Ask Not For Whom the IRS Bell Tolls, It Tolls for eBay…

… wow, not sure how I missed this.

Found this today on the eBay Ink blog.  Points to a WSJ piece from last week that explains how the new housing bill includes provisions that require payment providers to report accounts with over $10,000 in transactions to the IRS.  Hello, PayPal.  Hello, eBay sellers.

The new reporting requirement is similar to a proposal the Bush administration has put forward in its most recent budgets as a way to ensure that taxes owed are being collected. It also applies to intermediary banks that process card payments for restaurants and brick-and-mortar retailers. Congressional tax estimators predict the reporting change will help the IRS collect an additional $9.5 billion in taxes owed by online and traditional businesses over the next 10 years.

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 $10,000 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.

It was likely inevitable, of course, that the government would find it necessary to insert monitoring hooks into payment services and online marketplaces.  And this new policy doesn’t take effect until 2011.  But I don’t think people really appreciate how much this might affect the economics of online selling and small businesses.

Look at the advice given to eBay sellers:

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 two of the past five years. Another is if the person would still, say, frame landscape photographs, or carve garden gnomes, or buy and sell rare 45s, regardless of whether or not they made any money from the activity.

“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.

If you don’t think issues and requirements like this don’t translate into overhead for small businesses, then I have a bridge to sell you.  More importantly, I don’t think people realize how issues like this can stifle the initial enthusiasm for selling that often predates any idea that you might be able to “make a living” selling online.

Very few people realize the economic magic that eBay enabled in the last decade, making “small business” activity available and affordable to millions of people who normally would not have thought to step out on their own.  It facilitated nationwide markets with low transaction costs for highly illiquid markets.

Because very few people realize this, it will most likely die a quiet death; unmourned by those who assume that the priority should be protecting the older, “real life” small businesses and their particular economic structures.  There is an argument to be had there, but only after some analysis has been done on the new economic systems and opportunities that have been created in the past decade.

My bet is that argument really isn’t happening, and that the inertia of the real world will overwhelm these new entrepreneurial opportunities.  These online retail businesses will retreat, like physical retail, back into the hands of a smaller number of larger entities who can handle the regulatory and economic challenges.

At eBay Live 2004, I remember a woman coming up to me after a talk I gave on Buying & Selling Lots on eBay.  She had been a paralegal, but had quit five years before to sell cosmetics on eBay.  Her business was not large by retail standards, but enough money for her to stay home with her children.  She told me her son had now placed into an advanced program at school, and she credited eBay for giving her the time to stay home and support him.  She said she hoped that he would go to great schools, and go on to work for a company like eBay someday.

It’s the kind of story that sticks with you.  And it makes me a little sad to see that economic opportunity disappearing.

4 thoughts on “Ask Not For Whom the IRS Bell Tolls, It Tolls for eBay…

  1. That’s my point. Most small sellers online don’t start out with a “serious business”. It tends to start as a hobby for people, which grows over the years.

    I don’t think the people who say, “I’m going to start a business” will have a problem here. It was the people who discovered, almost accidentally, that they could start a business who will be pushed out.

    My guess is that I’d likely support some effort like this, but at a much higher level of sales. Maybe $100,000 a year. Remember, with typical retail margins online slim as they are, $100,000 in sales might only be enough to pay one person $20,000 a year.

  2. I believe that it is entirely fair for an eBay seller that meets a small business threshold to track and pay the taxes that they are due.

    It is fantastic that eBay has enabled 1000’s of people to generate an income from home.

    The problem is that as a hobby selling a few things evolves into a small business, there are no significant tools provided by ebay that allows an individual to covert their status into that of a business. The eBay systems do not recognise an eBay account as a business entity.

    What a wonderful product innovation it would be if eBay could embrace the problems faced by the very people that represent their traditional heartland, and help them make this transistion simple.

    For example:
    * tools that calculate the total tax payment to be withheld
    * tools that alert a seller that they are approaching the taxable thresholds.
    * etc

    From my perspective customer problems are just product innovations waiting to happen.
    –nick coster

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