Tax for online sellers

How does 1099-K reporting work for online sellers?

Under the OBBBA restoration, payment settlement entities (PayPal, Venmo, Stripe, and marketplace platforms like eBay, Etsy, and Amazon) must issue Form 1099-K when gross payments to a seller exceed $20,000 AND the seller has more than 200 transactions in the calendar year. Both thresholds must be met. The original American Rescue Plan Act had lowered this to $600 with no transaction count, but Congress restored the higher thresholds.

The critical issue for online sellers is that 1099-K reports GROSS payment volume, not profit. If a seller has $95,000 in gross sales, $22,000 in COGS, $8,500 in platform fees, $6,000 in shipping, and $4,500 in returns/refunds, the 1099-K shows $95,000 but the actual net receipts are far lower. Sellers must reconcile the 1099-K amount on Schedule C by reporting gross receipts matching the 1099-K and then deducting COGS, fees, shipping, and returns as separate line items. Reporting net sales lower than the 1099-K amount without explanation is a guaranteed IRS notice.

Sellers operating on multiple platforms (eBay + Etsy + Poshmark + direct Shopify) may receive multiple 1099-Ks. The total of all 1099-Ks should reconcile to Schedule C gross receipts. Platforms may split 1099-K reporting by state for sales tax purposes, but for federal income tax, the total is what matters.

Sellers below the 1099-K threshold still owe tax on net profit. The absence of a 1099-K does not mean the income is tax-free. The IRS cross-references bank deposits, platform data, and shipping records. Casual sellers (occasional garage-sale-type activity) selling personal items at a loss generally have no taxable income, but consistent buying-for-resale activity at a profit is a trade or business regardless of the 1099-K threshold.

1099-K is issued when gross payments exceed $20,000 AND transactions exceed 200 in a calendar year. The form reports gross sales, not profit; sellers must reconcile the difference on Schedule C. (IRC Section 6050W; OBBBA Section 80301 (threshold restoration); IRS Notice 2023-74 (transitional guidance))

How should online sellers account for inventory and COGS?

The cost of goods sold (COGS) is the single largest deduction for most online sellers and is reported on Schedule C, Part III (Cost of Goods Sold), not as a regular business expense. COGS includes the purchase price of inventory (or materials for handmade goods), inbound freight, and direct labor for production. COGS is subtracted from gross receipts before calculating net profit.

Under IRC Section 471, businesses required to maintain inventories must use an accrual method for inventory purchases and sales. However, most small online sellers (under $29 million average annual gross receipts over the prior three years) qualify for the small business exception under Section 471(c), which allows them to use the cash method and either (1) treat inventory as non-incidental materials and supplies (deduct when sold or used) or (2) conform to their financial accounting treatment.

Section 263A (Uniform Capitalization / UNICAP) requires certain businesses to capitalize additional costs into inventory beyond direct purchase price, including warehouse rent, storage, and handling. However, Section 263A does not apply to resellers with average annual gross receipts of $29 million or less (the small reseller exception). This means most individual online sellers are exempt from UNICAP and can treat their COGS as the direct purchase price plus inbound shipping.

Amazon FBA fees, eBay final value fees, Etsy listing and transaction fees, PayPal/payment processing fees, and platform advertising costs are NOT part of COGS. These are period expenses deducted on separate Schedule C lines (advertising, commissions/fees, or other expenses). Capitalizing platform fees into inventory overstates COGS in the current year and potentially misstates income. Outbound shipping costs paid by the seller are deductible as a business expense, not COGS, unless the seller includes shipping in the product price (in which case it is part of gross receipts and the shipping cost offsets in COGS).

For resellers sourcing from thrift stores, liquidation pallets, or wholesale, maintaining records of purchase cost per item is essential. Many sellers use inventory management tools (SellerCloud, InventoryLab, Sellerboard) that track per-item cost basis. Without per-item records, the IRS may disallow COGS or require estimation methods that produce less favorable results.

Inventory costs (purchase price + inbound freight) are COGS on Schedule C Part III. Platform fees are period expenses, not COGS. The small business exception ($29M) exempts most online sellers from UNICAP and allows cash-method inventory. (IRC Section 471(c) (small business exception); IRC Section 263A (UNICAP); Treas. Reg. 1.471-1; TCJA Section 13102)

When does the hobby loss rule under Section 183 apply?

