Smart TaxesSmart Taxes

How online sellers can avoid tax trouble

Those who peddle their wares on eBay, Etsy and other sites are required to pay income and self-employment taxes on their profit. Big sellers will get a new form this year.

By MSN Money Partner Mar 19, 2012 8:18PM

This post is by Raina Kelley of The Fiscal Times.


In February 2008, just as the recession deepened, Rob Kalin, the founder and CEO of, the Brooklyn-based online market place for handmade goods, showed the audience of "The Martha Stewart Show" some of the big sellers on this site. Among them: a “sock money soap popsicle” and knitted pussy willows. "Anyone here -- if you're in school or out of school, at any age -- you can start a business from home," he told the audience.


Lots of people have done just that. Etsy says more than $314 million in goods was sold on the site in 2010, up from $87.5 million in 2008. In addition to big sites like Etsy, eBay and Craigslist, there are plenty of newcomers, such as, and that allow people to turn a DIY hobby into a business.


Not surprisingly, the Internal Revenue Service is figuring out ways to get its fair share. If you’re using an online auction site to unload old baby clothes or unwanted furniture for less than what you originally paid, the IRS probably isn’t interested.


It’s a different story if you are handling a large number of online transactions and selling items for more than your cost. Anyone who is self-employed and earns more than $400 in annual net profit from a business must pay self-employment tax as well as income tax. (Post continues after video.)

Fiscal planning can be a little trickier for online sellers, because they typically have lower expenses and higher profit margins than traditional retailers. If your tea cozies made from vintage quilts suddenly are featured on Etsy’s home page, you could wind up with an unexpected windfall.


"The self-employment tax can really trip people up," says Bob Meighan, a certified public accountant and vice president of TurboTax. Last year, that was 13.3% of your business income -- down from 15.3% in 2010. "What you’re doing is paying into Social Security and Medicare for yourself," he adds. That can be a big bite from a small

revenue stream.


Beginning this year, companies that process payments are required to send 1099-K statements to taxpayers who annually sell more than $20,000 worth of goods and have more than 200 transactions on sites such as Etsy or eBay. Most online sellers, of course, don’t do that kind of volume, but all small businesses must report their income and expenses to the IRS. Many online sellers don’t realize that many of the fees they pay to Ebay and Paypal are deductible, as are their materials costs and shipping expenses.


"The biggest mistake [Etsy sellers make] is not becoming knowledgeable about the tax law before starting their business," according to JJMFinance, an Etsy store that provides tax services to other Etsy sellers. "Every Etsy seller should have a bookkeeping system that they feel comfortable using the moment they start spending or receiving their first revenues.”


Even if you have no intention of growing your online sales business into a Fortune 500 company, it’s a good idea to keep good financial records just in case Uncle Sam comes calling. Options vary from a basic Excel spreadsheet to full-blown accounting software such as Quickbooks. Most tax prep software also can help you determine what is and isn’t a business expense.


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