Yes, you have to pay taxes on cottage food income. The IRS treats money from selling homemade baked goods, jams, and other shelf-stable foods as fully taxable business income at the federal level, no matter how small the operation. Once your net earnings for the year reach $400, you also owe self-employment tax on top of regular income tax. Sales tax is a separate matter handled by your state, and the rules there vary widely.
How Federal Income Tax Applies
By default, a one-person cottage food business is a sole proprietorship in the eyes of the IRS. You report gross sales as gross receipts in Part I of Schedule C (Profit or Loss From Business), subtract your allowable expenses, and the resulting net profit flows onto your Form 1040. That profit is taxed at your regular income tax rate alongside wages, interest, or any other income.
If you formed a single-member LLC, nothing changes for federal tax purposes. A single-member LLC is a “disregarded entity,” so you file Schedule C exactly like a sole proprietor and pay self-employment tax the same way.1Internal Revenue Service. Single Member Limited Liability Companies The LLC may give you liability protection, but it doesn’t change what you owe the IRS.
Self-Employment Tax and the $400 Threshold
Self-employment tax is your contribution to Social Security and Medicare. When you work for someone else, an employer withholds half and pays the other half. When you sell cottage food, you’re both sides, so you pay the full amount.
The combined rate is 15.3%, made up of 12.4% for Social Security and 2.9% for Medicare.2Internal Revenue Service. Topic No. 554, Self-Employment Tax It kicks in the moment net earnings reach $400 for the year. You can deduct half of the self-employment tax you pay as an adjustment to income on your 1040, which trims your income tax bill a little.
Quarterly Estimated Payments
Cottage food income has no withholding, so the IRS expects you to send tax in as you earn, using Form 1040-ES.3Internal Revenue Service. About Form 1040-ES, Estimated Tax for Individuals For 2026, the quarterly 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 combined income and self-employment tax. If you also draw a paycheck from a job, the withholding from that job counts toward what you owe, so factor it in before writing the check.
You avoid an underpayment penalty if you owe less than $1,000 on the return, or if you paid at least 90% of the current year’s tax or 100% of last year’s total tax, whichever is smaller. If your prior-year adjusted gross income was more than $150,000, that 100% figure becomes 110%.4Internal Revenue Service. Underpayment of Estimated Tax by Individuals Penalty That mostly matters if you have a high-earning spouse or other significant household income.
Deductions That Lower What You Owe
Every dollar you spend running the business reduces your taxable profit on Schedule C. Tracking expenses carefully is where most of the tax savings live.
Cost of Goods Sold
Usually the biggest deduction. This covers the direct cost of making your products: ingredients, packaging, labels, anything you buy for resale. You calculate it by taking beginning inventory, adding purchases during the year, and subtracting whatever inventory remains at year-end. Only materials that went into products you actually sold count.
This trips people up because it requires knowing inventory at both ends of the tax year. For most cottage food sellers the inventory is small and turns over fast, but you still need to document it in case the IRS asks.
Business Use of Your Home
If you use part of your home exclusively and regularly for the business, whether that’s a dedicated kitchen area, a storage room, or an office corner for taking orders, you can claim a home office deduction. Two calculation methods are available.
The simplified method gives you $5 per square foot of dedicated business space, up to 300 square feet, capped at $1,500 per year.5Internal Revenue Service. Simplified Option for Home Office Deduction Just measure the space. The regular method works out the percentage of your home used for business and applies it to actual expenses like utilities, mortgage interest, property taxes, insurance, and depreciation. More paperwork, usually a bigger deduction, especially given the electricity and gas that running ovens and refrigeration consume.
The exclusive-use test is strict. If your kids do homework at the same table where you package cookies, that table doesn’t qualify. The space has to be used only for business.
Vehicle Expenses
Driving to buy ingredients, deliver orders, or work a farmers’ market is deductible business mileage. For 2026, the IRS standard mileage rate is 72.5 cents per mile.6Internal Revenue Service. IRS Sets 2026 Business Standard Mileage Rate at 72.5 Cents Per Mile That one rate covers gas, maintenance, insurance, and depreciation. You can instead track every actual vehicle expense and claim the business-use percentage, but the mileage rate is simpler for most sellers.
Either way, keep a mileage log with the date, destination, business purpose, and miles for each trip. No log, no deduction if audited. One side issue worth checking: some personal auto policies exclude coverage for food delivery, so ask your insurer whether business driving is covered or whether you need a commercial-use endorsement.
