FTB 3730 – Online Buying or Selling – Know Your Tax Obligation
Be informed about Internet sales and online auctions. The Internet Tax Freedom Act prohibits the taxing of access to the Internet. The Act does not apply to tax on income from online sales or sales or use tax on purchases made online. Some individuals mistakenly think that this law exempts income from Internet sales and online auctions from income tax, and that buyers do not have to pay use taxes on their purchases.
If you are an online auction seller or buyer, you may have tax responsibilities.
Online Sales – Income Tax
California residents are taxed on all income, regardless of source, within and outside of the U.S. This includes income passed-through from limited liability companies (LLCs) formed in other states. California nonresidents are only taxed on income from California sources, e.g., gain from sale of property in California, or wages earned in California.
Part-year residents are taxed on all income received while a California resident, and income from California sources while a nonresident. Several factors are involved in determining a change in residency status.
- FTB 1031 – Guidelines for Determining Resident Status
- 540 Instructions – Instructions for Form 540/540, California Resident Income Tax Return
- Form 540NR – Nonresident or Part-Year Resident
- FTB 1032 – Tax Information for Military Personnel
- FTB 1123 – Forms of Ownership
- FTB 689 – Read the Fine Print: Forming A Business Entity Outside of California
Earnings from Online Auctions
Earning money by selling items on the Internet affects a growing number of individuals and businesses. If you occasionally sell items through online auctions, you may be underreporting your income. Any time you earn income other than wages, you should evaluate whether the transaction is taxable. If you have an established business and you augment your sales with online auctions, remember to include the online auction sales in your business income. If your online transactions reach the level of a business activity (see the discussions on Hobby or Business that follows), you should determine whether it is appropriate to deduct ordinary and necessary business expenses. An ordinary expense is an expense that is common and accepted in your trade or business. A necessary expense is one that is appropriate for your business.
If you are in the business of selling items through auctions, you may also owe self-employment tax, employment tax, or excise tax.
- FTB 984 – Common Business Expenses for the Business Owner and Highlights of the Federal/State Differences
- FTB 1001 – Supplemental Guidelines to California Adjustments
- IRS Pub 334 – Tax Guide for Small Business (For Individuals Who Use Schedule C or C-EZ)
- IRS Pub 463 – Travel, Entertainment, Gift, and Car Expenses
- IRS Pub 525 – Taxable and Nontaxable Income
- IRS Pub 535 – Business Expenses
- IRS Pub 583 – Starting a Business and Keeping Records
- IRS Form 1040 – Self-Employment Tax
- IRS video on Business Income
Hobby or Business – Is your hobby really an activity engaged in for profit?
Generally, your activity is considered a business if it is carried on with the reasonable expectation of earning a profit.
If your activity is a hobby/not-for-profit activity, allowable deductions cannot exceed the gross receipts for the activity. See Internal Revenue Code Section 183, Activities Not Engaged in for Profit, for limits on deductions that can be claimed.
If you are not sure whether your activity is an activity engaged in for profit, reaching the level of a business activity, or a hobby, here are eight questions that will help you determine if your activity is a hobby or a business:
- Does the time and effort put into the activity indicate an intention to make a profit?
- Do you depend on income from the activity?
- If there are losses, are they due to circumstances beyond your control or did they occur in the start-up phase of the business?
- Have you changed methods of operation to improve profitability?
- Do you have the knowledge needed to carry on the activity as a successful business?
- Have you made a profit in similar activities in the past?
- Does the activity make a profit in some years?
- Do you expect to make a profit in the future from the appreciation of assets used in the activity?
An activity is presumed carried on for profit if it makes a profit in at least three of the last five tax years, including the current year.
Deductions for hobby activities are claimed as itemized deductions on Schedule A, Form 1040. These deductions must be taken in the following order and only to the extent stated in each of the following three categories:
- Deductions you may claim for certain personal expenses, such as home mortgage interest and taxes, may be taken in full.
- Deductions that do not result in an adjustment to the basis of property, such as advertising, insurance premiums, and wages, may be taken next, to the extent gross income for the activity is more than the deductions from the first category.
- Deductions that reduce the basis of property, such as depreciation and amortization, are taken last, but only to the extent gross income for the activity is more than the deductions taken in the first two categories.
- IRS Fact Sheet 220-23 – Is Your Hobby a For-Profit Endeavor?
Business Deductions for Online Auctions
If you operate an online auction as a business, you may be entitled to deduct business expenses. In general, you may deduct ordinary and necessary expenses for conducting a trade or business or for the production of income. Trade or business activities and activities engaged in for the production of income are activities engaged in for profit. Good records help you monitor the progress of your business, prepare your financial statements, identify the sources of your receipts, keep track of deductible expenses, prepare your tax returns, and support items reported on your tax returns.
