is deriving monetary value from the ads on this site, I am therefore a WordPress contractor somehow liable for the value I’m adding to their system. Link to Mikecanex.wordpress.com
IRS can tax you on value that you derive but not on value that you create for others. Bloggers should be cautious about bartering to avoid recognizing taxable income, but IRS will tax Wordpress on value they received, not Mike Cane.
Bottom line: If you are a blogger or web site creator and receive Google Ad revenue, whether $20 or $20,000, you should report that as income on Schedule C. You should also report all the deductions that you incurred in earning that income, such as your web site hosting, monthly ISP bills, and maybe even depreciation on your computer. The net income is subject to both income tax and self-employment tax. Whether you consider your blog or website to be a business or a labor of love, if you receive money from advertisers, from a paypal link on your page, or by any other means, your web site is a business. I join the creator of the Online Etymology Dictionary in hoping that his unhappy surprise helps others avoid a similar fate.
11 comments:
However tempting assuming that everything written in the first person is a blog post is, the cited paragraphs were *not* made by a "blogger". ;) They were an announcement on a home page (what an anachronism...) of a typical webpage (a rare occurrence these days, again), whose author... well, perhaps does maintain a blog, but it is not what he is primarily known for.
See etymonline.com.
Sorry for a half-topic comment.
My apologies. I was linked to the web site by a third party and wasn't aware of the context in which it appeared. I will correct my post.
What happens if your expenses are greater than your ad income? Doesn't the IRS frown on calling something a business that loses money year after year?
Ha,
You make a good point. The rules you describe are called hobby loss rules and they may prevent you from claiming a bet loss against other income, but those rules would not prevent you from claiming enough deductions to offset the ad revenue.
Phew! This is alarming stuff! I can't help but wonder when the IRS (or in my case) the ATO will start trying to collect off the Aussie tax payer too. I think they may have to wait a while though...there are far more 'tryers' out there than 'succeeders' and until they change the tax laws again (which they do on a regular basis anyway)they will owe the Aussie tax payer more than they can ever collect.
Running a website/blogsite is costly when you don't get any returns on it. But hey, the ATO could perhaps refund our money...whatdoya think? Worth a try :-)
What if I have never cashed out any of the money made from ads? I added google ads to my blog a while ago and have made less than $20.. Because I never received any money from it, I don't need to worry about the tax stuff right? I'd rather cut the ads out than having to deal with this later.
Dear Taxman, I have a question regarding deductions on the Schedule C in a situation like this, basically, how is the value against taxes calculated?
For example, If I make $1000 from Site A in a year and pay $10/month in hosting, is my overall tax burden reduced by $120? Or is it the taxable income that is reduced now to $880? Is there a formula and is there a limit to deductions? What if you had $1000 in expenses on $1000 in earnings? Do you pay no taxes on it?
Basically I am trying to figure out how deductions work and if investing on something like equipment and labor to build a product makes sense from a tax perspective.
I hope that question makes sense, and I would greatly appreciate an answer. This post was really interesting to read, since I am also generating earnings from the same program.
Much thanks, I am subscribing to your blog.
Anon #1: Most small businesses adopt the cash method of accounting. So, you aren't taxed until the year you receive the money from Google. So, I would agree that you don't have to worry about the $20 that Google hasn't paid you.
Anon #2: Deductions reduce your income in computing taxable income, they don't directly offset the tax liability. So, in your example, the $120 expense would reduce the $1,000 income, resulting in $888 of net business income that is subject to tax. Consider other expenses such as your monthly ISP bills, and possibly depreciation of your computer equipment. IRS even allows a 100% write-off of most furniture and equipment (called 179 expense) used solely for business. Home computers are in a category called listed property and require you to keep records of your percentage of business use to claim depreciation or 179 expense.
I really appreciate your comments and taking time to read my post. This topic is apparently of great interest to a large number of people. Please note that my advice is general in nature and should be discussed with your tax advisor.
https://www.google.com/adsense/static/en_US/TaxInfo.html
Seems pretty clear.
Would you say that ad revenue earned from a mobile app should also be reported on Schedule C?
Yes I would say that ad revenue from a mobile app should be recognized as income on Schedule C for an individual.
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