Yes, you have to pay taxes on cottage food income. The IRS treats money you earn selling homemade baked goods, jams, and other shelf-stable foods as taxable business income no matter how small the operation, and once your net earnings reach $400 in a year, self-employment tax kicks in on top of regular income tax. Most sellers also have a separate state sales tax obligation to sort out. Here is what each piece looks like and where cottage food operators most often go wrong.
How the IRS Treats Your Cottage Food Income
By default, a one-person cottage food business is a sole proprietorship. You report your total sales as gross receipts on Schedule C (Profit or Loss From Business), subtract allowable expenses, and the net profit flows onto your Form 1040. That profit gets taxed at your regular income tax rate, stacked with any wages, interest, or other income.
If you set up a single-member LLC for liability reasons, nothing changes on the tax side. The IRS calls a single-member LLC a disregarded entity, so you file the same Schedule C and pay self-employment tax the same way as a sole proprietor.1Internal Revenue Service. Single Member Limited Liability Companies The LLC form offers legal protection; it does not reduce your federal tax bill.
Self-Employment Tax Kicks In at $400
Beyond regular income tax, you owe self-employment tax whenever net earnings from the business reach $400 or more in the year. That is your Social Security and Medicare contribution. As both employer and employee, you pay both halves.
The combined rate is 15.3%, broken into 12.4% for Social Security and 2.9% for Medicare.2Internal Revenue Service. Topic No. 554, Self-Employment Tax The Social Security portion only applies up to the annual wage base, which is $184,500 for 2026.3Social Security Administration. What Is the Current Maximum Amount of Taxable Earnings for Social Security Most cottage food sellers never approach that cap, so the full 15.3% applies to all their net earnings. One partial offset: you can deduct half of the self-employment tax you pay as an adjustment to income on your 1040, which trims your income tax calculation.
Paying as You Go: Quarterly Estimates
No one is withholding taxes from your cottage food sales. The IRS still wants its money through the year, which means quarterly estimated tax payments using Form 1040-ES.4Internal Revenue Service. About Form 1040-ES, Estimated Tax for Individuals For 2026, the deadlines are:
- First quarter: April 15, 2026
- Second quarter: June 15, 2026
- Third quarter: September 15, 2026
- Fourth quarter: January 15, 2027
Each payment should cover roughly a quarter of your projected income tax plus self-employment tax for the year. If you also have a W-2 job, count the withholding from those paychecks when you figure out how much the estimates need to add.
You avoid an underpayment penalty if your return shows you owe less than $1,000, or if you paid at least 90% of the current year’s tax or 100% of the prior year’s total tax, whichever is smaller. If your prior-year adjusted gross income was over $150,000, that 100% safe harbor becomes 110%.5Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty That higher threshold catches cottage food sellers whose spouse earns a high income.
What You Can Deduct Against Your Sales
Every legitimate business expense you track reduces the profit the IRS taxes. Four categories do most of the work for cottage food operations.
Ingredients and Packaging (Cost of Goods Sold)
Your largest deduction is usually cost of goods sold: ingredients, packaging, labels, and items bought for resale. You calculate it by taking beginning inventory, adding purchases during the year, and subtracting whatever remains at year-end. Only materials that went into products you actually sold count.
This surprises new sellers because it requires measuring inventory at the start and end of the tax year. Cottage food inventory tends to be small and turn over quickly, which keeps things manageable, but you still need to document the numbers in case the IRS asks.
Business Use of Your Home
If you use part of your home exclusively and regularly for the business, whether a dedicated kitchen area, storage, or workspace for processing orders, you can take a home office deduction. The simplified method gives you $5 per square foot of qualifying space, capped at 300 square feet and a $1,500 deduction.6Internal Revenue Service. Simplified Option for Home Office Deduction The regular method takes the business-use percentage of your home and applies it to actual costs like mortgage interest, utilities, insurance, and depreciation. The regular method is more paperwork but often produces a larger number once you account for the electricity and gas that ovens and refrigeration pull.
The exclusivity requirement is strict. A kitchen table that doubles as homework space does not qualify. The area has to be used for the business and nothing else.
Vehicle Mileage
Driving for ingredient runs, deliveries, and farmers’ markets is deductible. For 2026, the IRS standard mileage rate is 72.5 cents per mile.7Internal Revenue Service. IRS Sets 2026 Business Standard Mileage Rate at 72.5 Cents Per Mile That rate covers gas, maintenance, insurance, and depreciation in one number. You can instead track every actual vehicle expense and claim the business-use percentage, but the standard rate is simpler for most cottage food sellers.
