After writing this information out about a dozen times in the last few years (especially since joining Etsy, where thousands of new shops are created every day), I've decided to post this information here in hopes that even more people will find it useful. I should add that I am not a tax professional nor am I an attorney, however I am a sole proprietor who has run a small business in two states, as well as participated in hundreds of craft fairs in many states over the last 30 years. As a reminder (see the title of this post above), this information is mostly for California artists, however those living in other states may benefit from this post as well.
You'll need a seller's permit. The Board of Equalization (BOE) issues this permit, at no cost to you. This permit is what allows you to collect sales tax on your sales. Of course, once you've collected the sales tax, you'll need to turn it in. The BOE will tell you what schedule you're on -- monthly, quarterly, annually, etc. Most new, small, businesses are on an annual filing schedule. The BOE has changed to an online filing system, so you will now prepare your sales tax return online. If you do art/craft fairs (or other events) in other states while living in California, those states may require you to obtain a sales tax permit or license from them as well -- however, please don't worry about this until you need to! Also, if you sell in cities or counties other than the one in which you reside, you should check on the tax rate for those other areas; in California the sales tax rate varies from place to place, and ranges from about 8% to more than 10%!
Your city or county may require you to have a business license -- even if you're only selling online or at craft fairs. Fees for local business licenses vary widely, from free to $100 or more per year. Call your city clerk and/or county clerk's office or go to your city's or county's web site and look for a link about "Doing Business in ..." This business license is strictly for the business, it doesn't have anything to do with sales tax. Some cities where you do art or craft fairs may require you to get a local permit. This is often included in the application fee for the show, however sometimes the show promoter will tell you how to apply for it directly.
If your business operates under a name other than the owner(s) full legal name, then a Fictitious Name Statement must be filed with the County Clerk's office (sometimes called the County Clerk-Recorder) in the county where the business is located. Look in your phone book's government pages or do an internet search to find the address and phone number of this office in your own county. This generally requires publication in a newspaper, however that requirement can often be met by using an inexpensive community-based paper rather than a big city paper!
For those of you starting businesses in 2011, you'll need to file business income taxes for 2011. This is the income tax due on April 15, 2012. You'll need to complete Schedule C (Profit or Loss from Business) and possibly Schedule SE (Self-Employment Tax) in addition to your 1040 and any other schedules or forms that you're required to file. Look at this year's Schedule C to get familiar with the various categories of deductions. I've used Schedule C for many years and it hasn't changed much in all that time.
For your record-keeping, you can either use an Excel or Google spreadsheet or specialized software such as QuickBooks; the main point is to keep accurate records that back up what you're reporting on your income tax return. A spreadsheet has always worked well for me. Each year I set up a spreadsheet with a column for each type of deduction from Schedule C (rent, supplies, utilities, etc.). Be sure to save all business-related receipts for supplies or anything else related to the business! If you buy from someone who doesn't or can't give you a receipt (at a flea market, for example), write your own "receipt" with as much information as you've got (date, location, seller's name if you know it, what the item was, how much you paid, etc.). It's easier when tax time rolls around if you've kept your bookkeeping up-to-date throughout the year. However, if you're organizationally and/or mathematically challenged, at least put your receipts in a shoebox or envelope so they're all in one place and you can hand them over to your tax preparer when tax time rolls around.
Schedule SE only gets filed if you show a profit of more than $400 (this amount may change at some point). It's a very short form and super-simple to complete!
As for selling online, you don't need any additional licenses or permits to do that. At this time, sales tax is only collected on items shipped to a state where you have a "physical presence." (There has been ongoing debate for about a dozen years -- ever since the internet, and e-commerce/online shopping, really took off -- about changing this. The "Amazon Tax" which you may hear about on the news is related to this, so pay attention to those news reports!) For small business owners, "physical presence" is generally defined as where you live, although when your business grows much larger and you establish a manufacturing facility in another state, then you'll have a physical presence in that state as well (we can all dream of that day, right?). If you happen to live in one state, but have a studio or shop in an adjoining state, you probably have a physical presence in both states; if this is your situation, just check with the sales tax authority in both states and they can help you sort it all out.