Home Office Deduction
If you use a portion of your home for your online auction business, you may be able to take a home office deduction. In order to deduct expenses related to the business use of your home, you must carry on a “bona fide” business, as well as meet other specific requirements. Your deduction may be limited. To qualify to claim expenses for the business use of your home, you must meet both of the following tests:
- Use of the business part of your home must be:
- For your trade or business.
- The business part of your home must be one of the following:
- Your principal place of business.
- A place where you meet and deal with customers in the normal course of your trade or business.
- A separate structure you use in connection with your trade or business.
- IRS Pub 587 – Business Use of Your Home (Including Use by Day-Care Providers)
- IRS Form 8829 – Expenses for Business Use of Your Home
Online Garage Sales – Income Tax
If your online auction sales are the equivalent of an occasional garage or yard sale, you generally do not have to report the sales. In a garage sale, you generally sell household items purchased over the years and used personally. If you paid more for the items than you sell them for, the sales are not reportable and any losses on personal use property are not deductible. If your online garage sale develops into a business and/or you have recurring sales and purchase items for resale with the intention of making a profit, you may have started an online auction business.
Sales of Appreciated Assets at an Online Auction
If you have online auction sales where the sales price is more than your cost or other basis, you usually will have a reportable gain. These gains may be business income or capital gains.
Sales of Depreciated Business Assets
If you sell business assets or close your business you may have capital gains, ordinary gains, and depreciation recapture to report.
Online Purchases - California Sales and Use Tax
California residents are also required to pay a tax when they purchase tangible property that will be used, consumed, or stored in California. California law requires tax on in-state purchases, and also requires tax on items purchased out-of-state for use in California. Tax collected by the retailer here in California is called sales tax, and the retailer is responsible for reporting and paying the tax. When an out-of-state or online retailer doesn't collect the tax for an item delivered to California, the purchaser may owe "use tax," which is simply a tax on the use, storage, or consumption of personal property in California. Items that are exempt from sales tax are exempt from use tax as well. Use tax liabilities are often created by Internet or mail order purchases with out-of-state retailers not required to collect the tax. If you are purchasing from an online auction seller you may have a Use Tax responsibility. Be sure to review your receipts for Internet and other out-of-state purchases to determine if tax was charged. For more information, go to the California Board of Equalization website at www.boe.ca.gov. You can also call their Information Center at 800.400.7115.
- Pub 61 – Sales and Use Taxes: Exemptions and Exclusions
- Pub 105 – District Taxes and Delivered Sales
- Pub 110 – California Use Tax Basics
- Pub 123 – California Businesses: How to Identify California Use Tax Due
- FTB 988 – California Use Tax and Your Filing Requirements
Do I need to get a seller's permit to sell on online auction sites?
If you are a California resident and sell items on online auction sites regularly, you will most likely need a seller’s permit. A “retailer” is defined in the law (section 6019 of the Sales and Use Tax Law) to mean, among other things, every individual or firm making more than two retail sales of tangible personal property during any 12-month period. Persons engaged in the business of making retail sales at auction of tangible personal property owned by such person or others are retailers, and are, therefore, required to hold sellers’ permits and pay tax on the gross receipts from such sales. A seller’s permit allows you to collect sales tax from California customers and report those amounts to the board. There is no charge for a seller’s permit, but security deposits are sometimes required.
As a California retailer, you are responsible for paying the correct amount of sales tax to the California State Board of Equalization for sales made to Californians unless the item or person is specifically exempt by law. You may be reimbursed by your customers for the amount of tax you owe on a sale. If you do not pay the correct amount, the additional tax plus applicable penalty and interest will be charged. For more information, go to the California Board of Equalization website at www.boe.ca.gov. You can also call their Information Center at 800.400.7115.
- Pub 107 – Do You Need a California Seller's Permit?
- Pub 73 – Your California Seller's Permit
- Pub 109 – Are Your Internet Sales Taxable?
- Pub 177 – Internet Auction Sales and Purchases
- Pub 100 – Shipping and Delivery Charges
- Pub 101 – Sales Delivered Outside California
- Regulation 1565 – Auctioneers
- California City and County Sales and Use Tax Rates
Online Garage Sales – Sales/Use Tax
People who hold garage sales generally are not required to hold seller’s permits unless they hold more than two garage sales in a 12-month period or are required to hold a seller’s permit for being engaged in the business of selling merchandise, goods or items (tangible personal property).
Generally, if you make three or more sales in a 12-month period you are required to hold a seller’s permit. This applies even if your sales are made through Internet auction houses or websites that offer online classified advertisements (online advertisers). For more information, go to the California Board of Equalization website at www.boe.ca.gov. You can also call their Information Center at 800.400.7115.