Selling in volume regarding taxes.

[Fred]

Steve,

In your hypothetical situation you are only making 15% on your investment. There are times when you could have made more money on some cards and less money on other cards. That would mean that you may have made only 8% -10% on some cards and perhaps you made 23%-25% on other cards. In that scenario it'd be pretty ballsy to try and make 20 bucks off a $250 dollar purchase. My idea of buying cards under market is probably a bit different. Hey at least you're not too greedy....

Just funnin around with your hypothetical, that's all....

[BobC]

Sorry I didn't see this thread sooner or I would have weighed in at the start. Bill T. has done a great job of explaining some of the rules regarding hobby versus business treatment of selling cards. Based on some of the questions and comments made in the thread though, I'm not sure everyone has a real good understanding of what Bill was trying to explain. I wanted to add a few things for clarification and practical consideration.

The rules for determining if an activity is considered not-for-profit (ie: a hobby) are generally covered under IRC Section 183. As Bill T. stated, the specific things the IRS looks at are not always yes or no answers and they will look at all the factors in making their determination of business vs. hobby. Included in this code section is a test the IRS relies upon in their determination process that is commonly referred to by tax professionals as the "Hobby Loss Rule". SImply stated, it is presumed by the IRS that you are engaged in an activity for profit (ie: you are a business and not a hobby) if you made a profit in at least three out of the past five years. The IRS can/may still look at the other factors in their determination but, the fact that an activity meets this test means the IRS will generally not challenge the reporting of that activity as a for-profit business.

The implications of that determination can be both good and bad for someone selling cards to "just support their hobby". If I had a dollar for everytime I heard that comment come from people on this forum, I'd probably be able to afford a T206 Wagner. So if you consider yourself as just being in a hobby and therefore report you gross profit from selling cards as Other Income on Line 21 of your federal 1040 tax return, that should be fine. However, if after five years you reported a taxable profit on your 1040 return from your so-called hobby in three or more of those years, under the "Hobby Loss Rule" I mentioned above, the IRS presumption is that you are engaged in a for-profit business and not a hobby. The service can still look at the other factors to make a final determination but, most of you aren't going to like the answers. Included in the list of other factors the IRS looks at are questions like:

Do you have the knowledge to run this activity for profit/as a business?
Do you ever change methods of operation to improve profitability?
Do you expect to make a profit from future appreciation of assets in the activity?
Do you put in the time and effort to this activity expecting to make a profit?

Most of you would likely have to answer yes to these questions. Heck, the statement that most of you make saying you sell cards to fund buying other cards is a clear indication you're out to make money on the cards you do buy and then sell. So in the IRS' eyes, a lot more of you could end up being in a business than in a hobby than you would ever guess.

To recap the major good and bad points of being in a for-profit business vs. a hobby are:

Good:

1) You can claim all ancillary and other related costs to carrying on the business (not just the direct cost of goods sold) as deductions on your 1040tax return as a Schedule C activity, or if you set up a formal entity, through a partnership, S-Corporation or regular corporate tax return.

2)

[BobC]

Sorry, ran out of room on the last post.


Good:

2) You can even deduct things like a home office and related expenses, including mileage to go look at cards, shows, etc.

Bad:

1) You are considered as a dealer in cards and all profits are considered as ordinary income. You do not get the benefit of being able to treat your profit as being from the sale of "collectibles", which are limited to a top tax rate of no more that 28%.

2) Being in a for-profit business, all net income (Gross income - COGS - Expenses) you report will be subject to self-employment taxes. That is the same as the FICA and Medicare taxes an employer withholds from an employee on their paycheck (7.65%) plus, you also have to pay the other half of those taxes (7.65%) the employer is normally responsible for. That is how those taxes get up as high as 15.3% The annual FICA limit does come into play and caps the 12.4% FICA tax at a certain amount each year. The remaining 2.9% of Medicare tax has no annual cap. Also, you get a tax deduction equal to employer's deemed 50% portion of self-employment taxes you pay. This gets deducted on page 1 of the 1040 return. (There would be no self-employment tax if you set the business up in a corporate entity.)

