Section 7.2. Doing the Paperwork

7.2. Doing the Paperwork

Welcome to the ranks of the self-employed! Whether you're selling full-time or as a sideline , when you're doing business on eBay, you get to be your own boss. The freedom is heady, but it's not without responsibility: you have to keep good records, learn a little bookkeeping, and comply with the legal and tax requirements of self-employed sellers. This section shows you how.

Note: Although this section offers basic information, be sure to consult an accountant or tax professional for guidance on the tax laws that apply to entrepreneurs.

7.2.1. Write a Business Plan

The old adage, "Fail to plan and you plan to fail" is never more true than in business. If you're serious about hanging out your own shingle, you need to create a business plan .

Think of a business plan as an outline describing the goals you want to accomplish with your business, and how you intend to accomplish those goals. You want to include things like how much money you want your business to make (and when), how much money you plan to invest, what marketing strategies you intend to use, what kinds of customers you intend to go after (and how you intend to reach them)that sort of thing.

The great thing about a business plan is that putting one together forces you to think through your business from beginning to end before you quit your day job and invest your life savings. In other words, you get to see on paper, from the comfort of your favorite armchair, whether or not your eBay business has a good chance of succeeding.

If you need another reason to get out paper and pencil, be aware that if you find yourself looking for a business loan, you'll need a business plan to get financing.

If you do decide to write a business plan (and you really should), here are the sections you should consider:

• Description . What's the scope of your business? What makes it or your products unique?

• Marketing . Who are your potential customers and how will you reach them? Who is your competition? How will you make your products stand out?

• Finances . This section includes income statements and your business's balance sheet (Section 7.2.4).

• Management . Is your business bigger than a one-person show (or do you expect it to be)? Who is responsible for various tasks ? How many part-or full-time workers do you expect to hire right away? In the future?

Tip: A business plan doesn't just give you an edge in managing your business; it helps you plan for the future. Use your business plan to measure your progress as your business grows, marking both milestones and missed goals. Revise the document as you meet goals and develop new ones.

For more information about writing a business plan, check in with the Small Business Administration (www.sba.gov), as shown in Figure 7-4, or BPlans.com (www.bplans.com). Both sites offer a wealth of free information; BPlans.com also sells Business Plan Pro, a Windows-based business-plan-writing program.

Figure 7-4. The Small Business Administration's Web site is packed with advice and information for small businesses like yours. From the right-hand menu, click Starting Your Business to learn about finding a niche, writing a business plan, and understanding what else you need to start a business. Financing Your Business lists different loan and grant resources. Managing Your Business discusses planning, leadership, and marketing.

7.2.2. What Kind of Business Are You?

When your eBay hobby grows into a business, you designate it as one of three legal structures: sole proprietorship, partnership, or corporation. This section tells you what these terms mean and looks at the advantages and drawbacks of each.

Note: The Internal Revenue Service's Web site offers information about different business structures and associated tax issues at www.irs.gov/businesses/index.html, shown in Figure 7-5.

Figure 7-5. Uncle Sam taxes corporations, partnerships, and sole proprietorships differently. To learn more about the tax advantages and responsibilities of the different kinds of businesses: on the IRS Businesses Web site, go to the left-hand menu and then click the appropriate link. (Small Business/Self-Employed is a good place to start.)

7.2.2.1 Sole proprietorship

This is the simplest business structure, and for that reason alone, it is the most popular for eBayers. In fact, if you're selling things on eBay (for yourself, not as someone else's employee), you're already a sole proprietor. In a sole proprietorship, one person owns and operates the business. That makes you the one and only boss. Taxes are easier for a sole proprietorship than for the other structures, because you report business income and expenses on your personal income tax return. That means that any losses from your business can offset other income.

The main drawback to a sole proprietorship is that you're personally liable for the obligations and debt of your business. That means that you could lose your personal assets (like your home) to business debtsor legal claims against the business. Also, a sole proprietorship usually runs on the owner's resources; it's harder to get banks to lend you money for this kind of business.

7.2.2.2 Partnership

Being a sole proprietor can be exhausting: you own the business and get all the benefits, but you also take on all the responsibilities. Sometimes, it's better to get by with a little help from your friends . There are two kinds of partnerships:

• General partnership . In a general partnership, all partners are active in the company and responsible for its debts . This model is the more common for small businesses.

• Limited partnership . This structure has both general partners, who manage and run the business and assume financial responsibility, and limited partners, who are simply investors with no say in the running of the company and no liability risk beyond their initial investment. You don't usually see new or small businesses set up as a limited partnership.

Partnerships offer a tax advantage because the company doesn't pay tax on its income but passes profits and losses on to individual partners.

