Q:

Subject: Question--blog topic?

Kerry,

 

Thanks for taking the time to help so many people understand tax matters.  I have gotten better information on your blog than I have in meeting face-to-face with my tax preparer.  Since you seem to be "plugged in" to such matters, I wanted to ask you about my situation...

 

I'm a full time grad student, married since 2003.  In December 2003 I started buying government surplus equipment and reselling it on Ebay, usually selling about 2 items a week.  This is to supplement my wife's wage income and help pay for tuition.  In 2003 I only sold a few things and had a small loss, which I did not list on my return for that year.  In 2004, I made a stupid mistake on a spreadsheet, which led me to believe that I had no net profit for 2004 either.  While this didn't seem quite right, I was in a hurry to finish the 2004 return, and again did not list my business on it.  The 2004 return showed (correctly) $9K in wages for my wife and I, $35K in capital gains from sale of a rental house, and about $5K in expenses relating to that house, for an AGI of $39K.

 

Well, in 2005 my little Ebay trade did make a profit of over $15K.  When I started getting everything together for the 2005 return, which I've not yet filed, I found the error on my spreadsheet and realized that I actually made a profit in 2004, of about $5K.  So now I have to file an amended return for 2004.  I've had many sleepless nights lately and would be glad to hear your opinion on:

 

1.  Do you think my amended return will trigger an audit?  The error was due to my own carelessness, but I would imagine the sudden appearance of $5000 in previously unreported Schedule C income would look somewhat unusual.  There will be a check for the full amount due attached to my amended return, of course.  How would you phrase the explanation for this error?

 

2.  I use the cash accounting system since my gross receipts are (way) under $1 million.  This means what would otherwise be the "cost of goods sold" is instead treated as an expense, pushing my expense ratio to about 80%.  I have read on other tax sites that this ratio should be kept under 60% or an audit can be expected.  Is this something to worry about?

 

3.  Is there any truth to the persistent rumor that the IRS is targeting Ebay sellers this year, and that they have obtained a list of "powersellers" - those grossing over $1000 monthly on Ebay - and are systematically auditing them?  I heard this from a fellow "powerseller" who was audited recently, who said his auditor was the source of the info.  If so, they may already be investigating me.... fantastic.

 

Sorry for the long-windedness.  I am so busy with school - and our financial margins are so tight - that I want to do everything I can to avoid future trouble.  I've even taken the time to go back and account for every penny deposited into our bank account for the past two years, just in case.  I've read and heard so many horror stories about the IRS that I live in perpetual dread of an audit.

 

Thanks again-

A:

In regard to filing amended tax returns with IRS, the highest risk of triggering an audit seems to be with those claiming  refunds.  I haven't heard of any such risk with 1040Xs where the people have "volunteered" to pay additional taxes.

Interest will be due on those tax payments; but IRS generally doesn't charge late penalties on voluntarily disclosed  additional taxes.  That is not the case if you fail to file a 1040X on your own and then IRS later discovers your unreported income.  Penalties will be assessed in that case.

If you  live in a state with an income tax, you will have to file an amended State return as well.

You claim to have had a net loss for 2004.  In the old days, I would have advised filing a 1040X for that year; but that is not advisable now because of IRS's policy of auditing refund claims.  You should work with a professional tax advisor to see if some of your 2004 costs can be set up as start-up expenses and carried over and amortized on your  2004 and subsequent years' returns.


You seem to be misunderstanding the concept of cost of goods sold for a cash basis business.  You do still need to keep track of inventory cost in the CoGS section of your Schedule C.  Any experienced professional tax advisor should be able to instruct you on this.

I have heard that IRS is aware that many online businesses, such as eBay sellers, are not reporting their income.  IRS can get eBay records with no problem and go after the biggest sellers.

Besides the peace of mind, there are tons of benefits to reporting all of your business income and expenses.  Any experienced professional tax advisor should be able to help you stay legit. 

Good luck.

Kerry Kerstetter

Follow-Up:

Kerry,

 

Thanks so much for your help.  I will do as you recommend and hope for the best.

 

Regards,

 

 

- posted by Kerry M. Kerstetter, MBA~CPA~ATP~ATA @ 2/06/2006 02:40:00 PM Send this post: