EBay Profits: The Taxman Commeth
For many people, Internet auctions represent a thriving business opportunity. Thousands of people make their full-time living using eBay. Thousands more use eBay to supplement their regular income with a profitable work-from-home, part-time business.
As more and more people tune in to eBay as a source of extra income, a nagging question is starting to surface: Do I have to pay taxes on my eBay earnings?
The Internet and eBay are new technologies. Traditional laws and regulations just don’t seem to fit the new models of communication and marketing. And since there’s so much doubt and confusion, it’s easy to avoid the question all together. Some even feel the opportunity is at its best while the industry is unregulated. The unspoken attitude of many online traders seems to be one of wanting to exploit the current system for as long as possible.
It reminds me of the wild, wild west I remember seeing in old black and white western movies. Cowboys and bandits shooting up the town, drinking and gambling run amok. All of the chaos and lawlessness tolerated because the laws had yet to be defined and applied to the new frontier.
Indeed, the Internet is the new frontier. Maybe it’s not as dramatic as what we see in western movies, but it does raise some new questions about how the current laws and regulations are applied to a new and different situation.
So, what is the answer? Are eBay profits taxable?
Strictly defined, the IRS considers earned and unearned income from all sources worldwide to be taxable unless specifically declared untaxable.
Under this definition, a lot of activities are reportable on your personal income tax return – garage sale income, lottery winnings, jury duty pay, lemonade stand profits, and even income from illegal activities.
(That’s right! Drug dealers and embezzlers are required to report their illegal gain on their tax returns. Remember, the government couldn’t get Al Capone on murder charges but they put him away for a long time because of âÂ?¦ income tax evasion!)
So that means that eBay and other online profits are subject to income tax.
But how does this play out in the real world?
Well, many people just don’t bother claiming their earnings. It’s the easiest and most convenient solution – certainly the most profitable – but it’s not necessarily the right choice.
Failing to report income could result in you owing additional taxes to the IRS. And if you don’t pay those taxes on time, they’ll tack on additional penalties and interest as well.
How easy is it for the IRS to find out about your online activities? That’s a tough question. Certainly the IRS has the power to review your financial documents, including bank statements. Anomalies – like large or frequent deposits – that can’t be explained would raise suspicions.
Unless you are in the middle of an audit for other reasons, this is not likely to come up. But what about eBay? Do they have any obligation to tell the IRS about sales that come through their website?
Currently eBay (and other similar websites) does not report income to or earnings to the IRS. In fact, eBay has taken a strict position that they are not responsible for reporting transactions. They claim simply to be a medium that connects buyers and sellers. In this respect, they are no different from a newspaper that publishes classified advertising.
For the time being, eBay is not backing down on this position. They do not want to be put in a position to report to the IRS any of the millions of transactions that move through their system each year. And unless Congress or the IRS forces a change, eBay won’t be reporting transactions in the near future.
eBay does, however, encourage it’s members to learn about the tax laws that may apply to them.
It would seem, at least for the time being, that income from eBay and other online sources are under the IRS radar. But is that good news or bad news? Are there any situations where reporting eBay income would be advantageous?
Owning a home business can be a major deduction on your personal income tax return. Reported income can be offset by legitimate expenses – in this case, the cost of inventory or the listing fees that eBay charges. As with all businesses, it’s possible to post a loss which, in turn, reflects on your personal income tax return as a lower adjusted gross income. A loss on your business could mean a lower overall tax liability.
You have to be careful, however. The IRS won’t appreciate you taking a loss every year just for the tax benefits. In fact, you will need to post a profit at least three years out of every five. If you don’t the IRS may reclassify your business as a hobby. If they do that, you’ll still be obligated to report your income, but you won’t be able to take any losses that are greater than the income you received. You can break even, but you just can’t take a loss. Even then, you won’t be able to deduct your losses unless you itemize using a Schedule A.
Whether your eBay activities can be considered a hobby or a business is another gray area cloaked in confusion. It usually comes down to your intent. If your intent is to make a profit or earn a full-time living from eBay, then you would probably classify your activities as a business.
If, on the other hand, your goal is to clear out your garage and sell all your dust-collecting kitsch in the great internet yard sale, then it could be considered a hobby.
As with other areas of your financial life, talk to your tax advisor about the best treatment for your own situation.
There is one other reason why you would want to report your business income to the IRS. When you own a business you are responsible for paying the social security and Medicare taxes on your earnings. The down side to this is that you’ll end up owing more taxes. The upside, however, is that self-employment income counts toward your social security retirement. The additional tax you pay now will be deposited to your retirement account. We’ll save the discussion on the merits of the Social Security System for another day.
So, now you know that your eBay profits are taxable and owning a small business could be a considerable tax advantage. Check with your tax professional to discuss your unique situation. It’s worth the price to stay clear from trouble with the IRS.
While the Internet frontier may appear to be a wild wasteland free from regulation and oversight right now, it’s only a matter of time before the government figures out how to get their share of a billion dollar industry. And when they do, you can be sure that the tax man will come calling.