Note: One kind of partnership of interest to many eBayers is called a husband/wife trading partnership , a kind of general partnership that offers tax savings to married couples. If you're married, you don't have to file any special papers to establish this partnership. Ask your accountant for more information if you think this model could benefit you.

The main disadvantage to a partnership is the same as for a sole proprietorship: partners are personally responsible for business liabilities. And dissension among partners can cause problems, because each partner can act on behalf of the partnership, which could cause problems for the business and the individual partners.

To form a partnership, contact a good lawyer. A lawyer who's had experience with partnerships can help you draw up the agreement, as well as help you to ask questions and forestall problems you may not have thought of.

7.2.2.3 Corporation

The main advantage of a corporation is that it protects your personal assets by separating your business from the actual people who own and operate it. This shields you from being personally liable for your company's debts and obligations. In addition, if you have or expect to have employees , you can put together benefits packages for them: health insurance, a pension plan, and so on. You can extend those benefits to yourself, too.

On the other hand, corporations are complex. Because a corporation is a separate legal entity from the people who own and run it, it must comply with a separate set of regulations and tax requirements. Corporations require more money, time, and paperwork to set up and maintain than partnershipsor sole proprietorships. Plan on hiring a lawyer and an accountant.

There are many kinds of corporations. But if you're thinking of incorporating, you'll probably be interested in one of two kinds, described in the box below.

If you want to incorporate , you must file with your state: either through the secretary of state's office or another office that registers corporations. A lawyer can guide you through all the forms and red tape, but can cost up to a couple thousand dollars, depending on your area.

POWER USERS' CLINIC
Types of Corporations

If you're considering forming a corporation, there are two types you're most likely to investigate. Warning: this information is dense and legalistic.

• S corporation . This corporate structure, meant for businesses with fewer than 75 shareholders, offers liability protection to the business owner. Income and losses are passed to shareholders and reported on their individual tax returns, so in a new business with early losses, shareholders can offset any such losses against their personal income. There are, however, a number of drawbacks to forming an S corporation. For example, this kind of business is subject to greater legal and tax costs an partnerships or sole proprietorships are. In fact, S corporations are, in a sense, taxed twice: you pay both corporate tax and individual tax on dividends .

  Forming an S corporation, like any corporation, takes time (sometimes months) and money, and you'll have higher ongoing costs for legal and accounting fees. Limitations on stock can cause difficulties when you want to raise money.

• Limited liability company (LLC) . This structure aims to combine the benefits of a corporation with the benefits of a partnership. The company's owners and managers receive the limited liability and tax benefits of an S corporation without the S corporation restrictions. For example, an LLC has no limitation on the number of shareholders. Income and losses pass through to the owners and count toward their personal tax returns. As in a partnership, any member of the LLC can participate in running the business. Rules governing LLCs vary from state to state; not all states offer the same advantages.

7.2.3. Keep Good Records

If you're in business for yourself, good record keeping is a must. You can go low-tech (stuff receipts and other pieces of paper into a shoebox) or high-tech (use a spreadsheet like Excel, Lotus 1-2-3, or Quattro Pro), but when you're figuring out income, deductions, and expenses, you need to know where the money went.

Tip: Mac fans looking for a spreadsheet program should check out NeoOffice/J, which is free, open source software for Mac OS X. You can download NeoOffice/J from this Web site: www.planamesa.com/neojava/en/download.php.

In a nutshell , these are the records you need to keep track of:

• Income . This aspect of record keeping can get confusing, because as an eBay seller, you probably have income arriving in several different ways: PayPal, personal checks, money orders, possibly even credit card companies. What's important is to make sure that you record the same information, no matter how the payment comes in. Keep track of the transaction date, who's paying (the name and address of your buyer), the type of payment (PayPal, check, and so on), and the amount you received.

• Business expenses . This category includes inventory (the money you spend to acquire the items you sell), of course, but there's more to it than that. Expenses related to your eBay business can include the fees you pay for Internet access, packing and office supplies , travel to auctions and antique centers to purchase inventory, subscription fees for business- related publications and services, other fees you pay to independent contractors to help with Web design, packing, shipping, and more. Whatever the expense, keep a record of its date, type, and amount, and the name of the person or company you paid.

• Business assets . Assets are equipment you own and use to run your business. Assets might include your computer and its accessories, the digital camera you use to take photos for your auctions, a postage scale if you have one, and so on. The records you should keep regarding business assets include the type of equipment (name and model number), the date you bought it, the amount you paid for it, and how much time you use the asset for personal purposes. (In other words, you can't count the hours you spend using your computer to play Minesweeper, or, if you're going on vacation, you'll probably grab your digital camera, rather than reserving it exclusively for eBay-related photos.) When it comes to tax time, though, you can only deduct the depreciated cost of an asset based on how much you use it for your business (Section 7.2.4).

