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Internet Sales Tax: Are eBay Sellers Required to Pay Income Tax on Sales

Published 3/27/08 (Modified 6/17/11)
By MoneyBlueBook

I used to sell products on eBay as a money making hobby and even once attempted to make a side business out of it. It wasn't easy trying to make profit while at the same time avoiding all the internet fraud and scams out there. While I eventually decided to pursue other ventures, I had a friend who continued to dabble in eBay auctions. Soon enough, he had successfully turned what started out as a one room operation to an impressive one man eBay business machine that engulfed his entire basement. Everytime I stopped by his house I was always startled at the sheer number of brand new Dell laptop and ThinkPad boxes stacked in piles throughout his basement that overflowed into his unoccupied garage.

Through his closely guarded network of online connections (he never disclosed them to me), he was able to secure excellent wholesale deals on hot electronics like laptops, desktop computers, and handheld PDA's for sale on eBay. His racket continued for several years to my continued amazement as I wondered how he managed to stay so consistently profitable despite rising eBay fees and heavy online competition. One day I finally turned to him and asked him if he was reporting his eBay earnings as taxable income on his federal income tax. He simply smiled and changed the subject. Obviously, the answer was no, thus exposing the secret to his profitable eBay success - tax evasion!

Frankly I don't really blame him for withholding his eBay profits from the Internal Revenue Service (IRS), although I wouldn't have done that myself. The subject of eBay tax enforcement has been murky for years, mostly due to the lack of proper paper trails and the undeveloped legal area of online auction income. However, the IRS has been recently making moves to crack down on eBay powersellers and auction proprietors to compel the reporting of all business profits. The IRS has also set its taxation efforts on other popular online auction sites like Amazon and UBid, as well as other online hobby market networks like Etsy. I suppose it was about time the almighty IRS dealt with the issue of online auctions.

The IRS Struggles To Compel eBay Sellers To Divulge Their Taxable Earnings

When it comes to reporting their sales income to the IRS, eBay sellers currently operate on the honor system. However, this honor system has resulted in a significant shortfall of under-reported and untaxed auction earnings. Currently, eBay does not report seller stats or submit sales records to the IRS unless it is honoring a subpoena request for information. Many amateur and aspiring eBay entrepreneurs have been able to work the eBay tax loophole for some time and avoid having to pay tax on their profits. It's a risky game of tax evasion roulette, but the lax enforcement has allowed it to persist for some time.

Recently, the federal government and the IRS has begun to put pressure on major online auction retailers like eBay to cough up user information and sales records, and has even introduced legislation to require market hubs to report personalized sales activity. Of particular taxation concern are the millions of auction sellers who consider eBay as their primary or secondary source of income but fail to accurately report their earnings. Obviously this effort is going to encounter much resistance from sellers and even the auction sites themselves since new tracking policies will undoubtedly result in higher tracking and record keeping costs. The prospect of requiring sites like eBay to track user information based on individual Social Security Number will obviously have the usual online privacy advocates up in arms.

While this taxation crackdown may bug a few eBay sellers, the requirement to report auction income and taxable business earnings is nothing new and has always been around. It's just only until recently that the IRS finally decided to work harder at plugging up the tax gap to stem tax evasion activities. Mandating the implementation of tools to enforce tax compliance already exists in most employment sectors and the IRS believes the new frontier of online auctions should be no exception.

When Do Proceeds From An eBay Auction Sale Have To Be Reported As Taxable Income?

From the amateur seller who considers eBay to be nothing more than a hobby, to the heavy traffic Powerseller who runs his or her operation as a profit generating business, no one really wants to spent the time to report earnings as income if he or she can help it. However, the IRS instructions make it clear that all sources of income can be taxed, which includes everything from online auction profits, and income from gambling activity, to even illegal "business operations" such as drug dealing and prostitution.

Even if the eBay seller makes a few sales here and there as a hobby, the IRS requires all income to be reported - this includes wages, salaries, tips, gambling winnings, money found on the floor, sweepstakes earnings, business income, and yes, eBay earnings (both hobby and business). The hobby or business nature of your eBay income only becomes an important factor when determining whether your eBay losses and operation costs may be used to offset your eBay income as a business deduction.

The correct question to ask regarding taxability is not necessarily the frequency or dollar amount of the transactions - but rather - did the eBay auction activity result in a net profit? For those who use eBay or other internet auction sites to sell old stuff that's been piling up in your garage, you probably don't have to worry about paying income taxes on the proceeds since the cost (the basis) usually exceeds the selling price. Under current tax law, an individual who sells an item online and collects more money than its original purchased value is expected to report that money as income on his or her tax return. Items whose original purchase basis value cannot be determined is typically valued at $0 under current tax law. Thus, it's advisable for all eBay sellers to get in the proper habit now of retaining their purchase and sales records. You never know when the IRS will flip the switch and go nuts with the eBay seller tax audits. It's only a matter of time.

Why Does It Matter If Your eBay Selling Is A Hobby Or A Business?