IRC Section 183 denies deductions for activities 'not engaged in for profit.' If the IRS classifies an online selling activity as a hobby rather than a business, the seller can deduct expenses only up to hobby income (no net loss) and only as an itemized deduction on Schedule A (which is currently suspended through 2025 under TCJA, effectively making hobby expenses non-deductible). This turns a reported loss into taxable income equal to gross hobby receipts.

The primary safe harbor is the 3-of-5-year profit test: if the activity produces a net profit in at least 3 of the last 5 consecutive tax years (including the current year), it is presumed to be a for-profit activity. The IRS can still rebut this presumption, but the burden shifts to the IRS. If the activity is profitable in fewer than 3 of the last 5 years, the burden is on the taxpayer to prove profit motive.

The IRS applies nine factors (Treas. Reg. 1.183-2(b)) to determine profit motive: (1) manner in which the activity is carried on (business-like records, separate bank account, business plan), (2) expertise of the taxpayer, (3) time and effort expended, (4) expectation of asset appreciation, (5) success in carrying on other similar activities, (6) history of income and losses, (7) amount of occasional profits, (8) financial status of the taxpayer (does other income subsidize losses?), and (9) elements of personal pleasure.

For online sellers, the strongest defense against hobby classification is maintaining business-like records (accounting software, inventory tracking, separate bank account), having a documented business plan (growth targets, sourcing strategy, marketing plan), and demonstrating genuine effort to become profitable. A first-year loss is expected and does not trigger hobby treatment. Consecutive losses over 3+ years with no clear path to profitability will attract scrutiny, especially if the seller has substantial W-2 or other income that the losses offset.

Profit in 3 of 5 years creates a presumption of business activity; otherwise, the IRS may classify the activity as a hobby and deny net losses. (IRC Section 183; Treas. Reg. 1.183-2(b) (nine-factor test); IRC Section 67(g) (TCJA suspension of miscellaneous itemized deductions))

How do multi-state sales tax nexus and marketplace facilitator laws work?

Following South Dakota v. Wayfair (2018), states can require out-of-state sellers to collect and remit sales tax once they exceed a state's economic nexus threshold (typically $100,000 in sales or 200 transactions in the state). For Amazon FBA sellers, physical nexus is also created by inventory stored in FBA warehouses across 20+ states, triggering sales tax collection obligations in every state where inventory is housed.

The saving grace for most online sellers is marketplace facilitator laws. All 45 states with sales tax (plus DC and Puerto Rico) have enacted marketplace facilitator legislation requiring the marketplace (Amazon, eBay, Etsy, Walmart Marketplace) to collect and remit sales tax on behalf of third-party sellers. This means the seller generally does NOT need to register for sales tax permits or file sales tax returns for sales made through these platforms, as the platform handles collection.

The trap: marketplace facilitator laws apply only to sales THROUGH the marketplace. Sales through the seller's own Shopify store, direct website, craft fairs, or any other non-marketplace channel are the seller's responsibility. A seller with $200,000 in Etsy sales (marketplace-collected) and $30,000 in direct Shopify sales must handle their own sales tax for the Shopify channel in every state where they have nexus.

Income tax nexus is separate from sales tax nexus. FBA inventory stored in California, Texas, and New Jersey creates income tax filing obligations in those states, even if Amazon handles the sales tax. Most states with income tax require non-resident businesses to file returns on income sourced to that state. The apportionment formulas vary: some states use single-sales-factor (income allocated based on where customers are located), others use three-factor formulas (sales, payroll, property). For a sole proprietor seller, this can mean filing non-resident income tax returns in multiple states.

Practical approach for small FBA sellers: many states have de minimis thresholds for income tax nexus or provide safe harbors for businesses with minimal in-state activity. Consulting a multi-state tax advisor is essential once FBA revenue exceeds $100,000, as the compliance cost of filing in 15+ states can be significant.

FBA inventory creates physical nexus for sales and income tax in every warehouse state; marketplace facilitator laws shift sales tax collection to the platform for marketplace sales only. (South Dakota v. Wayfair, Inc., 585 U.S. 162 (2018); IRC Section 7 USC 381 (P.L. 86-272, income tax protection for solicitation-only nexus — does not protect inventory presence))