7.2.4. Account for Yourself

If you own your own business, accounting keeping track of your business's income and outgo using special IRS-approved rulesis a necessary evil. You can either do your own accounting or pay an accountant to do it for you. Even if you decide to hire an accountant, though, you still want to read through this section (if for no other reason that to keep your accountant honest).

From an accounting point of view, there are two ways to figure your finances: cash-based accounting or accrual based accounting. Here's what each term means:

• Cash-based . With cash-based accounting, you wait to record a transaction until you've made or received payment. In other words, the date money changes hands is the date you record the transaction. This simple accounting method is the most common for small businesses.

• Accrual-based . If you use accrual-based accounting, you record income on its due date and expenses on the date you incur them, no matter when the money actually changes hands. Accrual-based accounting tells you what you've earned, not what you've collected. It can help you to get a stronger sense of overall cash flow than cash-based accounting. The downside is that it's more complicated and that you can end up paying taxes on money you've earned but not yet received.

Note: If you maintain an inventory for your business, the IRS says you must use the accrual-based accounting method.

Whichever accounting method you use, you should create a balance sheet to give an overall snapshot of your business's financial picture at a given moment in time. Here's what you need to include in a balance sheet:

• Assets are what your business owns. There are two main kinds:

  • Current assets include cash and anything you could sell (and convert to cash) within one year, such as your inventory. If people owe you money (accounts receivable) and you're likely to collect it, this owed money also counts as a current asset.

  • Long-term (or fixed) assets include anything whose useful life lasts beyond a year. Property, office equipment, and office furniture are examples of long-term assets. In figuring the value of long-term assets, you also figure out their depreciation: how much does it cost to use the asset over the course of its useful life? To figure depreciation, estimate how many years you're likely to use an asset, like your computer, and then divide its original cost by the number of years you think you'll use it. For example, if your computer cost $1, 800 and you plan to use it for six years before replacing it, divide 1800 by 6 to get a depreciation of $300 per year.

• Liabilities are the bills your business owes. Like assets, these come in two main flavors:

  • Current liabilities are anything you have to pay within the next year, including accounts payable and taxes.

  • Long-term liabilities are debts due over a period of years. If you've taken out long-term loans to support your eBay business, like a mortgage on a warehouse, include this loan in your balance sheet as a long-term debt.

• Equity is your initial investment in the business plus any earnings that you've reinvested in the business.

The balance sheet got its name for a reason: it should balance assets against liabilities and equity. After you've made all your entries, your business's balance sheet should reflect this equation: Assets = Liabilities + Equity. Another way to work the equation is: What you have (assets) what you owe (liabilities) = what you're left with (equity).

Note: If your balance sheet is unbalanced, you haven't recorded everything correctly. Go back and check for missing entries and typos.

Preparing a balance sheet lets you take a peek at your business's liquidity , which basically means its ability to pay the bills. A balance sheet can let you know whether you have enough money to pay upcoming bills, so when you're getting started, it's a good idea to prepare and review a balance sheet regularly, perhaps once a quarter. It takes some time to get familiar and comfortable with reading financial statements like balance sheets, so if you're doing your own accounting, go over your statements with an accountant or tax professional the first few times you prepare them.

7.2.5. Keep It Legal

eBay can seem like a free-for-all, a giant swap meet where anyone can join in and no one's keeping tabs. Uncle Sam and your state government see things a little differently. If you're making money by selling things on eBay, you need to be aware of the laws and tax obligations governing e-commerce.

7.2.5.1 License to sell

Although nobody's likely to come around spying to see whether you're selling stuff out of your garage, if you don't file the necessary paperwork to do business in your city, county, or state, skipping that little detail could come back to haunt you. Do you need a license to do business in your town? What about zoningis it OK to work out of your home in your neighborhood? Does the warehouse you're planning to use have a certificate of occupancy that lets you move in and do business there? Take the time to find out what government offices you need to contact, and then make the calls. It could save you fines and penalties in the future. A good place to start is with your local chamber of commerce, which is a great source of information for starting a local business.

Here's a list of licenses, permits , and other legal issues to consider:

• Business license . Call your town, city, or county clerk to learn about whether you need a business license and, if so, how to apply for one.

