Operating an online business is convenient and profitable, but it involves specific IRS tax reporting obligations. Many entrepreneurs mistakenly believe selling through digital platforms like Amazon, eBay, Etsy, or Shopify exempts them from traditional IRS rules. This misconception can lead to severe financial penalties or even potential life altering criminal tax investigation or prosecution if income is viewed by the IRS to have been intentionally underreported or omitted.
If you face an IRS audit triggered by your online business activities or if you become subject to a broad audit where online transactions come under scrutiny, IRS agents will almost certainly inquire about your online sales. While some taxpayers mistakenly believe they can evade or obscure their online business dealings, the IRS will diligently investigate multiple angles until they determine the true nature and extent of your activities. However, taxpayers who diligently prepare with the assistance of experienced dual-licensed Tax Attorneys and CPAs can effectively clarify discrepancies and entirely avoid criminal tax investigation and minimize civil penalties through strategic and proactive audit defense.
Reporting Income from Online Sales
The IRS views online sales revenue similarly to income from physical businesses. Essentially, all income earned via online platforms must be reported, regardless of your business’s size or earnings. Businesses typically report online sales through Schedule C (Form 1040) for sole proprietors or appropriate business tax forms (Form 1120, Form 1120-S, or Form 1065) depending on their entity type. Non-compliance can trigger high-risk federal civil audits, eggshell audits, or in worst cases, clandestine IRS criminal tax investigations.
According to the tax code, all U.S. citizens and permanent residents must pay taxes on all income, no matter the source. Therefore, the IRS taxes money earned from online sales.
How is Income from Direct Internet Sales Taxed?
In previous generations, door-to-door salespeople marketed products directly to consumers, a practice largely replaced by online sales today. Regardless of whether your sales occur face-to-face or online, profits earned are considered taxable income by the IRS. The exact amount owed depends on factors such as sales volume, deductible business expenses, allowable tax credits, and your specific business entity structure. Employees typically have taxes withheld by employers, but independent contractors and business owners must account for self-employment taxes, and failure to do so can result in substantial penalties, fines, and interest.
Beyond income taxes, online sellers must consider additional tax responsibilities, including sales and use taxes, that apply to conducting business online.
Form 1099-K: Reporting by Payment Processors
Payment processors and online platforms report transactions directly to the IRS using Form 1099-K. Starting with the 2023 tax year, any payment settlement entity (PSE)—including PayPal, Venmo, and Stripe—must issue Form 1099-K if transactions exceed $600 annually, significantly lower than previous thresholds. The IRS cross-references these forms with taxpayer returns to detect discrepancies, making accurate reporting critical.
Businesses that must submit Form 1099-K typically include third-party settlement organizations like PayPal, Venmo, and Zelle; online marketplaces such as eBay, Etsy, and Airbnb; and credit card companies like Visa, Mastercard, and American Express.
Updated 1099-K Thresholds and IRS Enforcement Trends
Although the $600 threshold is already in effect, the IRS has introduced a phased reporting approach for third-party settlement organizations:
$5,000 in 2024, $2,500 in 2025, and $600 in 2026 and beyond.
Despite these thresholds, Form 1099-K may still be issued even for lower amounts, depending on the platform’s internal policies. And regardless of whether you receive the form, all income from sales of goods or services must still be reported on your tax return.
The IRS distinguishes between business income and personal transfers. Payments received through payment apps for gifts or reimbursements from family and friends—such as splitting rent or paying for concert tickets—should not be reported on a 1099-K and are not considered taxable. If such transactions are mistakenly reported, taxpayers should request a corrected 1099-K or adjust their filing to reflect the error using IRS guidelines.
Handling Form 1099-K for Non-Business Transactions
Sometimes individuals receive a Form 1099-K for transactions unrelated to business sales. For instance, if you sell personal items, the profit could be considered a capital gain, reported on Form 8949 and Schedule D if owned over a year, or ordinary income if owned less than a year. Payments for side hustles or freelance work, like art commissions or rideshare driving, are treated as self-employment income and reported on Schedule C (Form 1040). If your net earnings from such activities exceed $400, you must file Schedule SE for self-employment taxes.
If you mistakenly receive a Form 1099-K for non-sale transactions, the IRS advises contacting the issuer listed as the “FILER” to request a corrected form. If a corrected form is not issued, you can still report the error on your tax return by including the amount as “Other income” on Schedule 1 (Form 1040), Part I, and then subtracting the same amount in Part II under “Other adjustments,” both labeled as “Form 1099-K received in error.”
At the Tax Law Offices of David W. Klasing, we can help you understand the taxability of every type of online transaction you receive. If you’ve received a 1099-K in error or are unsure whether certain payments are taxable, our dual-licensed Tax Attorneys and CPAs can ensure compliance, mitigate risk, and, if necessary, resolve any audit or notice resulting from incorrect IRS reporting.
Reporting Expenses Associated with Online Sales
Businesses must also accurately report all associated expenses. Legitimate deductible expenses include platform fees, transaction processing costs, shipping and handling expenses, product storage and inventory management costs, marketing and advertising expenses, and expenses related to returns or refunds. Proper documentation of these expenses can reduce taxable income significantly and help withstand IRS audits.
Online sellers must also be aware of sales tax responsibilities. While typically a California state issue from our perspective, inconsistent or inaccurate sales tax reporting can attract IRS scrutiny. Given California’s aggressive enforcement of sales and use tax laws—particularly following the U.S. Supreme Court’s decision in South Dakota v. Wayfair, which expanded state authority over online sellers—compliance has never been more important for businesses operating in the digital space.
At the Tax Law Offices of David W. Klasing, our dual-licensed sales tax attorneys and CPAs provide online businesses with comprehensive guidance on California and multi-state sales tax nexus, the distinctions between sales and use tax, and evolving economic nexus thresholds. Whether you’re facing a CDTFA sales tax audit, seeking proactive compliance advice, or needing integrated legal and accounting support to navigate California’s complex digital sales tax regime, we deliver strategic planning, audit representation, and bookkeeping solutions designed to mitigate risk and support long-term success.
Contact the Tax Law Offices of David W. Klasing If Your Business Sells Online
At the Tax Law Offices of David W. Klasing, our dual-licensed Tax Attorneys and CPAs help online sellers navigate the IRS’s complex and evolving reporting obligations. We work with clients to make sure that all online sales income is properly reported, that income on Form 1099-K is accurately matched to corresponding tax returns, and that deductible business expenses are thoroughly documented and defensible under audit.
