OT: IRS Paypal Tax Situation

[BobC]

I've been doing taxes for almost 40 years and have a client that sells on Ebay, so I know what you got yourself into. You neglected to report the results of your online selling activity through Paypal, which obviously sent information about your activity into the IRS for 2014. You should have received a copy of this 1099 form sent from Paypal also. The IRS threshold for having Paypal report to them on an individual is that they have at least $20,000.00 of receipts, and at least 200 transactions, for a calendar year. The person who suggested you may have to determine if your are dealer or just selling collectibles/investments can forget that, at that volume you are most likely going to be considered a dealer by the IRS, trust me. As such, if your business isn't incorporated or set up as some type of Limited Liability Company, you're supposed to file a Schedule C as part of your federal tax return and report your sales activity for the year. In other words, you treat it as a sole proprietorship. Obviously to report this you'd start with your gross receipts or sales, and then list your allowable deductions, to finally determine your net taxable income for the year.

As some others mentioned, there are various expenses you can claim and use to reduce your taxable income, such as Paypal or Ebay fees, postage costs and shipping materials, etc. You're probably ignoring the biggest expenditure of all though, which is most likely your Cost of Goods Sold (COGS). Yes, you're supposed to keep track of the costs you incurred to acquire everything you sold. and then only deduct the actual cost of each item sold against the sale price you received for it. You can't just say that you bought $30,000 in cards during the year and only sold cards for $25,000, and claim you had no income and instead, a $5,000 loss. It doesn't work that way. Any item you buy and hold, as a dealer, basically becomes an asset of the business knows as inventory. You hold the value for each business inventory item purchased as an asset until you sell it. It is only then that you report the sales price as income and offset it by the cost you originally incurred to acquire the item sold.

The IRS doesn't know anything about what you do, other than the fact they got a 1099 form from Paypal showing you had gross receipts of a certain amount. Since you didn't report this income on the tax return nor show any expenses against it, the IRS can only assume you had no deductible expenses and went ahead and recalculated your return based on what they know. The letter they sent, and the amount shown as due on it, were sent for one main reason.......to get your attention, which they obviously did. You need to go back and try to figure out all your expenses from that year related to your card selling, including your COGS, and come up with your net taxable income.

And to add insult to injury, assuming that you are actually handing the sales and work yourself, you are actively involved in the business and not only is the net income going to be subject to ordinary income tax rates but, it is also probably going to be subject to self-employment tax (social security and Medicare) of upwards of 15.3% on top of of the income taxes.

The best thing for you to do is go back and star putting together all the data you can to try and figure out what expenses you may have. The IRS already knows your gross income based on the report they got from Paypal. Determining what your COGS sold is could be tricky if you don't keep decent records. And then in determining your other costs you want to try to include as much legitimate expense as possible. Don't forget things like mileage to drive to the post office, internet access costs and fees, possibly a home office deduction if you have an exclusive area of your home you us for the business, and so on. if you are not very experienced with the IRS or the rules, you probably should look for some expert advice. Once you think you have all that, you should write back to the IRS and explain that you have expenses to be deducted against the income reported to you from Paypal. You want to list everything out as best you can and include any supporting documents in your response. Once you've come up with what you believe is your true net income, ask the IRS to review your account and if need be, recalculate what you owe them. At that point you wait to hear their response back.

You should be able to bring the IRS calculated tax due way down but, don't be surprised if you do end up with a balance still due. And of course then they can also tack on interest and penalty charges for not originally reporting the income and paying the tax late. Good luck.

BobC