• Zoning issues . Most of the time, you can do business out of your home without worrying about whether you're breaking zoning laws. But strictness in enforcing these laws varies from place to place. If you regularly have big trucks pulling up to your house in support of your businessor even if a nosy neighbor complainsyou might have to choose whether your home business is going to be out of your home or just plain out of business. Call your local zoning department to find out what zoning laws permit.

• Fire department permit . If your business is open to the publicfor example, if people come in to drop off items you sell for them on consignmentyou might need a permit from the fire department. If your business uses flammable materials, you should also check with the fire department to see whether you need a permit.

• Health department permit . eBay restricts the kinds of food you can sell, but if you do sell food, be aware that you have to pay attention to federal, state, and local laws regarding its preparation and sale. Call your local health department to schedule an inspection and apply for a permit.

• Reseller certificate or sales tax license . The name of the permit varies, but if you're selling things you didn't manufacture yourself, you may need this certificate. Check with your state tax office. On the plus side, having a reseller's certificate exempts you from paying sales tax on items you buy in order to turn around and sell them.

  Note: In some states, it's a criminal offense to sell things without a sales tax license.

• DBA certificate . If your business is a sole proprietorship or partnership (Section 7.2.2.1) and you want to do business under a name that's not your own legal name, you probably need to register the name and obtain a DBA ("doing business as") certificate. For example, if you want to sell used clothes under the business name Retro Threads, you probably need to register that name. Call your town, city, or county clerk for more information. In some places, you'll have to advertise the DBA name in the local newspaper for a certain period of time.

  FREQUENTLY ASKED QUESTION
  Insurance

  Do I need to insure my eBay business?

  Neglecting to buy insurance is a commonand unfortunatemistake made by a lot of small business owners. Too many home-based businesspeople assume that their home owner's insurance policy also covers any business they operate from home. But as some have found out the hard way, this isn't necessarily true.

  Check with your insurance agent to see whether your home owner's policy covers at-home businesses. If it doesn't with(and most don't), or if your coverage is insufficient, it's time with to shop around. This can take some time and research.

  Rates can vary widely from one insurer to another. Get several with bids. Enlist the help of your insurance agent and look on with the Internet. Even if your home owner's policy doesn't cover with your home-based business, the insurer who holds that policy might offer you a multiple-policy discount on business insurance, so be sure to ask. You might be able to save more money by consolidating your auto, home, and business insurance with one company.

  Look for coverage that protects your inventory and business equipment (go for full replacement cost), protects you against personal liability, and also protects your business against general liability. General liability policies tend to have a lot of exclusionssuch as shoddy workmanshipso know exactly what the policy you buy does and doesn't cover. If you have employees, you'll need workers' compensation insurance. Also, consider business-interruption insurance. Sometimes an unexpected catastrophe can put your business on hold for days or even months. Business interruption insurance will help you meet costs until you can resume normal business operations.

  
  

• Certificate of occupancy . Depending on local regulations, you might need a certificate of occupancy for a building or space you plan to use for offices or storage. A certificate of occupancy is proof, issued by your city or town, that the building is fit to use or inhabit. Call the building inspector's office to find out.

• Sign permit . If you hang out a shingleor any kind of signto show the world you're in business, you don't want to have to haul it back in because it's too big. Drop-off consignment stores (Section 7.5.1) or proprietors of brick-and-mortar stores are likely to need a sign permit. Many towns restrict the size , location, lighting, or style of signs that can hang in the community. Find out whether that's the case in your area.

The preceding list isn't comprehensive, by any means; it just shows the kind of regulations and laws you might need to consider. Do your homework to find out any and all local regulations that apply to you before you take your eBay business online.

FREQUENTLY ASKED QUESTION
State Regulations

Does my state regulate online auction sellers?

It was bound to happen sooner or later. Online auctions are such big business that states are looking for ways to get their piece of the eBay pie. More than half a dozen states, including Ohio, Tennessee, California, Illinois, Florida, Maine, Missouri, and Texas, have passed or are considering bills that will mandate state regulation of some online sellers.

Some states, like Tennessee and Ohio, are taking the approach that online sellers are auctioneers and therefore need to get an auctioneer's license, a process that may include shelling out money for classes, passing tests, and paying the actual licensing fee. Other states, like California, are trying to classify some online sellers as pawnbrokers.

Because this is a whole new area of regulation for states, the new and proposed laws can be confusing, and it's not always clear which eBay sellers must comply. Most of the laws seem to target Trading Assistants (Section 7.5.1) or consignment sellers (sellers who list and sell goods for other people), but the laws may affect other sellers too. Besides the cost, the regulations threaten to consume sellers' valuable time with additional paperwork.