Either method requires a mileage log with date, destination, business purpose, and miles for each trip. Without the log, you lose the deduction in an audit. Commuting to a regular job never counts; trips from your home kitchen to a market or supplier do.
Other Deductible Costs
Cottage food permits, food handler certificates, and local health department fees are ordinary business expenses on Schedule C. So are thermometers, mixing equipment, scale calibration, your business website, credit card processing fees, and business liability insurance. None of these items is large on its own; together they often cover a meaningful share of your profit.
State Sales Tax Is a Separate Problem
Sales tax has nothing to do with income tax. It is money you collect from the buyer and hand to the state, with you acting as the collection agent. Five states have no sales tax at all: Alaska, Delaware, Montana, New Hampshire, and Oregon. Everywhere else, the first step is registering for a sales tax permit with your state’s department of revenue before you make your first taxable sale. Selling without one can trigger fines that vary by state.
The harder question is whether your products are even taxable. Many states exempt basic groceries but tax prepared food or food sold for immediate consumption. Homemade baked goods and jams often sit in a gray zone because they are assembled or cooked before sale. Some states have carved out explicit cottage food exemptions; others treat these products as prepared food. Check your state’s definitions before you set prices, because getting it wrong means either overcharging customers or owing back taxes you never collected.
Rates combine state, county, and sometimes city levies, so the rate depends on where the transaction takes place. Selling at a market one county over may mean charging that location’s rate rather than your home rate. Once you are collecting, you remit to the state on a schedule tied to your volume: monthly for busier sellers, quarterly or annually for small operations. The state tracks this separately from the IRS, with its own penalties for late remittance.
If You Bring Someone In to Help
Hiring help changes your tax picture. The classification of that worker, employee or independent contractor, matters a great deal. The IRS weighs three factors: behavioral control (do you dictate how the work gets done), financial control (do you control pay and who supplies tools), and the nature of the relationship.8Internal Revenue Service. Worker Classification 101: Employee or Independent Contractor A person you schedule, train, and equip is likely an employee.
Employees mean withholding income tax and paying the employer share of Social Security and Medicare. Independent contractors handle their own taxes, but starting in 2026 you must issue Form 1099-NEC to any contractor paid $2,000 or more in the year. For prior years that threshold was $600.9Internal Revenue Service. General Instructions for Certain Information Returns Misclassifying an employee as a contractor to dodge payroll tax is a fast route to penalties.
What Late Filing or Nonpayment Costs
The IRS runs two penalties side by side. The failure-to-file penalty is 5% of unpaid tax per month or partial month, capped at 25%. For returns more than 60 days late with due dates after December 31, 2025, the minimum penalty is $525 or 100% of the unpaid tax, whichever is less.10Internal Revenue Service. Failure to File Penalty The failure-to-pay penalty is 0.5% per month, also capped at 25%.11Internal Revenue Service. Failure to Pay Penalty When both apply at once, the filing penalty is reduced by the payment penalty, so the combined rate is not 5.5% a month. After five months the filing penalty maxes out and the payment penalty keeps running.
The practical point: if you cannot pay what you owe, file the return anyway. The filing penalty is ten times steeper than the payment penalty, and the IRS offers payment plans.
Records to Keep
Good records are the difference between filing with confidence and guessing. They are also your defense if the IRS questions a return. Open a separate bank account for the business so money never mixes with personal funds.
Save every invoice, sales receipt, and daily sales tally. Keep original receipts for ingredients, packaging, equipment, and utility bills. For the regular home office method, hold onto records of total home costs. For vehicle deductions, maintain the mileage log. Track sales tax collected separately from gross revenue; those dollars belong to the state and should not fund operations.
The IRS asks you to keep records for at least three years from the filing date.12Internal Revenue Service. How Long Should I Keep Records If you underreport income by more than 25% of gross income, that window stretches to six years.13Internal Revenue Service. Topic No. 305, Recordkeeping Depreciation records for equipment should be kept as long as you own the asset and three years after you dispose of it or stop claiming depreciation.
The QBI Deduction Went Away for 2026
If you have read advice about the Qualified Business Income deduction letting sole proprietors deduct up to 20% of their business income, that provision expired at the end of 2025. The Section 199A deduction was available for tax years ending on or before December 31, 2025, and is not available for 2026 unless Congress passes new legislation to extend it.14Internal Revenue Service. Qualified Business Income Deduction Cottage food sellers who claimed it in prior years should expect a higher effective tax rate on the same income this year.