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IRS Agent: you mean my eBay earnings are taxable?

April 21, 2010

One of the hazards of the online economy is the way it can enable employees to surreptitiously compete with their employers. When your employer is the IRS, that can be a bad thing.

An IRS revenue officer from California rode the eBay wave in 2004 and 2005, conducting what she called an "on-line garage sale." She decided that she didn't need to keep track of her eBay income and expenses because she wasn't in a "business." Her employer was less than understanding, and things ended up in Tax Court yesterday:

Petitioner testified that she did not understand why respondent so persistently asked for proof of her costs and expenses. She testified that she purchased personal items and never kept a receipt. "That would be ridiculous, unheard of. Unless there was some really bizarre reason why I kept a receipt, there were no receipts", according to petitioner. To address respondent's claim that she was operating a business, petitioner said she put together two charts, based on her bank statements and PayPal records, showing her "business" expenses. "I didn't have receipts. I sold wedding gifts." "I had gift cards. I said well, I didn't pay anything of [sic] these gift cards from my wedding, so I guess I just take all of that as a loss. They said no. The basis is the gift card."

I know that sort of explanation wouldn't work for my clients.

On the other hand, petitioner admitted that she "occasionally" purchased items for sale in the ordinary course of her eBay sales activity that would still "have tags on them". When she was reminded that most of the items she sold were "advertised" as new, petitioner responded: "I always advertise as new only because you can get a better price for that." And she added, "So basically when you're asking these questions about why things are new, I document them as new if it appears new. Is that wrong?" Petitioner explained that she sold clothing and shoes of various sizes because she contracted plantar fasciitis and was unable to keep up her exercise routine. Lack of exercise caused her dress size to increase, according to petitioner, and the use of orthotics caused her shoe size to increase.

Translation: I fib to my customers, judge, but I'm telling you the truth!

Things went badly for the agent with the judge:

Petitioner is a revenue officer with the IRS. With this background, she has a wider range of knowledge of tax matters than do members of the general public. See Kendrix v. Commissioner, T.C. Memo. 2006-9. Petitioner is, or certainly should be, familiar with the recordkeeping requirements of section 6001, and she had access to a wide range of tax resources relating to the reporting of income and deductions. The Court might not expect for a taxpayer to keep records for a few small items sold on eBay. In view, however, of the large number of transactions in 2004 and 2005 in which petitioner engaged, she should have realized that her activity might be subject to question. Accordingly, respondent's determination is sustained.

The result: tax and negligence penalties.

The Moral: If you do eBay on the side, keep good records. The IRS doesn't buy the "garage sale" story.

Cite: Orellana, T.C. Summ. Op. 2010-51

Update: The TaxProf has more.