Do I Really Have a Business Here?

Are You Really in Business When You Sell on eBay? Business Versus Hobby

Q: "I started selling on eBay last year and have made about $50,000 so far. At what point do I have a real business on eBay?"

A: You would be amazed—amazed!—how many times this question crops up in eBay University programs around the country. A lot of people have made a lot of money on eBay without realizing they have to do something about paying taxes, filing tax returns, keeping accurate books and records, and so forth. Selling on eBay is one of the greatest ways to back yourself into a successful business, because usually you're having so much fun that you're not even aware you are an entrepreneur until it's too late!

This is really two questions that need to be answered separately.

The first question is: At what point do I have to start paying taxes on the money I made selling on eBay? The answer to this one is easy: If you have made so much as $1 of profit (your total income from eBay selling, less whatever you paid for the goods, less the eBay and PayPal fees), you have to report it as income on your tax return and pay income taxes on it. The Internal Revenue Service (IRS) doesn't care whether your eBay selling is a business or a hobby as long as you are making money; income from both businesses and hobbies is taxable.

The second question is a bit tougher to answer: Should I be treating my eBay selling as a business or a hobby? The answer depends on whether or not you are making money selling on eBay.

If you are making money selling on eBay, you have to pay taxes on your profits whether you treat it as a business or a hobby. If you treat your eBay selling as a business, you can deduct a lot of business expenses you incurred in order to sell on eBay. So why not treat it as a business?

If you incurred a loss (you made less in eBay profits than what you paid for the goods you sold) and your eBay selling is a business, you can apply that loss to reduce the income you made from other sources (such as the salary from your day job). If you can't use all of the loss this year because you didn't have enough income from other sources to soak it up, the IRS allows you to carry it forward into future years—up to twenty years in the future—to reduce your taxable income.

If you incurred a loss and your eBay selling is a hobby, you can apply the loss only to reduce income you might have earned from other hobbies. So, for example, if you made a $100,000 profit selling your rare coin collection at Sotheby's and lost $10,000 selling bobble-head dolls on eBay, you can apply the $10,000 loss against the $100,000 gain to report only $90,000 of taxable income.

You cannot, however, apply a hobby loss against income you earned from other sources (such as the salary from your day job). Nor can you carry it forward the way you can a business loss—if you can't use it this year, you lose it forever. Many people who have hobby losses don't even bother reporting them on their tax returns because they're pretty much useless.

All things considered, if you are willing to take your eBay selling seriously and be disciplined about things like record keeping and documenting your business transactions, you should not hesitate to treat your eBay selling as a business for tax purposes. Just try not to look as if you're having too much fun!

Q: "At what point will the IRS consider me as having a business when I'm selling on eBay?"

A: The decision whether or not to treat your eBay selling as a business is pretty much up to you. As you can see from the answer to the previous question, I'm pretty much biased in favor of treating it as a business unless there's a compelling reason to do otherwise. Still, there's always the risk that the IRS will treat your eBay selling as a hobby even though you declare it a business on your tax return. If the thought of a tax audit keeps you awake nights, it may be better to treat your eBay selling as a hobby until you're 100 percent sure you will meet the IRS requirements.

The IRS treats an activity as a business if it makes money (i.e., a profit) in three consecutive tax years, including the present one. For businesses younger than that or businesses that make money in some years but lose money in others (a typical pattern for early-stage eBay sellers), the IRS uses what it calls a "facts and circumstances" test to determine whether treatment as a business is appropriate. It looks at such factors as:

• How disciplined you are in keeping good business records and accounts

• Whether you have formed a corporation or a limited liability company (LLC) for your business and are complying with the laws that apply to those legal entities

• Whether you keep regular hours working in the business

• (Believe it or not) whether the activity is, by its nature, overly pleasurable or fun

A more complete discussion of this topic appears in Chapter 1 of my book

The eBay Seller's Tax and Legal Answer Book.

Q: "Who decides whether my selling on eBay is a business or a hobby—me or the IRS?"

A: Basically, you decide whether to treat your eBay selling as a business or a hobby for tax purposes by filling out the appropriate lines on your tax return (see the answer to the next question for details). But the IRS has the final word here—if you treat your eBay selling as a business and the IRS disagrees during an audit, they can reclassify your eBay selling as a hobby and disallow any business-related deductions or losses you may have claimed. To my knowledge, the IRS has never challenged a taxpayer's claim that his or her eBay selling was a hobby and forced the person to reclassify it as a business.

Q: "Even if I made money selling on eBay last year, can I still treat my eBay selling as a hobby?"

A: Yes, although there is absolutely no tax advantage to doing so. You would report your income (profit) from selling on eBay on the Other Income line of Form 1040.

Q: "Do I have to pay taxes on the money I make on eBay if it's just a hobby?"

A: Yes, if you made money (profit) selling on eBay this year and have no hobby-related losses to offset the profit (or don't have enough hobby-related losses to offset your income entirely), you would report your income (profit) from selling on eBay on the Other Income line of Form 1040.

 
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