Online businesses be prepared! New IRS reporting requirements.

If your business accepts merchant cards for payment or receives payment through a third party network such as Amazon, eBay and PayPal, you may receive form 1099-K this year. Form 1099-K is a new form that will be completed by payment settlement entities (PSE’s) such as banks, credit card companies and third party networks to report the proceeds of payment card and third party network transactions made to payees under Internal Revenue Code 6050W.

All businesses that accepted merchant cards for payment and businesses that accepted payments through a third party network that (1) exceeded $20,000 in gross total reportable transactions and (2) the total number of those transactions exceeded 200 for the calendar year, will receive Copy B of form 1099-K.

Copy B of 1099-K will include the following information:

• Filer’s Name, Address, Phone
• Filer’s Federal Identification Number
• Payee’s Taxpayer Identification Number
• Type of Filer (PSE or Third Party)
• Gross amount of payments
• Monthly amount of payments

As a business owner, you will need to compare the information provided on 1099-K to your gross receipts from that PSE and verify that the amounts track with what you will report on your taxes. Bottom line – The IRS will now have a record of your eBay, Amazon and PayPal transactions, so make sure you match up and report all income on your tax return. For 2011 you won’t have to break it out separately on your business tax return but for 2012 you will.

Look for your Copy B of 1099-K in the mail soon. PSE’s are required to provide form 1099-K to payees by January 31. You may receive the form by mail or electronically. If the PSE elects to send the form electronically, you will be required to provide consent for receipt of electronic statements. Consent can be granted electronically.

For more information from the IRS, go to www.irs.gov/form1099k
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If you’d like more information on 1099-K or other tax issues, contact me at 619-819-0252 or Online.

Dave Heistein is a Certified Public Accountant in the state of California. He is a San Diego CPA, as well as an advanced QuickBooks Pro Advisor and Instructor. As a small business owner, he is dedicated to educating and informing other business owners on bookkeeping and accounting matters.

What is the New California Sales Tax Law?

California has adopted a new law placing it at the forefront of efforts to collect online sales tax from online sales in the state. As of July 1, 2011, the new California sales tax requires online retailers to collect sales tax if the company has any business presence in California. This includes online sales tax applicable not only to companies based in California, but also any company with business affiliates in the state. Thus, the new taxation of online sales impacts the operation of California’s affiliate marketers, as their relationship with online companies opens those companies to the online sales tax.

Affiliate Marketers

There are an estimated 25,000 affiliate marketers in California, operating websites in California that earn referral fees for directing customers to the online retailer. These websites, such as Savings.com and Ebates.com, provide coupons and services for comparison shopping. According to Performance Marketing Group, $1.9 billion of advertising revenue was generated last year by California affiliates of online retailers. These affiliate marketers are seeing their range of offerings decline as a result of the new online sales tax law. Amazon.com has already dropped arrangements with California-based websites to carry advertisements and links to its products to avoid the online tax. Other online retailers, including Overstock.com and e-commerce jewelry retailer Blue Nile, have also terminated their connection to California based affiliate marketers as a result of the tax. These termination notices are reportedly causing significant sales declines for California’s online affiliate marketing websites.

Shoes ‘R Us is a prime example of a small affiliate marketer operating in California. The founder, Nick Loper, began his affiliate marketing career by establishing a website, writing a blog to draw attention, and earning revenue as readers clicked on an ad that linked to a site where they made purchases. Mr. Loper reports that as a result of the new online sales tax ShoesRUs.com has lost 70 percent of his company’s revenue. The website states that the domain name is for sale and Mr. Loper has indicated that he is moving to Nevada.

Impact of New Sales Tax Online

By some reports, over 70 affiliate marketers have already left California to avoid the new sales tax. Some appear to have moved operation of their websites to other states; states which seem welcoming to these businesses and are eager to gain the business taxes that California has always collected from affiliate marketers. Other affiliates are considering new business models, such as payment based upon click through activity rather than commission on sales.

From the state’s point of view, California reported that sales tax collections for July were 12.5 percent below forecasts. This $139.4 million shortfall appears to confirm fears that the new online sales tax legislation will fail to raise tax revenue and leave shoppers with fewer options from Californian websites. If consumers turn to other sources, affiliate marketers and other online companies must resort to job cuts despite an already depressed California employment market in order to survive.

Both governments and affiliate marketers are watching California closely for the effect of the new law – particularly the reaction of Amazon, which has vowed to collect sales tax only if there were a federal solution, rather than a patchwork of state-by-state laws. Supporters of the new tax rule say that it levels the playing field by forcing big out-of-state retailers to collect sales tax on goods sold in California just like brick-and-mortar stores, and seven other states have passed similar laws for a sales tax levy of online commerce. Many physical location retailers long complained they had an unfair disadvantage by charging sales tax that effectively created higher prices for consumers. But thousands of affiliate website operators now say that the effect of the new online sales tax causes small business website affiliates to struggle. Consumer choices have been reduced because online retailers like Amazon and Overstock have cut off Californian affiliates. Meanwhile, the sales tax isn’t hurting Amazon as much as an entire segment of California’s Internet entrepreneurs.

Meanwhile, companies are waiting to see if a ballot initiative backed by Amazon succeeds in rolling back the new sales tax law in an election next year.

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.

You probably don’t have correct information about the tax impact of selling on eBay, or on eBay taxes in general. The right answer depends upon the distinctive nature of your selling activity.

There are three ways to use eBay as a sales avenue. Firstly, you can simply sell items you originally acquired for personal use. This can include property you purchased, inherited, or received as a gift. Selling a first edition of Melville that you bought in 1979 or grandma’s diamond necklace you inherited in 1988 is a lot different than selling items you recently acquired specifically for resale.

When you buy stuff that you plan to sell, you are a trader. Doing this as a hobby is the second type of eBay seller. If you trade often enough, you’re probably engaged in a business activity. That’s the third type of eBay seller.

When considering taxes on eBay sales, don’t think you’re off the hook from owing the US Treasury if you don’t have a business. The Internal Revenue Service considers everything you own as a capital asset. Selling it for a gain is therefore a taxable event. You owe capital gain tax and possibly a lot of it if the item is classified as a collectible for tax purposes.

This means you have to know the acquisition date and cost basis for all of your stuff. The capital gain is the difference between the sale proceeds and the cost basis. So keep track of how much you paid for that 1953 Mickey Mantle baseball card or the toy James Bond spy kit. You even need to know how much Mom paid in 1967 for that Star Trek lunch box you found in the attic. All will be subject to a capital gain tax.

The cost basis for items given to you is a little tricky. If you inherit something, your cost basis is the value on the decedent’s date of death. If it’s something extremely valuable, you might want an appraisal as of that date. Your best chance to obtain a fair market value is from the estate executor. A value is probably listed on the probate papers. It may be worth it to find an expert in the field, to help you with your eBay accounting needs.

When you receive something as a gift from a living person, be sure to obtain the giver’s costs basis. Getting grandfather’s 1964 Mustang as a birthday gift also means obtaining his original $2,100 cost basis. In that case, expect a considerable tax on your eBay sale. But at least you have some basis to subtract from the sale proceeds. Don’t use a zero cost basis just because the property cost you nothing. That just causes you to owe even more capital gain tax.

Don’t bother reporting on your income tax return any losses from selling personal items. Losses on the sale of personal-use property are not deductible. Pay capital gain tax on the items you sell for more than your cost basis and forget about the things you sell for less than cost basis.

The situation is different if – instead of selling property you held for personal use – you sell items on eBay that you purchased for resale. I’ll detail that type of eBay tax in another blog post!