Individuals who participate in online sales at auction sites such as eBay face a plethora of bookkeeping and tax issues regarding their entrepreneurial ventures. Some people choose to ignore the issues and simply not report their financial activity.Earlier this spring, the IRS completed a National Research Program study in which it was determined that an annual tax gap of more than $300 billion exists. The tax gap represents the difference between the amount of tax that should be paid and the amount actually paid in any given year.
Furthermore, the study found that more than $100 billion of the tax gap is a result of understated business income earned by individuals. No specific determination has been made regarding the amount of understated business income that might be derived from online reselling.
While some people simply don't report their online sales, others are diving in and muddling through various software and spreadsheet record-keeping solutions in an attempt to keep up with the expectations of various government agencies. As a result, many online resellers are finding that taking the time to learn some basic rules of accounting can actually create tax savings in unexpected ways.
"The biggest mistake some people make on their tax return is not reporting the income at all, either as a hobby or as a business," said Cliff Ennico, a small business attorney, syndicated columnist, and legal and tax instructor at eBay University. "The second biggest mistake I think that they make is treating something as a hobby that really should be treated as a business, because, frankly, then you qualify for all kinds of wonderful deductions that the IRS will not allow to a hobby."
In fact, the main factor that seems to separate the pros from the novices in the world of online reselling is the determination of whether the activity is a hobby or a business.
"If the thought of record-keeping and being disciplined about it makes you gag," continued Ennico, "then you're probably better off treating it as a hobby."
The defining line between hobby and business seems to be whether or not the individual enters into the venture with the expectation of making a profit. But there are other factors to consider as well.
For example, did the venture show a profit in at least two of the past five years? Is the venture conducted in a way similar to other viable businesses in the same field? Is there a written business plan? Does the venture have its own bank account? Are income and expenses kept separate from the personal deposits and expenditures of the owner? If these questions result in positive answers, the venture probably qualifies as a business.
A rash of software solutions entered the market this spring, all providing various bookkeeping capabilities and tax return assistance for online resellers. Many of the programs are specifically designed to co-exist with eBay and with Intuit's QuickBooks bookkeeping software.
Boulder, Colo.-based SageFire Inc., for example, has developed a record-keeping program called KeepMore, and has been endorsed by eBay as an eBay Certified Solution Provider. KeepMore was debuted at the eBay Live annual conference this spring.
JP O'Brien, chief executive of SageFire, claims that using accounting software effectively can save the typical e-tailer an estimated $2,000 per year.
"We actually asked our customers how much did you save using our system," O'Brien explained, when describing the $2,000 estimate. "These are amounts they saved on taxes. This does not include reduced accountant fees, it does not include wasting time trying to organize a shoebox of receipts."
Barbara Briskin, owner of the eBay store She Sells Cool Stuff, attended the eBay Live conference in June, along with more than 10,000 other eager eBayers, and took advantage of a special offer to try the KeepMore program.
She said that, as a result, she's now motivated to "keep the records."
"It's not difficult to keep track of the actual sales and the actual transactions, because eBay stores all of that information for you," she explained. What she had trouble getting a handle on was accounting for the cost of the items she sold and her supplies. "Now I have a place where that information can go," said Briskin. "Everything is accounted for."
O'Brien points to mileage and meals as two significant areas where legitimate business deductions are often overlooked.
In many situations, e-tailers are also entitled to claim a tax deduction for their home office. The deduction for the home office is not just for administrative office space, but for storage space as well. "For eBay sellers, that's a big deal," said Ennico. "If you get a container-load full of bobble-head dolls, it's going to take up a lot of space in your basement, and you should be including that."
"I think if you're an online seller and you're working out of your home, you're crazy not to take the home-office deduction," said Ennico. He recommended having a contractor come in to the home and take professional measurements of the space used for business.
Bookkeeping and tax issues get trickier when trying to determine how much of a sale represents income, and when a loss can be used to offset income on a tax return. Again, the issue centers around the hobby-versus-business question.
"Products sold through online auctions are subject to capital gain rules just like any other sales," said IRS spokesman Raphael Tulino. "If the item is sold for more than the seller's basis, the difference is gain and must be reported as income. Losses are not deductible unless someone is in the business of sales."
Hooked up with QuickBooks
Another software developer, Homestead Technologies, announced last month that its small business software Storefront now integrates with Intuit's new QuickBooks Merchant Service for Web Stores, enabling synchronization with credit-card payments, inventory management, shipping integration, direct downloads from eBay, and incorporation of financial information into QuickBooks, thus providing the business owner with a complete business management package and the ability to avoid redundant data entry.
Homestead is just one of several third-party small businesses that interact with the QuickBooks Web store product. In addition, Affinity Internet, eBay's own ProStores, GoDaddy.com and WebSite Pros have announced affiliations with Intuit to offer QuickBooks-ready e-stores.
EBay itself has created an application called the Accounting Assistant, available at no charge to subscribers of eBay Stores and other eBay subscription services, which is able to download eBay transactions automatically into QuickBooks.
Geography does matter
Accountants have seen an influx of clients who are involved in online sales.
Sean Kelley, a manager in the state and local tax group of RSM McGladrey, has seen his client base grow in the area of online sellers, and he described the significance of selling across state lines. "They face a number of tax issues, most notably multi-state filing, filing in the states where they sell the products, as opposed to just where their headquarters are located," he said. "This would be income tax and sales taxes, but predominantly sales taxes."
Sales tax is a significant issue looming on the e-selling horizon. Currently, sellers are required to pay sales tax on sales delivered within their own state, and also on sales delivered within a state where the item being sold is located.
"There are a number of interstate compacts out there where states have agreed to charge each other sales tax - a lot of border states have that," said Ennico. "This is probably one of the biggest challenges facing the online community."
The sales tax problem will probably get bigger as states explore options for assessing sales tax on online sales. The Streamlined Sales Tax Project, for example, has garnered participation from about 40 percent of the states that want to enact a program for simplifying and automating the collection of sales tax on Internet sales.
Although many owners of start-ups participating in online reselling might still be stumbling through the quagmire of tax and record-keeping rules, Ennico points out that there is a silver lining. "Tax problems are good problems to have," he said. "If you have tax problems, it means you're successful, it means you're making money - consider yourself lucky!"
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