When Do I Pay Income Taxes?

"Aw, Do I Really Hafta Pay Taxes When I Sell on eBay?"

Q: "I sold a lot of stuff on eBay last year. Do I really have to pay taxes on the money I made?"

A: Most eBay sellers do not intend to go into business for themselves when they first start out. They start selling stuff out of their attic, basement, or garage just to make a few extra bucks, and before they know it they've made $30,000 on eBay. By this time they know they have to do something about complying with the law, but they're not sure exactly what.

The short answer is "Yes, you do have to pay taxes if you made a profit selling on eBay." You do not pay taxes on your gross sales, only on your net profits, when you sell on eBay. If you sold stuff at a loss—the buyers paid you less money than you actually paid for the items—then you have incurred a loss for tax purposes and will not have to pay taxes on what the buyers paid you for your merchandise. You probably will not be able to deduct the loss, however (see discussion below).

If, however, you did make a profit selling on eBay—the buyers paid you more money than you actually paid for the items—then you must report the excess amount only (called taxable income) on your federal and state income tax returns and pay taxes on it.

It does not matter whether you treat your eBay selling as a business or as a hobby (see Chapter 1). If you made even one penny in profit selling on eBay this year, you are required by law to report it as income and pay income taxes on it. If you treat your eBay selling as a business, you file Schedule C on your federal tax return (and a similar form on your state tax return, if your state has an income tax). If you treat your eBay selling as a hobby, you report your income as follows:

• If the items you sold on eBay qualify as capital assets (almost everything you own for personal use or investment will qualify), then you would report your eBay profits as capital gain on your income tax return (federal Form 1040) and pay taxes at the (currently) favorable capital gain rates.

• Otherwise, you would report your eBay profits as hobby income on your income tax return (federal Form 1040) and pay taxes at the (currently) unfavorable ordinary income rates.

The definition of capital asset is a little tricky. Ask your accountant whether or not your eBay inventory qualifies, or read IRS Publication 544 (Sale of Capital Assets), which is available as a free download from the IRS website, www .irs.gov.

What if you lose money selling on eBay? That's when the difference between a hobby and a business becomes all-important.

If you treat your eBay selling as a business, you can deduct your loss on your federal and state income tax returns and apply it against income you earned from other sources (such as your day job). If you can't use the loss this year (because you didn't make any money), you can carry the loss forward and take it in future tax years. Business losses, while painful, are good things to have when tax time rolls around.

If you treat your eBay selling as a hobby, however, you can deduct your loss only if you have income from the same or a different hobby. So, for example, if you sell your rare coin collection at Sotheby's and make a $100,000 profit, and you lose $10,000 selling stuff from your attic on eBay in the same year, you can apply the $10,000 hobby loss against the $100,000 hobby gain and report only $90,000 in hobby income on your income tax return. (Because this gain came mostly from selling rare coins—which clearly are capital assets—you should qualify for reduced capital gain rates when paying taxes on the hobby income in this example.)

If you can't use your hobby loss this year because you have no hobby income to apply against it, you lose your hobby loss—you can't carry it forward into future years the way you can business losses. Hobby losses are not good things to have when tax time rolls around. They are basically useless, and many people don't even report them on their tax return if they don't have hobby income they can apply against it.

The bottom line is that you have to pay income taxes (and sometimes other taxes as well—see the following questions) whenever you make a profit doing anything, regardless of how you characterize it. If you've been making money selling on eBay and haven't been reporting your income on your tax return, now is the time to get yourself into compliance, before the IRS or your state tax authority finds out you have been running an illegal business behind their backs.

 
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