On July 30, 2008, in an article titled: Online Sellers Face New IRS Rules, The Wall Street Journal reported that those who regularly sell items online may find themselves affected by recent legislation which will set new rules to help the IRS collect more taxes from online sellers. According to the IRS many online sellers either don't know about their tax obligations or are ignoring them. This new legislation, part of the housing rescue package that is expected to be signed into law immediately, will require online payment processors like PayPal to report total annual transactions, with some limitations, to the IRS. The change also applies to the process of credit and debit card payments for restaurants and other real-world retailers as well.
According to the new legislation card and payment processors will be required to file a 1099 form with the IRS for each merchant with more than $20,000 in gross sales and over 200 transactions a year. Any online seller should do the following so as not to find themselves in trouble with the IRS:
Report all income from online sales, even from casual or hobby selling. If you made a profit from goods sold online you owe income or capital gains taxes and, perhaps, self-employment taxes as well. No taxes are owed, however, on used items that you sold for less than what you paid for them.
If you intend to deduct expenses you need to act like a business. A common mistakes online sellers make is to claim deductions to which they are not entitled. You are allowed deductions for legitimate business expenses, but deductions for individuals who make a little money from their hobbies are limited.
The rule of thumb used to determine if an individual is in business or not is if they made a profit in any three of the past five years. Another is if the person would still be involved in the "hobby" if they didn't make any money from it. Determining if your activities do, in fact, rise to the level of "business" is a very important issue.
Keep your personal and business accounts separate. Have separate personal and business bank accounts, online payment accounts, and credit cards. Treating your business like a business is the first best thing you can do.
Claim the home office deduction. This deduction is often seen to be a trigger for IRS audits but, in fact, it is a valuable deduction that you should not ignore if you maintain a separate space in your home used exclusively for business purposes. You will owe more taxes on amounts that you have depreciated should you ever sell your home but the deduction is still a major benefit as it reduces your business income for the purposes of self-employment tax.
Keeping accurate records, making correct claims in regards your deductions, and making the proper filings each year go a long way to building, and maintaining, a legitimate and successful business. Be sure to seek qualified professional advice for your business accounting needs.