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Navigating eBay business tax deductions: do you run a hobby or business?

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The last time I wrote about the ebay sales tax, I described the importance of knowing your cost (or other basis) for assets you personally hold. Selling them on eBay – like selling by any other private transaction – will incur a capital gain or loss.

The situation is different if you purchase items to resell on eBay that were not acquired for personal use. When you engage in active trading, you either have a business or a hobby. Your income tax situation can benefit if you have a business, because you can claim business tax deductions. In other words, business losses are deductible against other sources of income.

A business tax deduction is created when you deduct ordinary and necessary business expenses that exceed your revenue. The expenses you may deduct from sales income include internet provider fees, shipping costs, digital camera, computer expenses, and maybe even a home office. Demonstrating that an activity is a legitimate business with an expectation of profit permits deduction of losses in the years when there’s no profit.

When determining whether you have a hobby or business, keep in mind that you may only have a hobby when merely selling occasionally. The IRS generally distinguishes a legitimate business as an activity that produces a profit in three out of five consecutive years. If you don’t meet that test, the IRS deploys subjective measures to determine if your activity is really a business. To prove you have a business usually requires maintaining business-like records. Another factor indicating that you are engaged in a business activity is whether you depend upon the income from it to pay your living expenses.

Failing to sell regularly and constantly on eBay likely means you have a hobby. The income from a hobby is still subject to income tax. But you can only deduct expenses up to the amount of income. There are no business tax deductions, and hobby losses are not deductible.

Qualifying as a business activity is therefore a good deal for income tax purposes. But there is a downside to operating a retail business: the small business tax. That is, retailers have to collect sales tax. Most states exempt residents from collecting sales tax who are not operating a business. That’s why occasional sellers at, say, a garage sale don’t collect sales tax.

Many eBay sellers have a large number of customer ratings. Several have ratings from over 10,000 customers. If that’s your situation, it’s an indication you’re unlikely to qualify for sales tax exemption as an occasional seller.

States generally require your business to collect sales tax on transactions with buyers who live in the same state where you operate. There is a place on the eBay listing template to enter a sales tax rate for your state. Sales tax is then calculated and added to the sale price when a buyer lives in your state.

If you don’t use this eBay feature, then any sales tax you owe to your state is payable from the sale amount you receive. You still owe the sales tax even if you didn’t collect it from the customer. That requires a calculation to back out the tax from your sale.

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This post was written by Profit Wise Accounting