Put simply, if your business is making any income from selling merchandise on online auctions, you've got to report it to Uncle Sam. This can apply whether you are a small business who sells all of your goods via auction, or if you used an auction site once to offload excess inventory. Believe it or not, e-commerce venues, including eBay and other major auction sites, are on the IRS's radar screen. If you don't want a federal or state bean counter pouring over your books, you better report. Here are some important tips on what data you should keep for your income taxes, how and when you should report, and, best of all, what you can deduct.
For starters, this information serves as only an introduction. Consult a CPA (certified public accountant) when determining what your tax liability is because of your profits from selling online. Depending on where you live, different county, state, and federal regulations might apply to you. For instance, many states require people to have a business or merchant license to deduct business expenses from their taxes. Moreover, you might have to report income generated from an online auction sale as a capital gain, even if you are not in the ''trade of business.''
Understand that many banks report to the IRS how much nonemployment-related money is deposited. They do this to avoid liability if the IRS tries to prosecute an individual for tax evasion. While this practice has been contested to determine if it's legal, it remains common in the banking industry. It's better to be safe than sorry--report the income you generate.
If you have ever bought and sold a block of stock for a profit, you know what a capital gain is. The IRS taxes an individual's gain on any capital asset that was sold for more than it was purchased--the cost basis. This can apply to any piece of property, from a share of stock, to a classic car, to a piece of fine art.
If you are not in the ''trade of business,'' but sell an item for more than it was purchased, technically the profit should be reported as a capital gain on Schedule D, Capital Gains and Losses with Form 1040. Realistically, most personal, nonmerchant auction transactions do not apply. Because of depreciation, personal merchandise usually sells for less than it was originally purchased. In this case, a seller has no tax liability or reporting responsibility. Unfortunately, unlike loses on securities, individuals cannot claim loses on the sale of personal merchandise. No one said life was fair!
File It Away
Though laborious, it's a good idea to file copies of all your auction transactions, as well as keep all receipts related to your sales, including postage, insurance, and packing materials. Finally, track all of your auction site charges, such as listing and final value fees. With this information you will be able to itemize your expenses and make legitimate deductions.
Sole proprietors of a business are required to file taxes quarterly (four times a year) as opposed to just once on April 15. If you claim more than $2,500 in business expenses, consider reporting as a business on Schedule C, Profit (or Loss) from Business or Profession, with your Form 1040.
With each filing you must include an estimated tax payment, calculated as a quarter of what you believe your total tax liability will be for the year. The filing dates are April 15, June 15, and September 15. A final return is then required on January 18 of the following year. Happily you don't have to report every auction transaction you completed each quarter. You can give a summary of your profits, calculated by deducting your auction expenses from your gross sales profit. The difference between the two is your estimated taxable income.
As a self-employed businessperson who files quarterly returns, no one withholds tax from your paycheck. This, however, does not mean you are exempt from making contributions to Social Security like everyone else. Typically, this contribution is called self-employment tax. Applied as fixed percentage, it must be computed at the end of the year and added to your year-end taxable income on your Form 1040.
State Sales Tax
Sales tax, as it relates to online auction transactions, is one of the most confusing and misunderstood subjects for sellers. Currently, online auction sellers are not required to apply sales tax to transactions made with buyers outside their state. In other words, sellers are not required to remit sales tax to the buyer's state.
In 1998, congress passed The Internet Freedom Act, which waived sales tax on out-of-state online sales. (It also placed a moratorium on new Internet tax legislation for three years.) With more than 7,500 U.S. municipalities and differing tax codes in each, Congress determined that the application of sales tax on out-of-state Internet transactions would be too burdensome for online merchants.
However, auction sellers in the "trade of business" are required to add sales tax to in-state transactions. Also, buyers are technically required to assess a "use" tax to their out-of-state purchases, remited to their state. This is rarely, if ever, done. Change might be on the way, though. Currently, Governor Gilmore of Virginia, is leading a commission to evaluate the current laws. Also, sales tax software is in development, which would provide the sales tax for any item in any municipality and make it technically feasible for sellers to remit state sales tax on any sale. Yikes!
Beyond the standard business expenses, such as final value fees, postage, and packing materials, you also can justify deducting the cost of mileage to the post office and magazine subscriptions that relate to your specialty. You should also think about trying to deduct the monthly expense of your Internet Service Provider if you use a dedicated line for your auction activity. If you buy supplies and merchandise from a discount warehouse store, you could even try to deduct the cost of your membership.
If your home is your principal place of business you also might be eligible for the new home office deduction, rolled out in the 1997 tax code. In addition, the update tax code's new Section 179 expense deduction allows self-employed business owners to deduct as much as $19,000 a year on business equipment. Previously, self-employed individuals had to deduct expenses on large items over several years as a depreciation deduction. That's no longer the case--now you can deduct the cost of whole items, such as a high-end computer, all at once. Finally, because of adjustments to the tax code, the self-employed health insurance deduction will increase from 60 percent in 1999 to 100 percent in 2003 and after. That's right--you'll be able to write off 100 percent of your health care premiums.
Tax Breaks and Shelters
Another way to offset taxes if you are self-employed is to open up a retirement plan, such as a Roth IRA or Keogh retirement plan. Income is either tax deductible going into a plan or tax deductible after being taken out at retirement. Remember, there are penalties if you deduct money from an IRA before retirement.
If you are self-employed and your auction business is unincorporated, you also can shelter income from taxes by employing your under-18 child or children. Income paid to self-employed individuals under-18 dependents is not subject to taxes. In essence, the parent is allowed a tax deduction of as much as $4,000 for the wages paid to the child. That's a good chuck of change! Before applying this technique, consult with a certified tax accountant.
For more information about online auctions go to www.AuctionWatch.com