Should I be paying taxes on my eBay income?  This was a question I was faced with yesterday from my friend / business partner as we celebrated our earnings for December. Our eBay partnership has been a success so far, bringing in over $700 for me last month!

When he asked me whether he needed to be reporting the income that he earned on eBay I turned to a resource by a friend of mine that’s all about managing your taxes on eBay sales, eBay Tax Tips Book. I ran him through the list of nine factors that the IRS looks at to determine if you are trying to make a profit, or if you’re just enjoying a hobby:

1. Whether you run the activity in a business like manner
2. How much time and effort you put into making a profit
3. Whether you depend on the activity for your livelihood
4. Whether your losses were due to conditions beyond your control
5. Whether you changed your operating methods to improve profitability
6. Whether you or your advisors have the knowledge needed to carry on a successful business
7. Whether you successfully made a profit in similar activities in the past
8. Whether the activity makes a profit in some years, and how much
9. Whether you can expect to make a profit in the future from the activity

He answered yes to enough of the questions that we determined he needed to establish a business entity to manage his eBay income and expenses. So yes, he should be reporting his income, in addition to tracking his expenses so he can offset some of the earnings and bring down the total tax bill. 

Of course, in order to deduct those expenses he’ll need to be able to prove he’s running a business.  We went over some things he can do to show that he’s indeed operating a business and not just a hobby:

· Get an employer identification number (EIN)
· Apply for a business name
· Have a separate checking account to be used for business transactions
· Hire an accountant to keep his books
· Create a business plan
· Keep track of the time he spends each week doing business activities
· Consult other business owners or advisors to help make his business profitable

I know he wasn’t happy with my answers since it meant some of the profit our partnership generated for him would have to be paid to Uncle Sam but it’s better that he starts tracking it now rather than wait until tax season and have to play catch up.

Do you want to start your own eBay business with minimal risk and no debt? I’m sharing the steps I took to build my eBay business and giving away a free multi-part tutorial on how to get started. Sign up for the free tutorial with the adjoining form and get started today!

Is it wise to go into debt when you’re starting a business? Do you have to borrow a chunk of money or is there any other way get started? I had a reader email me in response to my post on using credit cards to buy eBay inventory.

“Many small businesses use credit cards to fund their initial expenses.  A lot of times when you’re just getting started you need some seed money and credit cards are a simple way of getting it.  Sure there’s the risk you’ll carry a balance for a while until you become profitable but isn’t assuming risk just part of doing business?”

Startup Money
The saying goes “it takes money to make money”.  The good news is you don’t necessarily need a lot of money to get started.  The very first thing that Guy Kawasaki tells us in the “Art of Bootstrapping” is to focus on cash flow.

“Focus on cash flow, not profitability. The theory is that profits are the key to survival. If you could pay the bills with theories, this would be fine. The reality is that you pay bills with cash, so focus on cash flow. If you know you are going to bootstrap, you should start a business with a small up-front capital requirement, short sales cycles, short payment terms, and recurring revenue. It means passing up the big sale that take twelve months to close, deliver, and collect. Cash is not only king, it’s queen and prince too for a bootstrapper.”

Bootrapping on eBay
eBay fits Guy’s requirements pretty well. You can start off only selling one or a few things so the up-front capital requirement is small.  Auctions can last 3-10 days so the sales cycle is short, unless you sell in an eBay store which may have longer inventory turns. You can set your own payment terms, if you only accept PayPal then most people pay within a day or two of winning the item.  The recurring revenue of course depends on you finding new products to sell but the good news is products are everywhere.

Why Go Into Credit Card Debt?
The reader mentions that many small businesses use credit cards to get started. While this may be true, I would ask, why take on high interest debt when you don’t have to?  You can actually be profitable and have positive cash flow after your first sale on eBay, why go into debt that will just eat into your earnings? 

Of course, the way to keep initial capital requirements small for an eBay business is to start only selling a few things.  As you make money on the initial sales, you can re-invest the profits into additional inventory and grow the business without debt.  If someone is looking to start out with tons of inventory and sell hundreds of dollars of goods a week right off the bat, they may have to borrow money up front.

Alternative Funding
If you don’t want to go into credit card debt to start making money online you can always pursue other, less expensive funding sources such as taking out a second mortgage, dipping into personal savings, borrowing from friends or family, taking out a bank loan, or borrowing on Prosper.

eBay & Prosper
eBay is actually hosting a Prosper forum today for people interested in borrowing startup money on Prosper.com. Run by Prosper Marketing Director, Shira Levine, it will go over some of the basics of small business finances. Here is summary of the forum:

“We’ll cover the five basic questions every business should ask themselves before you finance, how to know where you stand financially, and the importance of cash reserves in your company. Then we’ll cover financing basics: debt vs. equity, credit scores and reports, and common pitfalls to avoid. The workshop will end with how to create an excellent loan listing on Prosper that will get your business funded.”

Credit Card Funding
Of course everyone’s situation is different and using a credit card as a funding source might work out for some people.  However, if you want to avoid high interest charges and are willing to start small and grow your sales over time then it’s possible to start making money on eBay without going into credit card debt.  Are there any other alternative funding strategies that I missed?

Big time real estate investors use leverage to try and make big time profits. You can use leverage on a smaller scale on eBay without exposing yourself to the large amounts of risk that they assume.

As I read JD’s post on leverage yesterday I thought about how I currently use leverage to earn 30% to 200% returns on eBay. JD summarizes the definition of leverage as “borrowing money to magnify returns”. I’m able to borrow money to purchase items to resell for a magnified return.

How is this Leverage?
I buy heavily discounted items at wholesale, outlet, or unclaimed goods stores then sell them on eBay. I borrow money for everything I purchase by charging it on my credit card. I take posession of the merchandise, list it for sale the same day, and haven’t yet paid a cent. Depending on how the purchase date falls in relation to the closing date on my credit card, I might not have to pay anything for the item for almost two months. If it sells in that time period, I’ll have made money on an item without actually putting down any cash.

Why is this Low Risk?
Most places have a 2 weeks to 30 day return policy so if an item turns out to be unpopular you can always return it. If it doesn’t sell right away but you purchased it for a low enough price you know it will sell eventually. By keeping it longer, you are no longer using leverage because at some point you’ll have to pay your credit card bill. However, you did get a month to test the market for your merchandise and help you revise your price point, all without paying a dime.

The upside to a leveraged real estate purchase is you can make thousands of dollars if you sell the property. What happens if you can’t sell it? Until you can get rid of the real estate you’re holding thousands of dollars of debt and monthly payments.

With my eBay approach, the items I’m selling are much easier to sell than a piece of property. If I do some bad market research and can’t sell an item for my target price, I can always discount it heavily to make back a portion of the purchase price. Of course, with less risk, comes less reward. Does the work required to procure, advertise, sell, and ship the items pay off?

Is it Worth My Time?
Real estate investors borrow large sums of money so they stand to make large sums if leverage works in their favor. In my case, I’ll earn $15 – $150 per item sold. I won’t get rich on one or two transactions but the income adds up over time. You can use this version of leverage to build up capital so when that great business opportunity does materialize you’ll have the money to jump in.

Not only will this give you the money you need for a business venture but it will teach you about market research, customer service, managing cash flow, product pricing, dealing with risk, copywriting, and other business skills vital to an entrepreneur. So what are you waiting for, get started today!