All eBay online auction sellers have a duty to report their earnings and to comply with tax law obligations to avoid an IRS audit. For most casual eBay hobby sellers who occasionally run the online equivalent of the garage or yard sale, they usually are not obligated to report their sales. That's because for most online garage or yard type sales, the items sold are usually personal household items purchased over the years and used. As such, the resulting selling prices are almost always lower than the original purchase basis price. The exception occurs when the item for sale has appreciated in value. Even if the transaction was intended to be a simple online yard sale, if the item being sold was something like a set of rare baseball cards that had appreciated in value in excess of the original purchase price, the resulting earnings must be reported as taxable income.

The hobby vs. business debate matters when it comes to self employment tax obligations and tax deduction benefits. If the eBay operation is properly regarded as a business, the taxpayer may be entitled to business deductions to write off operating costs. Whether the eBay seller will be treated as running a business will depend on his or her intent to generate profit. Activities such as visiting pawn shops for resale bargains like my friend used to do will likely be seen as demonstrating business intent. Furthermore, when the individual is running a business operation that results in regular profit sales, he or she may also be obligated to pay self assessed quarterly estimated tax payments through Form 1040-ES.

If you lose money pursuing a hobby, you cannot deduct your hobby loss from other income, but you can deduct your expenses up to the amount of your hobby income on your tax return. A hobby loss is a miscellaneous itemized tax deduction, and as such, only the total that exceeds 2% of the adjusted gross income may be deducted.

For more information regarding the differing IRS treatment of hobby and business related activity, check out the IRS explanation. The IRS also provides a good tax information resource for online auction sellers.

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12 Responses to “Internet Sales Tax | Online Sales Tax | eBay Tax | Money Blue Book” 

  1. EbayFormerPowerSeller says:

    Making money through Ebay is tough these days. With all of the get rich quick Ebay infomercials and scams appearing on television like Dave Espino's, the competition is getting way to stiff for many of us. I used to make a decent side living from my Ebay business but now it's not doing so well anymore....and Amazon's taking away much of the business I used to have from online auction based businesses. Now the IRS is trying to tax my net profits.... I know it's supposedly only fair that net gains be taxed and I'm not trying to be a tax dodger, but how about giving regular folks like me a fighting chance in this economy? Uggghh So frustrated!

  2. Raymond says:

    Ebay Former Power Seller guy,

    I totally feel your pain. I used to run a nice little eBay auction business as well, but the scammers, customer demands, incredible price driven competition, and rising eBay listing fees finally eliminated my profits to the point where it wasn't worth it anymore. It is still very possible to make a decent living from running an eBay online auction business, but it requires a lot more work than it used to. Competition is indeed super fierce and growing.

    But taxes are taxes and unfortunately net eBay profits have to be taxed, at least officially. Of course, whether you actually report your earnings as income is up to you, but just keep in mind that the IRS likely will get better access to the paper trails in coming years with new legislation and improve their crackdowns on eBay sellers who fail to report their earnings. Be careful!

  3. ian says:

    Do you just collect tax on items you sell in your home state? Or every transaction no matter what?

  4. jille says:

    "One day I finally turned to him and asked him if he was reporting his eBay earnings as taxable income on his federal income tax."

    Sounds like his money-making operation was driving you nuts with envy.

  5. gwen says:

    Thanks very much for this- it is extremely helpful. I have not been sure whether to report my very small income from selling used clothes, but now I feel much more clear on the matter. Thanks!

  6. john doe says:

    i found a nice loophole.

    i've got a mate that lives somewhere (where taxes don't apply since it's so poor there... undisclosed for security reasons)

    i send all my goods to him as donations. then he sells them online. he gives me the profits under the table.

    i've been doing it for years and years. who's laughing now fat man!!!!? bahahahahahaha

  7. Henk Glimlach says:

    Amazing... Even more so because THERE IS NO LAW THAT STATES THAT AN INDIVIDUAL IS REQUIRED TO PAY A DIRECT INCOME TAX.

    You only live with the level of tyranny you're willing to accept! Read the Constitution!!!

  8. fran says:

    So nice that you folks avoid paying taxes--while no doubt expecting the services. Meanwhile, I ride crappola transit to a lousy neighborhood to work at my crummy job and pay taxes on every cent. And have done so for 43 years. Stupid me.

  9. Peter says:

    I have been selling stuff online without any business license or company for the past 2 years. Never thought it's an issue since I also have a W2. Now I want to do the right thing by incorporation and report all earnings from now on. I hope the IRS won't find out my previous paypal transactions in the past 2 years.

  10. PD says:

    I pay may taxes for that i get a real civilization which includes road, police, fire dept school and such, unlike 3 world contries

  11. Jason says:

    Hey Henk,

    You might want to check out Title 26 of the United States Code, which very clearly spells out that there are income tax laws do in fact exist.

    Not only is there not "no law", there are several laws about it.

  12. Laz says:

    Let's see...US Constitution... Article 1... Section 8: "The Congress shall have Power To lay and collect Taxes" hmmmm, lets go further.... Amendment 16: "The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several States, and without regard to any census or enumeration." wow that's damning... what else we got... Code of Laws of the United of America, this looks important too... Title 26: Internal Revenue Code... Subtitle A (1): Well this all income tax code. Looks like libertarian stupidity strikes again!

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