Online Sellers Face New IRS RulesBy MARTIN VAUGHAN The New York Times -- Like many eBay sellers, Sarah Davis didn't set out to be a business owner. But somewhere between her first online sale and last quarter's $560,000 in sales of second-hand luxury handbags, it dawned on her that she had become one.
If you regularly sell items on online auction sites, you may find yourself on the Internal Revenue Service’s radar. Recent legislation aims to help the IRS collect more taxes from online enterprises, many of which either don’t know about their tax obligations or are ignoring them, according to the agency.
The provision will require PayPal and other processors of online payments to report annual gross receipts to the IRS for all but the smallest online merchants.
The payment processors will be required to file a 1099 form for each merchant to the IRS and to the merchant. They won’t have to file for merchants with less than $20,000 in gross sales and less than 200 transactions in a given year.
And they won’t start reporting until 2011, giving the banks and the merchants a couple years’ head start to make sure everything is in order. So far, online sellers have avoided many of the taxes paid by brick-and-mortar businesses. For one, they don't have employees. They hire consultants and contractors. Thus, they pay no employer payroll tax. For another, many pay no corporate tax, or state and local taxes. They pay only income tax on what they earn. The new IRS regulations aim to change that.
Report all income from online sales, even from casual or hobby selling. If you made a profit from goods sold on eBay -- whether vintage KISS action figures or hand-knitted doggy sweaters -- you owe income or capital gains taxes, and likely self-employment taxes, too. No taxes are owed, however, on used items that you sold for less than what you paid for them, essentially using the online service as a virtual garage sale.
If you mean to deduct expenses, act like a business. One of the most common mistakes eBay sellers make on their tax returns is to claim deductions to which they aren't entitled. The tax code allows deductions for business expenses, but deductions are limited for individuals who sometimes make a little money on the side from hobbies.
One rule of thumb the IRS uses to determine whether an individual is engaged in a business is whether they made a profit in any three of the past five years. Another is if the person continues to, say, buy and sell rare 45s, regardless of whether or not they made any money from the activity over a five year period.
"If the answer is yes, you may be on the wrong side of an IRS argument that you are taking a hobby loss," said Tom Ochsenschlager, vice president of taxation for the American Institute of Certified Public Accountants.
Keep your personal and business accounts separate. Make sure you have a PayPal business account separate from your personal one, an eBay business account that is separate from any casual buying and selling you do, and a separate business checking account.
These steps will not only make it easier for you to determine how much you owe, but may help protect your deductions by signaling to the IRS that you are serious about running a business. "Everything you can do to treat it like a business will help," says Kristine McKinley of Beacon Financial Advisors, based in Independence, Mo. Ms. McKinley specializes in tax advice to eBay sellers.
Claim the home office deduction. While this deduction has fallen out of favor because of a popular belief that it triggers IRS audits, it is still a valuable deduction if you have a separate space in your home that you use exclusively for business purposes, according to Ms. McKinley. It's true that you will owe more taxes when you sell the home on amounts that you have depreciated. But the deduction can still be a major benefit because it will reduce your income for the purposes of self-employment tax, she said.
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