More confusion arises from fixed-price Buy It Now sales, which technically speaking aren't auctions. Many sellers combine BIN listings (for example, in their eBay Stores) with listings in the traditional auction format. Will state regulations apply to all these sales or just some of them?

To find out whether your state has laws regulating online auctions, contact your state's business-licensing entity; you can probably find a link from your state government's home page (often located at www.yourstate.gov ; for example, www.minnesota.gov).

eBay has set up a Government Relations page at http://pages.ebay.com/governmentrelations. Here you can find eBay's official position on regulatory issues like auction regulation and government-imposed barriers to e-commerce. You can also click links to find out the names and contact information for your U. S. Senator and Representative, so you can contact them with your concerns. eBay has drafted a letter you can use or adapt to let your state legislators know your concerns. You can find the letter at this URL: http://pages.ebay.com/sellercentral/governmentrelations/write-rep.html.

7.2.5.2 Taxing issues

eBay emphasizes that it's a venue , not a party to the sales that take place within its marketplace . That's a polite way of saying that tracking and reporting taxes is your business, not eBay's. And that means you want to keep good records, know which tax laws apply to you, and follow those laws to the letter.

Below are some general tax guidelines you need to be aware of. For more specific information, the Internal Revenue Service's Small Business/Self-Employed Web site (Figure 7-6) is a good place to start.

Figure 7-6. The IRS resource page for small businesses (www.irs.gov/businesses) features articles answering common questions and explaining various tax-related issues; you can also search for specific information. The Online Classroom offers self-directed classes on tax issues.

• Income taxes . The IRS requires that you report any income over $600and that includes money you make on eBay. In addition, unless you're an employee of someone else's eBay business, your eBay income comes from self-employment. That means in April you must file IRS Form 1040 Schedule C, Profit or Loss from Business. Be prepared to pay self-employment taxes and file estimated payments each quarter.

  Note: There are a lot of crazy rumors flying around about eBay and income taxes. Don't believe hearsay. Check with your accountant or tax professional, or look for information on the official IRS Web site (www.irs.gov).

• Employees . If you hire other people to work for you, you have to handle your employees' withholding and payroll taxes. To ease the workload and make sure you do this right, hire an accountant. One way to avoid the hassle of payroll taxes is to work with independent contractors self-employed workers who work with your business on a contract or freelance basis, but don't work for you as employees.

  For example, you might pay a shipping service to pack and ship your items; the shipping service is an independent contractor, not your employee. But be warned : the IRS has strict guidelines to define who's an independent contractor and who's an employee. Is the person working for you free to work for others, as well? Can the worker decide when, where, and how to perform the work? If you answer no to questions like these, the IRS might say you're dealing with an employee, not an independent contractor.

  Note: To find out more about how the IRS defines an employee vs. an independent contractor, visit www.irs.gov. You can even download a form to submit to the IRS, who'll determine whether or not someone is your employee: Form SS-8, Determination of Worker Status for Purposes of Federal Employment Taxes and Income Tax Withholding.

• Sales taxes . Sales tax law is a morass of different state and local regulations. Some states collect sales tax; others don't. In general, if your business is in a sales-tax state, you have to collect sales tax on sales you make to residents of that state. This issue is in flux, however; states are lobbying Congress to ask for a federal law that will make it easier for them to collect sales tax on online sales, and regulations could change quickly. Keep an eye on any changes by visiting the Web site of your state's Department of Revenue, and ask your accountant or tax professional to keep you informed.

  The good news about paying taxesif there could ever be good news about such a thingis that reporting your income also means that you can take deductions against it. Here are some common deductions you might be able to take:

• Startup costs . Costs related to researching products and markets and startup advertising expenses may qualify as a deduction .

• Home office . If you use part of your home regularly and exclusively for business, you may be able to take this deduction.

• Business equipment . It's possible to deduct the equipment you use in your business, such as your postage meter and your computer (if you use it exclusively for the business).

• Business expenses . You rack up a lot of expenses running an eBay business, including eBay and PayPal fees, items you purchase to sell, advertising, ISP and telephone fees, legal and professional expenses (like that accountant you keep consulting), payments to independent contractors for shipping and such, subscriptions to services or publications, software, insurance, and more. All of these are legitimate , deductible business expenses. If you have employees, you can deduct their wages and benefits packages, too.

• Vehicle expenses . If you use a vehicle in connection with the business (think about all those trips to the post office), you can deduct mileage and fuel costs for business-related trips.

• Travel expenses . You might travel to auctions or estate sales, trade shows, or conventions. If you do, you can deduct reasonable travel-related expenses.

Again, your mileage may vary. Be sure to work with your accountant or tax professional to learn exactly whatand how muchyou can deduct.