Starting in 2011, all U.S. payment providers including PayPal will be required by the IRS to report sales information about certain merchants to the IRS. Power sellers on eBay and other online selling websites will be impacted by this new tax requirement. Before PayPal did not report your income to the IRS, so online sellers could 'fudge' their revenue reporting. But that all changes in 2011.
My theory is the anti-tax Tea Party rebellion of 2010 ticked off the IRS so they found a new way to tax Americans who have avoided paying income tax earned via online profits. "Protest the IRS and high taxes, eh? Well, take that tea partiers! Bam! Another loophole closed."
According to Paypal, this new tax rule applies to any merchants receiving over $20,000 in gross sales volume AND 200 payments or more. However, I read elsewhere that it can apply to anyone making 200 payments, regardless of the $20,000 minimum. Thus, popular sites of low-ticket items like $1 transactions on Second Life or $10 items on the popular Etsy site can trigger the 200 item threshold. It would seem to make more sense that it is $20,000 OR 200 transactions. Otherwise, you could make one transaction worth $1,000,000 and not have to report it. Well, technically, you have to report ALL income, but the IRS would have no way of knowing you earned that income since Paypal wouldn't have to report it to the IRS.
Also, many online sellers have costs associated with their eBay, Etsy, Craigslist, etc. listings. They have the cost of the listing, shipping fees, and are often brokers or middle-men, who buy things at wholesale and then list them online. Support I'm a broker and I buy a $3000 TV at a wholesale cost of $1000 but then sell it for $2500 via Paypal (a $1500 profit). The 1099-K form is only going to show the $2500 income earned for this sale and not the "true" $1500 profit. The IRS sees this as a $2500 profit, when in reality it's a $1500 profit minus the listing fees, shipping, etc. If you report less than what Paypal is reporting to the IRS, surely this will trigger an audit.
I'm not advocating online power sellers from "gaming" the tax system and cheating on reporting their income. However, this new tax seems a bit onerous. Though not as onerous as another new 1099 requirement - passed as part of Obamacare - that businesses must file 1099 forms with both the IRS and send them to the company that provided the services or sold the product for every expenditure that exceeds $600. Businesses will probably have to hire an additional accountant to meet these new guidelines. Home-based businesses and SMBs that cannot afford to hire will have to spend additional time pushing paperwork to meet IRS guidelines and reducing American productivity.
In any case, this new tax law applies for sales beginning on January 1, 2011. A 1099-K IRS form for merchant card and third party payments will be required.