The Taxman Cometh

With the economy worsening, more and more people are likely trying to make ends meet by selling goods via eBay, Amazon.com, Google Checkout and other online services. The Internal Revenue Service is fixing to wield a big new weapon to get its cut.

Desperate to generate revenues by narrowing the "tax gap" (and at the urging of the Bush administration), Congress last year passed legislation requiring processors of third-party payments and settlements--mainly payment card companies and services like Paypal--to report to the IRS individuals and business entities that receive at least $20,000 a year in credit- or debit-card charges from 200 or more transactions. The mandatory reporting, buried in the Housing Assistance Tax Act of 2008, would begin in 2011.

The IRS is already soliciting comments on how to implement the law. The primary mechanism likely would be a once-a-year issuance of a variation of Form 1099 reporting gross receipts paid.

Here's the big implication: If the IRS sees a credit card or Paypal 1099 issued for an individual who has filed a tax return that doesn't include a Schedule C (Net Profit From Business-Sole Proprietorship) or includes one showing too little in sales, or to a business reporting too little in sales, the agency might target the recipient for an audit. If an audit target fails to produce acceptable documentation of his or her business proceeds and expenses, the IRS might well include all the revenue reported on the 1099s, disallow any undocumented business expenses and then assess taxes, interest and possibly penalties on profits a taxpayer didn't even have.

A large number of mom-and-pop Internet sellers won't reach the $20,000, 200-transaction threshold for payment card reporting. But if you're one who might, or you simply want to avoid any IRS hassles, how best to protect yourself?

For starters, we recommend honesty. (After all, even sales that aren't subject to 1099 reporting are legally required to be reported on your tax return.) Close behind honesty is keeping good records, which, in this day of easy-to-use computer programs like Quicken, Microsoft Money and QuickBooks, is no longer an obstacle. On eBay, if worse comes to worse, regularly download and print out the page showing all transactions for the past two months.