Whether a Hobby or a Business, Online Profits Trigger Tax Requirement
By Kenneth Corbin
Casual online sellers, those who might describe their eBay activities as a hobby rather than a business, often think that they don't have a responsibility to pay income taxes on their ecommerce proceeds.
And quite often, they're wrong.
"The bottom line is if you make money, you have to report it. There's no dollar threshold, so if you make $5, technically, you have to report it," said Barbara Weltman, a small business expert who has written extensively on taxation issues.
Weltman is quick to point out, however, that making money is more than simply "bringing cash in the door," and that there are circumstances when online sales would not be subject to income-tax liability.
Perhaps the most straightforward of these is the scenario where someone cleans out their garage or attic, selling off old toys or books on eBay.
The IRS explains in a tip sheet for online sellers:
"If your online auction sales are the Internet equivalent of an occasional garage or yard sale, you generally do not have to report the sales. In a garage sale, you generally sell household items you purchased over the years and used personally. If you paid more for the items than you sell them for, the sales are not reportable."
"You're not making money just because you're bringing cash in the door," Weltman said. "If you're just emptying out your garage you're not going to be making money."
But an online garage sale is essentially a one-off event, and the seller would have no reason to anticipate similar, future sales, nor any expectation of turning a profit.
However, the IRS offers further guidance suggesting that the transition from a casual sale to a business can be subtle:
"If your online garage sale develops into a business and/or you have recurring sales and are purchasing items for resale with the intention of making a profit; you may have started an online auction business."
Likewise, the agency cautions that individuals who sell items that have appreciated in value, such as artwork or collectibles, may need to report those proceeds as capital gains or business income.
"There's no bright line, that's the problem," Weltman said.
The IRS has acknowledged that confusion persists about the tax responsibilities concerning ecommerce, as the rules around reporting proceeds for income-tax purposes have gotten muddied by the debates over online sales tax and the federal ban on taxing Internet access services.
That type of "misinformation," the agency has said, has "led some to incorrectly believe that Internet sales income including online auctions is not subject to income tax."
Christopher Miller, a spokesman for the IRS, declined to comment for this story, referring EcommerceBytes to the online materials the agency has prepared for online auction sellers and small business operators.
With no minimum threshold for reporting business income, even casual online sellers who turn a profit from their eBay hobby will still likely have a tax liability. However, as a practical matter, the IRS' ability to police the online sales market is severely constrained due to a perennial shortage of resources that has seen declines in audit rates in recent years.
Experts acknowledge that it is rare for the IRS to take action against online sellers for failing to report the proceeds of their Web business, though it's not unheard of. Just last month, the Justice Department took action against a North Carolina couple for allegedly failing to report years' worth of online sales revenue in a case that also contained allegations of fencing stolen goods on eBay and Amazon.
That case was distinct in that the unreported income allegedly totaled over $1 million, which (along with the charges of theft) could help explain why it drew the attention of federal authorities.
"It's the first I've heard of an IRS enforcement action, though obviously the amounts involved can be considerable for some people," said Joseph Henchman, a vice president at the Tax Foundation, a Washington research group. "People tend to think income is just wages on W-2s, interest income and 1099 independent contractor income, when it is actually all income from all sources, including things you sell online. If the amounts are large enough, it's worth the IRS to hunt it down and audit it."
Weltman advises sellers to err on the side of caution, and stresses the importance of keeping an accurate and detailed set of records to document income and business expenses.
"I would say that it really is just a great idea to keep good records about all of your activities and what's going on," Weltman said. "That will help you in case the IRS does decide to examine (your business)."
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About the author:
Kenneth Corbin is a freelance writer based in Washington, D.C. He has written on politics, technology and other subjects since 2007, most recently as the Washington correspondent for InternetNews.com, covering Congress, the White House, the FCC and other regulatory affairs. He can be found on LinkedIn here.
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