Selling stuff online? Here comes the IRS

If the tax agency gets its way, it could start demanding personal info on people who sell via Amazon and eBay. CNET's tax guide

Americans who sell items through Internet auction sites could be in for an unpleasant surprise at tax time next year, thanks to an IRS proposal designed to identify taxpayers who don't report income from those sales.

The U.S. Treasury Department wants Congress to force auction sites like eBay, Amazon.com and uBid.com to turn over the identities and Social Security numbers of a large portion of their users to the IRS--so tax collectors know how much each person made through online selling.

The effort is part of a larger plan, which enjoys enthusiastic support from both Democrats and Republicans, to close what's known as the "tax gap." It's a broad term that covers Americans who don't file tax returns or those who underreport their income, and the IRS believes it to total around $345 billion for the 2001 tax year.

But the proposal is likely to encounter stiff opposition from Internet auction aficionados, free-market advocates and the auction Web sites themselves, not all of which are large enough to be able to comply with the rules without financial hardship.

"It's a total nightmare," said Matt Stinchcomb, vice president of marketing for Etsy.com, which allows people to sell handmade goods. "Our goal as a company is to allow people to make a living making things, and this is just another impediment to that."

Stinchcomb said Etsy would be uncomfortable asking its users to divulge their Social Security numbers, which are required on the IRS 1099 forms used to report untaxed income. "There are so few things now that are private and sacred," he said. "I feel like your SSN is one of them. Imagine, too, if every e-commerce site starts requiring this, the amount of times that data will be collected or falsely collected. There's a huge potential for fraud and identity theft."

But Washington politicians are looking around for any idea that will increase tax revenue without a formal vote to raise taxes.

At a recent hearing, Senate Budget Chairman Kent Conrad (D-N.D.) praised the idea of additional "reporting of money flows so the IRS has the ability to match up what was reported to what's actually happening." Another Senate hearing on the tax gap is scheduled for Wednesday.

IRS' history of targeting online auctions
The idea of forcing auction sites to invade their customers' privacy through IRS reporting isn't exactly new.

In July 2006, IRS official Nina Olson told Congress (PDF) that it should require "information reporting on gross proceeds from sales conducted on Internet auction sites." "One recent study found that 700,000 Americans reported that eBay sales constitute their primary or secondary source of income. The IRS must have the tools needed to address underreporting of this income," she said. Olson said the reporting requirement should begin when someone made more than $600 in a calendar year.

Olson renewed her request to Congress two more times, congressional records show, but it wasn't until the idea appeared in the Bush administration's proposed 2008 budget that Congress began to take it seriously.

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A Treasury Department analysis of the budget (PDF) says: "A broker would be required to make an information return showing its customer's name, address and Taxpayer Identification Number, as well as gross proceeds from the sale of tangible personal property." Unlike Olson's suggestion, though, it proposes the reporting requirement kick in when someone makes more than $5,000.

"The budget proposal has come out and people are looking for ways to close the gap, so they're looking at a lot of things, and I think we're just one idea that has come up," said Catherine England, a representative for eBay, which opposes singling out online auction sites to report on their sellers to the IRS. "What's happening is there's this assumption that people aren't reporting," she said. "There are a good number of people who are professional sellers on eBay. However, there's no evidence or any kind of statistic out there to indicate those folks aren't already accurately reporting to the IRS."

The company's own statistics suggest that there are 1.3 million people around the world who make their primary or secondary source of income through eBay, with just over 700,000 in the United States.

In its report (PDF) last year, an influential IRS panel called the Information Reporting Program Advisory Committee also recommended that auction sites file 1099 forms. The panel said that "this change could permit further enforcement by the IRS."

"It's not trying to target or criticize the auction sites. It's merely trying to increase the reporting on these sales," said Paul Heller, the panel's chairman, who is also tax director for JP Morgan Chase's Treasury business. "And as these sales have become more and more popular...we need to now come into the 21st century and require some form of information reporting on those transactions. And that's what the government's real target is."

Currently, section 6405(c) of the Internal Revenue Code requires 1099 forms to be submitted by any person who, for a fee, "regularly acts as a middleman with respect to property or services." That definition clearly covers stock brokers, but according to tax experts it's not clear that it applies to eBay and its peers.

That's why the Treasury Department is asking for Congress to expand the tax code. "This proposal needs to be put in a piece of legislation and passed by both House and Senate and signed by the president to take effect," said a Treasury Department spokesperson who did not want to be quoted by name.

Heller, the IRS panel chairman, said in an interview this week: "Since eBay has all of the information, knows that a transaction has been consummated, knows who the seller is, and the seller is registered, then it would be appropriate for them to report the final transaction. They can track by taxpayer ID number how many transactions the seller does. Since they do have all that information, it would be appropriate for them to file a 1099."

While no formal legislation has been introduced yet, Heller said he expects to see it appear this fall.

An aide to the House Ways and Means Committee, which writes tax laws, told CNET News.com this week that there have been a few meetings, but members have not yet come up with a definition of who should be a broker or not. An aide to Sen. Max Baucus (D-Mont.), chairman of the Finance committee, said the panel was premature to speculate about what any legislation would look like.

Yet small-business advocates and pro-taxpayer groups are already preparing for a fight.

"The IRS coveted this kind of data for years and they didn't have a chance of forcing you to collect it from garages, from flea markets," said Steve DelBianco, vice president for public policy at the Association for Competitive Technology, which represents thousands of technology companies. "But they have a chance in the online world. They're getting the data because they can, not because it'll generate significant amounts of income."

Scott Weber, owner of GunrunnerAuctions.com, which sells about 400 firearms a month, said the additional paperwork would be a nightmare.

"I'm pretty much a one-horse operation here," Weber said. "I do everything myself. I'd have to hire a whole bunch of people. I'd have to hire someone full-time to do this. You'd need to track people all over the country, and you'd have to get their SSNs."

How much the tax gap can be narrowed by mandatory auction reporting remains a bit murky. Evidence suggests that taxpayers are far more likely to report income when the IRS receives 1099 forms. On the other hand, government auditors also have suggested (PDF) that a substantial amount of underreporting is due to "complex tax laws" or honest mistakes. In addition, a crackdown on online auctions could lead to a larger black market through garage sales, flea markets and, in the case of firearms, gun shows.

"This may be a bad sign that another front may be opening in the tax man's war on e-commerce," said Pete Sepp, vice president at the National Taxpayers Union.

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