3) To be able to actually claim all the deductions, you need to keep good, clear records and copies of supporting documentation and receipts. If the IRS questions you it is not like a court of law, there is no presumption of innocence. The burden of proof is on the taxpayer and the IRS gets to determine what they consider/accept as reasonable proof. This also includes evidence to prove the cost basis of inventory. Those cards you bought at a mall show for $100 cash 20 years ago, how do you prove that basis to an IRS agent today? See the problem?

For the earlier question/discussion about buying a group of cards where say one card is much higher in value than the others, before you even worry about how to allocate the value amongst the cards, make sure you have something to document the cost of the cards and what cards you got? Without that you can't even prove you have any cost for any of the cards. And then, the idea of spreading the cost evenly over the group of cards so that you falsely inflate the value of the less valuable ones you acquired is not necessarily an acceptable method of determining the inventory value of those cards. If under audit an IRS agent discovered that you had arbitrarily just assigned an average value to a card that was acquired as part of a group, and that the value assigned was way out of line with the actual cost, the agent would be able to adjust the inventory values to properly reflect the true values/costs of the cards. The real truth is, for that to happen you would have to get audited and then have an IRS agent that actually knew something about cards and their values. Then, the amounts in question would have to be large enough to actually make a significant tax difference for the agent to even bother with it.

Another area you touched on was whether or not you reported gross profit from card sales as Other Income on Line 21 of a 1040 return, or as a capital gain transaction on Schedule D. First of all, you would only report your gross profit from card sales in either of these places if you were operating the activity as a not-for-profit hobby, and not as a for-profit business. Card sales are a bit unique under the IRS rules in that gross profit from selling them can be considered as sales of collectibles. The Tax Relief Act of 1997 put the special treatment on gains from collectibles sales in effect. What it does is make the long term gain from sales of collectibles subject to a tax rate cap of 28%. This is similar to the current 20% tax rate cap on long term capital gains from the sale of stock, just capping the max rate at a higher amount. To get that 28% capped rate though, you have to report hobby activity card sales on Schedule D. If you report the gross profit from the card sales as Other Income on Line 21 of the 1040, it will not allow you to cap the tax rate on those cards sold at 28%. Also remember that capped rate is only for "long term" sales. In other words, you must have held the cards sold for at least a year to get the capped rate to be in effect. If held less than 12 months, the sale is considered short term and is subject to ordinary income rates up to the current max rate of 39.6% this year. Also, don't forget the wonderful Obamacare Medicare surtax on investment income. Depending upon a taxpayer's reaching certain levels of Modified Adjusted Gross Income this year ($200K single/$250K married filing jointly) the profit from both short and long term gains from collectibles sales will also be subject to an additional 3.8% investment income surtax. (A very good question is if you reported the card sale profit as hobby income on the Other Income line instead of Schedule D, would it still be subject to the 3.8% Medicare surtax on investment income? Did not research this but, would think not and wouldn't expect the IRS computers to catch this either.)

Speaking of the Obamacare surtaxes that take effect this year, if you end up having your card sales treated as if from a for-profit business (ie: subject to self-employment taxes), that means the net income from the activity is considered Earned Income and then potentially subject to the 0.9% Earned Income surtax. This Earned Income surtax kicks in for taxpayers after reaching the same Modified Adjusted Gross Income levels that trigger the Investment Income surtax.

Finally, you can't just pick and choose from year to year whether you're a for-profit business or not-for-profit. You are either one or the other. So in a like manner, you're probably not going to be able to segregate your card buying activity and say some cards you buy with the intent to resell are business related while other cards you buy at the same time and hold for your personal collection are part of your hobby activity. Remember, the burden of proof is on you. Just because you say you are making a card purchase part of your personal collection doesn't mean you couldn't change your mind and end up selling it tomorrow. So if you get determined to be selling cards for-profit and then turn around and sell one you've held in your personal collection for a long time, and try to report that as a long temr collectible sale instead, good luck if the IRS questions the transaction. Still, the chance that the IRS computers would be sophisticated enough to realize a Schedule C business actibity you had selling cards would be related to a collectible sale on Schedule D is pretty much nil. So unless you get unlucky and are pulled for an audit, and even then the agent involved would probably have to have some knowledge of cards/collectibles, and the dollar amounts involved would have to be significant enough to have a material effect on your income taxes, you're probably not going to get hassled about the tax treatment on your return.

Good luck.



BobC