Attention eBay Users: Online Sellers Facing New IRS Rules

Countless Americans selling as individual entrepreneurs on sites like eBay must now be aware that the Internal Revenue Service has modified their rules to make sure taxes are reported on private Internet transactions. As part of the housing rescue package just signed by President George W. Bush, the Internet transaction interface PayPal and other online payment processors will be mandated to report annual gross receipts to the IRS for almost all Internet sellers. The new law will not go into effect until 2011, time meant to afford banks and bigger merchants the opportunity for a smooth transition. The Government hopes to raise $9.5 billion over the next decade in tax revenue. The rules are outlined in the new Foreclosure Prevention Act of 2008.

According to analysts, the new law is designed to force the largest payment processors, like PayPal, and others, to give over records about the biggest online-sales players. Says Daniel Ballon, a policy fellow in technology studies at the San Francisco-based Pacific Research Institute, “The inclusion of all third-party settlement organizations was designed to target eBay power sellers. If they make more than $10,000 per year, the IRS will receive information about their sales.”

The new rules are found in the Foreclosure Prevention Act; Title III—Revenue Provisions, Subtitle B, starting in Sec. 3091. The subject is described as related to “third-party” transaction intermediaries, which includes any party processing online payments for transactions. The law states that the rules apply to “Returns Relating to Payments Made in Settlement of Payment Card and Third Party Network Transactions.”

The law states that Internet third-party payment intermediaries must keep records and pass them onto the IRS, reporting such information each year: “name, address, and TIN of each participating payee to whom one or more payments in settlement of reportable payment transactions are made, and the gross amount of the reportable payment transactions with respect to each such participating payee.”

The payment processors will need to file a 1099 form for each merchant and send it to the IRS and to the merchant. Merchants selling less than $10,000 and effectuating less than 200 transactions, per year do not need to be included in these filings.

The Wall Street Journal suggests some tips to staying out of trouble with the new law and the IRS:

— Report all income from Internet sales, even for things you might consider non-relevant, such as items you made. Excluded are subjects sold for less than their original cost.

— If you deduct costs on deductions, then make sure your entire approach is business-like and professional. The IRS defines as “business” an entity that made a profit in any three of the past five years. Contra, a hobby is something a person would still engage in, even if they did not make any profit from it.

— Separate business and private bank and checking accounts to avoid confusion and make record-keeping easier. Says, Kristine McKinley of Beacon Financial Advisors, “Everything you can do to treat it like a business will help.” Ms. McKinley specializes in tax advice to eBay entrepreneurs.

— Consider claiming the IRS “home office deduction.” This is a valuable deduction if space exists in your home you can use exclusively for business purposes. This will reduce your income for the purposes of self-employment tax.

As could be expected, many small-business owners are upset about the new rule. The U.S. Chamber of Commerce believes the law will create new, unjustified costs on merchants and hurt payment processors, too. The Chamber released an official statement, saying: “Many participating merchants will bear additional expenses related to the burdens of converting a payment distribution system that was previously not taxpayer-specific into one that would be.”

Nothing contained in this blog is to be construed as necessarily reflecting the views of the Pacific Research Institute or as an attempt to thwart or aid the passage of any legislation.

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