An Independent Tax Specialist's Advice for eBay Sellers
eBay Staff Member
You can't avoid death and taxes, the old saying goes. But with a bit of planning, careful recordkeeping, and knowing what you can show as business deductions, you may be able to legally reduce the amount of taxes you pay. This is especially relevant to eBay sellers, most of whom have small and medium sized businesses, where every dollar saved is a dollar earned.
Diane Kennedy, independent tax strategist
As many people across the country scramble to send in their tax returns before the mid-April deadline, The Chatter team spoke with Diane Kennedy, an independent tax strategist with over 20 years of experience in creating tax solutions for individuals and businesses. For the past few months, she's conducted monthly online workshops on tax issues. She's also written a book that many eBay sellers may find useful – Tax Loopholes for eBay Sellers.
Many eBay sellers often juggle their business on eBay between full-time jobs and taking care of their families. Acknowledging this situation, Diane says that it's understandable that most eBay sellers may not have the time or energy to wade through the sheer volume and complexity of state and federal tax laws. It's no wonder that, after filing their taxes, many eBay sellers wonder if they could have done something better in order to keep a larger portion of their earnings on eBay.
Diane says that the goal of her company, TaxLoopholes, is to educate people running small and medium sized businesses about how they can keep more of what they make. "All of us have a responsibility to pay tax, but none of us should pay more than our share. The tax laws are complex and written for the rich. Most of us do not have access to the kind of information that will allow us to use these loopholes that all taxpayers are entitled to.”
Below are the highlights of the team's conversation with Diane.
Disclaimer: The tax advice below is at a broad, general level. For advice related to your individual tax situation, please consult your tax planner.
What is the most important piece of tax-related advice you would give an eBay seller?
Actually, I have three pieces of advice that I'd urge eBay sellers to consider:
- Make sure you have a registered business in the eyes of the IRS. It can be to your advantage if you're operating as a business in the eyes of the IRS.
That means that you are in business with a profit motive and run it like a business with good record keeping and proof that you are working to improve the business.
From a tax perspective, if you have income, you'll have to pay taxes, no matter what. But if you have a loss, proving that you have a business can help you mitigate your loss. So if you haven't registered your business yet, go to your city clerk's office and start the process.
- Keep records, right from the start. Sometimes the IRS asks for proof of your deductions months, even years after you've filed your tax return. I strongly recommend that eBay sellers organize and their financial information on a weekly, or at least a monthly, basis.
- Look for ways to reduce your taxes all through the year. If you know about what you can classify as business deductions, you'll be watching our for opportunities to reduce your tax liability throughout the year.
How can eBay sellers better understand their business deductions?
The IRS says that an expense has to be "ordinary" and "necessary" to be a deduction. Look for ways your necessary personal expenses help your business.
For example, let's say you sell clothing on eBay. I'm sure you travel to other towns to see the latest trends in fashion, for trade shows, or to look for deals on over-stocked items that you can sell. If you use your car in your business on eBay, for example to drive to the Post Office, the FedEx store, Office Depot, Kinko's, and to the bank, it may be a business deduction.
But you do need to figure out how much you're using your assets (like your car) for business use, and how much you're using them for personal use.
In the case of the car, after figuring out how much you're using it for business and how much for your personal use, you can take a business deduction in two ways. The first method is to take a "cents per mile" calculation on your car as a deduction for your business. The second method is to deduct a percentage of all expenses on your car as a business deduction. If 25% of your car usage is for your business, then deduct 25% on the total expenses for your car, such as gas, oil, and tires.
"Ending inventory" could cost you
In my experience, the most commonly missed business deductions are travel, cell phone costs, home office equipment (computer, printer, fax machine, furniture), and the costs of furthering your education to help your business.
Another thing to watch out for is "ending inventory," i.e., the inventory you have near tax time. Some sellers think that making a last minute purchase of inventory can reduce their tax liability. It may not! Ending inventory is an asset, not an expense. It reduces a seller's cost and can be a problem at tax time. Purchasing $10,000 worth of inventory just before tax time may not help you. First, you don't get a deduction for it, and second, you don't even have the money to spend (because you already used it to buy inventory).
Most eBay sellers operate their business from their homes. Can they show business deductions for their home office or for their inventory storage space?
There's a lot of bad and out-of-date information out there regarding home office deductions. In 1994, there was a Supreme Court ruling, called the Solomon case, that disallowed a doctor's home office, because the judges ruled that he did his work in the surgery at a hospital (although he didn't have any other office). Since then, the law has changed a lot. There are only two things you need to prove to get the home office deduction:
- It must be a space in your home that is used exclusively for your business. So it can be a separate room where you do all the work related to your eBay business. It cannot be a space in your house that you also use for personal use – such as your kitchen.
- It must be used regularly for your eBay business.
That's it. You don't need to have a separate entrance, and it's okay to have another location for your business as well.
The rules for showing a deduction on storage space are different, and these are especially relevant to eBay sellers. If you store inventory, promotional materials, or shipping and packaging supplies in a space outside your home office, you get a deduction there as well. But you don't need to use the storage space exclusively for your business in order to show it as a deduction—it can be dual purpose. For instance, if you're using a part of your garage to store your eBay inventory, and the rest of the garage to park your car, you can get a deduction.
Here's how you can determine the amount of the deduction for your home office or your storage.
Measure the total square footage of the space, and also measure the area of the part you use for your business. The percentage that is used for business is then applied against all home related costs. For example, if you have 200 sq. ft. for your home office in your 2000 sq. ft. home, your business use is 10%. So, 10% of your costs such as mortgage interest, property tax, insurance, homeowner's association dues, utilities, maintenance, etc. are now deductible against income from your business.
Why is it important to keep detailed business records and use an accounting system?
In my mind, there are three good reasons why good documentation is vital to the eBay business owner:
- You can analyze your business much better. As you keep records, you'll quickly see what works and what doesn't work in your business. For instance, are you making money? Just knowing the balance in your checking account won't give you that answer. But looking at your income and expenditure statements over a period of time certainly will.
- You can plan for your taxes. If you don't know how much money you're making, you can't foresee how much you'll have to pay in taxes at the end of the year. Having a good handle on the taxes you expect to pay at the end of the year can help you work on a tax strategy to reduce that liability.
- A paper trail for the IRS. If you're audited, you've got the proof you need to show the IRS. This might be the most important reason of all to keep detailed records—it means you can sleep soundly every night.
There are moves afoot in State and Federal legislatures to have more stringent tax regulations for sellers. What should eBay sellers do to prepare for this possible reality?
Tax officials have been concerned that too many eBay sellers are slipping under the tax radar. I think it's inevitable that they're going to start looking for ways to start taxing eBay sales. The best defense is good record-keeping that proves you have a business, and looking for all the legitimate deductions you can.
What are your recommendations to eBay sellers about tax strategies and planning?
Business deductions are short term tax strategies. First, know what you want to do with your money in the long run. It always helps to think about your retirement plans, investment portfolios, savings strategies and so on first. A large part of your long-term tax planning will be based on these life decisions.
Second, use business structures wisely. The best way for me to explain this is in terms of a change in mindset when you go from being an employee at a company to being a business owner. A key part of long-term tax planning is looking at expenses with different eyes.
Let me clarify with an example. One of my clients left a job where he was earning $50,000 a year to start his own business. In his first year, he made exactly the same amount after subtracting his "cost of sales." Yet, he put $10,000 more in his pocket! Why? The difference wasn't in the amount of money he made, it was in the way he made the money. He did it as a business owner, not as an employee.