Other Common Expenses
Cottage food permits, food handler certificates, and state or local licensing fees are all deductible on Schedule C. So are equipment like thermometers, mixers, and scales; website costs; payment processing fees; and business liability insurance. Small items, but they add up over a year.
Retirement Contributions
One deduction cottage food sellers often skip: contributions to a self-employed retirement account. A SEP IRA lets you contribute up to 25% of net self-employment earnings, with a 2026 ceiling of $72,000.7Internal Revenue Service. SEP Contribution Limits (Including Grandfathered SARSEPs) A Solo 401(k) is another option with slightly different mechanics. Even modest contributions reduce taxable income dollar for dollar.
State Sales Tax Is a Separate Obligation
Sales tax has nothing to do with the income tax you owe the IRS. It’s a tax collected from the buyer and passed to the state, with you acting as the collector. Five states impose no sales tax at all: Alaska, Delaware, Montana, New Hampshire, and Oregon. Everywhere else, the rules apply.
Before your first taxable sale, register for a sales tax permit through your state’s department of revenue. Selling without a valid permit can bring fines that vary by state.
The tricky part for cottage food is whether your products are even taxable. Many states exempt basic groceries but tax “prepared food.” Homemade baked goods and jams often sit in a gray area because they’ve been assembled or cooked before sale. Some states have written specific cottage food exemptions; others treat these products like any other prepared food. Check your own state’s definitions, because getting it wrong means either overcharging customers or owing back tax you never collected.
Rates combine state, county, and sometimes city levies, so what you charge depends on where the sale actually happens. Selling at a market in a different county than where you live may mean charging that location’s rate. Once you’re collecting, you remit to the state on a schedule tied to your sales volume, from monthly for high-volume sellers to annually for small ones. Late remittances carry their own penalties and interest, tracked separately from anything the IRS is doing.
Penalties If You File or Pay Late
The IRS charges two separate penalties, and they can stack. The failure-to-file penalty is 5% of unpaid tax for each month or partial month the return is late, capping at 25%. For returns due after December 31, 2025, if your return is more than 60 days late, the minimum penalty is $525 or 100% of the unpaid tax, whichever is less.8Internal Revenue Service. Failure to File Penalty
The failure-to-pay penalty is smaller but persistent: 0.5% of unpaid tax per month, also capping at 25%.9Internal Revenue Service. Failure to Pay Penalty When both apply at once, the filing penalty is reduced by the payment penalty so you’re not paying the full combined rate.
The practical rule: if you can’t pay, file anyway. The filing penalty is ten times steeper than the payment penalty. Filing on time and arranging a payment plan is far cheaper than doing nothing.
Records to Keep
Good records are the difference between filing with confidence and guessing, and they’re your only defense in an audit. Open a separate bank account for the business so personal and business money never mix.
On the income side, save invoices, sales receipts, and daily sales tallies. On the expense side, keep original receipts for ingredients, packaging, equipment, and utility bills. If you use the regular home office method, hold onto records of total home expenses. For vehicle deductions, keep that mileage log.
Track sales tax collections separately from your gross revenue. Those dollars belong to the state, and mixing them with operating cash creates problems when it’s time to remit.
The IRS requires records supporting a return for at least three years from the filing date.10Internal 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.11Internal Revenue Service. Topic No. 305, Recordkeeping Records for depreciated equipment or property should be kept while you own the asset and for three years after you dispose of it.
One Change for 2026: No QBI Deduction
If you’ve read older advice about the Qualified Business Income deduction letting sole proprietors deduct up to 20% of 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 the 2026 tax year unless Congress extends it.12Internal Revenue Service. Qualified Business Income Deduction Cottage food sellers filing for 2026 will see a higher effective tax rate than in prior years if their income was previously eligible.
If You Hire Help
Bringing someone in to bake, package, or deliver adds a separate layer of tax responsibility, and how you classify that person matters. The IRS weighs behavioral control, financial control, and the nature of the relationship to decide whether a worker is an employee or an independent contractor.13Internal Revenue Service. Worker Classification 101: Employee or Independent Contractor Employees mean withholding and payroll taxes on your end. Contractors handle their own taxes, but starting in 2026 you must issue Form 1099-NEC to any contractor you pay $2,000 or more during the year, up from the $600 threshold in prior years.14Internal Revenue Service. General Instructions for Certain Information Returns Misclassifying an employee as a contractor to skip payroll tax is a fast route to penalties, so when it’s a close call, treat the person as an employee.