To answer that question you first have to know what the IRS considers “income”. If you sell something on eBay for a loss, then it is not considered income. But if you make a profit on your sale then it is income and you are required to report it to the IRS and pay taxes on it.
For example, you purchase a DVD for $29.99 and sell it on eBay a few weeks later for $10.00. You take a net loss of $19.99. Since you made no profit this is not considered taxable income and you are not required to report it. On the other hand, if you buy a DVD for $10.00 and sell it for $29.99 making a $19.99 net profit, this is taxable income and you are required to claim it on your tax return. Actually, if you don’t claim it you will technically be committing tax fraud.
You may have heard rumors about income tax exclusions for “eBay as a hobby” or that you don’t have to pay income taxes until you’ve made over $500. Those rumors are absolute nonsense. Once you’ve made a profit on any single transaction you have become a business in the eyes of the IRS. This means that even if you lose money on 9 sales but make a profit on the 10th, then the income from that one sale means you have to file your taxes completely differently. Whether you intended it or not you now run a business. And hate to tell you this but your life just got a whole lot more complicated.
Right now you may be thinking you can still sneak a few profitable eBay sales under the radar. Many people do and get away with it because it’s just not worth it for the IRS to go after every nickel and dime infraction. Just keep in mind that the longer you sell on eBay, and the more money you make, the more likely it becomes that IRS will eventually send you a letter you don’t want to receive. Already Paypal is required report any seller that makes over $20,000 dollars in transactions per year. The IRS can lower that limit at any time. They can also assess you back taxes for under reporting years down the road. So if you’re going to have a business on eBay, I suggest you do it right from the very beginning. Here’s what you’ll need.
6 Basic Tax Requirements for eBay Sellers
An EIN- That stands for Employer Identification Number. It’s also called a Federal Tax Identification Number. You’re going to need that ID number to file your taxes. Technically, you can use your own social security number for a small business but that’s not a good idea because this number will appear all over future business related documents. It’s like giving your business its own social security number so you can keep yours private. It’s free to get one all you have to do is go to this IRS EIN application page and fill it out.
A Vendor’s License Not only are you required to pay income taxes on your business, you are also required to collect sales taxes for any sales made within your own state. And by the way, you have to pay for the license that grants you the right to do so. That’s a Vendor’s license. You can get one for about $25 from your local court house. The licenses are issued at the state level and each varies a little in its requirements depending on where you are. Note that these sales taxes have nothing to do with your income tax. It’s just that in order to legally run a business you must be licensed at the state level which requires you to agree to collect taxes for them.
A Bookkeeping System- You’re going to need to keep track of everything you sell, everything you buy, and all of the bills and fees associated with your business. Unfortunately, there is no one simple way to do this. On a monthly basis you need to keep a file with all of your business receipts. Start with your gross sales which can be found on your monthly eBay invoice. From there you must document all your costs such as eBay fees, Paypal fees, postage, shipping supplies, and the cost of the items you sold. You can subtract all of those costs from your gross sales and get your profit (taxable income). Some further deductions you should also track include mileage on your car when used for business, and home office deductions.
Deducting home office expenses for an eBay business isn’t as simple as it sounds. It’s not just ink and paper. You must calculate how much square footage you use from your business and divide that by the square footage of your entire home. You can then use that percent as a basis to calculate the utility costs of your business. For example, if you use 10% of your home for your business, you can also deduct 10% of your electric, gas, water, phone, and internet bill as a cost of your business. If you rent, you can deduct 10% of that too. If you pay a mortgage it’s way more complex. Then you have to calculate something called depreciation and take the value of the 10% over several years.
Estimated Tax Payments- Also called quarterly tax payments. At a normal job your employer takes your social security, medicare contribution, and taxes out of your check every week and sends them in for you. Then everything was simply filed with a W-2 form at the end of the year. Alas, those were the good old days. Now you have to pay self employment tax. And instead of sending it in weekly, you have to do it quarterly. Oh, and you’ll have to figure out how much it’s going to be on your own. You can read more about it and how to estimate the payments directly on the IRS Estimated Taxes Page.
A 1040 with Schedule C- No more 1040 EZ for you my friend. Now you’re in with the big dogs and they usually file a Form 1040 with a Schedule C attachment. The schedule C is where you file your “Profit or Loss From Business”. Remember that bookkeeping we were just talking about? Well this is where all those numbers are going to go. And it comes with a 17 page book (available here) telling you how to fill it out. Good times. Anyone else want a drink yet?
An Accountant- OK honestly just hire an accountant to take care of the 5 requirements above. You will drive yourself completely mad trying to figure all this out. You’ll pay $150 to $500 a year and they will make most of this go away. You’ll still have to pay taxes, and you’ll still have to stash receipts, but they can tell you who, where, when, what, and how much to pay. Real businesses have to hire accountants, and according to the IRS that’s what you are now so just do this the easy way and get back to writing eBay listings instead of worrying about your income taxes.