In my previous post “eBay Blocks Users for Not Providing Tax IDs to PayPal”, Tina posed this question:
Does this mean you have to start collecting sales tax on the items you sell as well?
The short answer to Tina’s question is that sales tax and income tax are two different things. Whether you need to collect sales tax depends on the state where your business is located. The Tax ID required by PayPal is for the purpose of reporting income, and not related to sales taxes.
Her question made me realize there may be some sellers who are still confused about the PayPal Tax ID issue; and “operating a business” is a new concept to them. So I thought I’d do a post about what you need to know.
First off, I am not a tax attorney and everything I’ll tell you is from my own perspective and does not necessarily reflect the actual law. Having said that, DH and I have owned our own home business for over 20 years. I also worked over 20 years for local government in code enforcement and worked closely with the business license divisions. So I hope I’ve learned a few things along the way …
Contrary to popular belief, there is no such thing as “hobby selling”. Even if you sell one thing, by law you are required to report the income of that sale on your state and federal tax returns.
The IRS finally figured out they can require payment processors (like PayPal and Amazon) to report payments received (income), which is why PayPal is “requesting” your Tax ID (usually your SSN). So what does this mean to you and me?
It means payment processors will be reporting "gross" payments to the IRS next year on Form 1099K for 2011 transactions. You will be getting a copy of this form (probably in January 2012), which will tell you what has been reported to the IRS.
NOTE: Want to know your PayPal gross payments to-date? Scroll to the end to find out how.
This means, that by law, you will be required to report the income of your eBay et al sales on your state and federal tax returns. And unless you relish the idea of a tax audit and the ensuing wrath of the IRS, it’s best to make sure this income is reported on your tax forms to Uncle Sam.
Now, wipe the sweat off your brow! This doesn’t mean you will necessarily owe taxes on your total online sales. If you are a “sole proprietor” (single business owner), you will be able to list your deductions (business expenses) by filling out a Profit and Loss (Schedule C) form along with your regular Form 1040.
Schedule C is used to figure out the net income or loss for your business by calculating your business income and subtracting your business expenses. This may include the costs associated with maintaining a home office as well as many other deductible business expenses. The total profit (or loss) is then entered on your 1040 as income.
Typical deductions include, but may not be limited to, the following (for more info, click on each link):
Office expenses, including supplies and postage
Phone & Utilities
Other Expenses: This may include cell phone, internet provider and website expenses, as well as bank charges and other miscellaneous expenses, such as reference books.
If you use a portion of your home for business, you may be able to take a home office deduction. HOWEVER, the IRS is very specific as to what constitutes a “home office” and what qualifies for this deduction. For more info, click here and here and here. If your home business does qualify for this deduction, the good news is you may also include mortgage interest, insurance, utilities, repairs, and depreciation as expenses.
Note that most business expenses have restrictions on their deductibility or conditions that must be met before they can be deducted.
Calculating Net Profit/Loss
To calculate your Net Profit/Loss, subtract your Total Expenses/Deductions from your Gross Income. The resulting number is what you must report on your income tax return. This profit or loss is added in with other income by you and your spouse to determine the amount of tax payable
This means your tax liability will be calculated on your net profit - not your gross sales. You may even discover you have a Net Loss and may not need to pay taxes on your sales income. The more expenses/deductions, the lower your profit and the smaller your tax liability.
In addition to income taxes, you will also need to pay Self-employment Taxes. A sole proprietor is a self-employed individual and must pay self-employment taxes based on the income (profit) of the business. These are taxes paid by self-employed business owners for Social Security and Medicare. If you have a net loss, then you do not need to pay Self-employment Taxes.
A Word About City Business Licenses …
If you are operating a business – and yes, you are if you sell 1 item or hundreds of items – then you are required to get a city business license. Even if you don’t have a brick-and-mortar retail location, you are still required to get a city license. I know cities just don’t have the resources to catch every unlicensed business. Even so, they do what they can to proactively find unlicensed businesses (after all, that is lost revenue). I am not saying that PayPal will send your info to your local county or city, but I am aware cities use various sources to solicit information on unlicensed business. With the bad economy, cities are desperately looking for revenue. Just a word of caution if you don’t already have a city business license …
Important Disclaimer: This information is provided for general information purposes and is not intended to be used for the purpose of completing a tax return without the assistance of a tax professional. Always be sure to consult with your CPA or Tax Advisor. We’ve had our Tax Advisor for over 15 years.
For more information:
- After logging onto your PayPal account, go the “History” link at the top of the page (just under the blue tabs).
- When you scroll your cursor over the word “History”, you will see a drop-down menu.
- Click on the “Reports” link. This will take you the “Reporting Center” page.
- Under “Summary Reports”, you will see a link to “Monthly Financial Summary”. Click on the link.
- On the “Monthly Financial Summary” page, you can select a month to view from the drop-down menu. This will generate your report.
- The first part of the report shows your balances. The second part shows your Sales Activity. The amount shown here is what PayPal will report on your 1099K.
- Do this for each of the past 11 months and you will get a pretty good estimate of the amount of payments you have received.
I highly recommend you do this so that you’re not surprised later on. I recently took the time to add up my monthly Sales Activity and discovered that PayPal’s amount is actually lower than my own calculations. It’s not by much so I believe the difference is due to the cash and money order payments I received.