Do You Need a Legal Entity to Be in Business on eBay?

Q: "Do I have to have a corporation or legal entity to be a business on eBay?"

A: No. The vast majority of eBay sellers are either sole proprietors or informal partnerships of family members or friends.

A sole proprietor is simply a human being over the age of twenty-one with a pulse who is engaged in a trade or business. You don't need any legal paperwork to designate yourself as one (other than a birth certificate that hasn't been revoked), although most states require you to file a document called a trade name certificate or DBA certificate (for "doing business as ...") with your town or county clerk's office if you are doing business using a name other than the one appearing on your birth certificate. So, for example, "Clifford R. Ennico, Attorney at Law" is not a trade name, but "Cliff's Antiques" is a trade name.

A partnership is two or more human beings engaged in a trade or business and sharing in the profits and losses of that business. Believe it or not, you don't need any legal paperwork to form one—you can become partners with just a handshake. Sometimes you can even form partnerships by accident, as we'll discuss in Chapter 2. When you're in a partnership, you are required to file IRS Form 1065 (partnership tax return) by April 15 each year. Each partner reports as income his or her percentage share of the partnership income and pays taxes on it. So, for example, if you and I are fifty-fifty partners and our partnership made $100,000 in eBay profits last year, you report $50,000 as income on your tax return and I report $50,000 as income on mine.

By forming a corporation or limited liability company (LLC), however, three very good things happen:

1. You qualify for all sorts of tax deductions and other benefits that sole proprietors and partnerships can't take (see Chapter 12).

2. If (heaven forbid) you are ever sued because of something you did on eBay, your personal liability is limited to whatever money you have put into the corporation or LLC; your household and other personal assets are not at risk.

3. If you are ever audited by the IRS or your state tax authority, they are much more likely to view your eBay selling as a business rather than a hobby.

The trade-off is that when you form a corporation or LLC you will have to do lots of legal paperwork to keep your legal entity alive. If you fail to keep current, the government strips away your entity and your personal assets are now at risk, as if you had never formed the entity in the first place. Corporations and LLCs require diligence and discipline; if the thought of doing legal paperwork is unappealing to you, do not form a corporation or LLC.

For a thorough discussion of the pros and cons of corporations, LLCs, and other legal entities, see Appendix G.

Reporting Your eBay Income and Paying Taxes

Q: "Is there a certain amount of money I have to make on eBay before I have to start paying income taxes on it?"

A: No. If you make even one penny of profit selling on eBay, you are required to report it as income on your tax return and pay income taxes on it. Contrary to some urban legends circulating in the eBay community, there is no minimum amount of income below which you have to pay income taxes. There are, however, minimum threshold amounts for paying self-employment taxes and estimated taxes, which are discussed in Chapter 12.

Q: "Where do I report the income from my eBay selling?"

A: It depends entirely on whether you treat your eBay selling as a business or as a hobby.

If you are pursuing a hobby and making money selling on eBay, you report your income (profit) from eBay selling on the Other Income line of your Form 1040.

If you are selling as a hobby, you lose money selling on eBay, and you do not have income from any other hobby to offset it, you do not report your loss at all on your tax return—it's a personal loss or a hobby loss, and you just suck it up.

If you are selling as a hobby, you lose money selling on eBay, and you do have income from another hobby to offset it, you report the loss as a capital loss on your tax return.

If you are a business, whether you make money or lose money selling on eBay, you fill out Schedule C (Income or Loss from a Trade or Business) and slap it onto your Form 1040.

Q: "If I have different product lines and am willing to take the time to set them up as different businesses with different tax IDs, can I deduct the ones that didn't make money and report the ones that did, rather than have my successful lines have to pay for my failures?"

A: If I understand your question correctly, you are asking if you can create separate tax IDs for the businesses that make money, report the income from each business on a Schedule C, then treat the businesses that lose money as hobbies and lump the losses together with your Form 1040 personal filing.

If that's correct, the short answer is, "Sure, why not?" Just remember that losses from a hobby cannot be deducted from your day job income; if the items you sold at a loss on eBay qualify as capital assets—virtually all antiques and collectibles will qualify—you may be able to deduct those losses against other capital gains (say, from your stock portfolio).

Q: "How do you start being a business after having operated as a hobby for several years? How does inventory already in-house get reflected?"

A: Start filing a Schedule C this year. You can deduct the cost of goods sold of any inventory you sold on eBay this year, but the cost of goods sold of any inventory you have at the close of business on December 31 cannot be deducted on this year's return. You can deduct it only when the inventory actually sells, presumably sometime next year.

Q: "I am fairly new to eBay and just started selling used items from around the house. I am making good money—nothing in comparison to what I paid retail for these items, of course, but still good. Do I claim my earnings next year as income for selling these used items? What part of the 1040 form do I use? I don't consider this activity a business. Do I claim it as a hobby, then?"

A: It depends on whether you made money. It sounds to me as if you sold these used items for less than what you paid for them at retail. If that's correct (and you can document that), then you will have a loss for tax purposes this year. If you file Schedule C on your Form 1040 this year and treat your eBay selling as a business, you will be able to deduct your loss against other income you made this year—including the wages from your day job.

If you prefer to continue treating your eBay selling as a hobby, you should determine whether the items you sold qualify as a capital asset (your accountant can help you with that). If they do, you can take the loss as a capital loss on your Form 1040 and deduct the loss against other capital gains you may have, such as income from a stock portfolio, but not against ordinary income (such as wages from your day job).

Taxes Due from Prior Years

Q: "I've been selling on eBay for a couple of years and just recently realized I should have paid taxes on the money I made. I will report the income I made this year on Schedule C when I file my tax return next April 15. But how should I report the money I made in previous years?"

A: You have choices here. You can file amendments to your prior years' tax returns, report the income from your eBay selling each year on the amendments, and pay the taxes you owed each year, along with interest and penalties imposed by the IRS for late payment. This is the way the IRS would prefer that you report your mistake. The downside, of course, is that you may be waking a sleeping dog at the local IRS office and opening the door to a thorough audit of all of your recent tax returns to uncover what other innocent mistakes you might have made.

The second choice is what most people in your situation would do. Figure out the income (profit) you made from your eBay selling in past years, add it onto the income you report from your eBay selling this year, and report the total on Schedule C when you file next April 15, as if you made everything this year.

It is unlikely that the IRS will discover that you were actually in business for prior years. Even if they do discover your prior activity, by reporting the past income and paying taxes on it this year you will stop the accruing of interest and penalties on the overdue taxes—you will have to pay these only for the prior years for which you did not report income.

If you choose to "forget" the income from prior years and make believe it didn't happen, the interest and penalties on the overdue taxes will continue to accrue until the IRS discovers you failed to report them—maybe years from now (there is no statute of limitations for underreporting income if the IRS believes you did so fraudulently).

 
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