How to Report Online Sales on a Tax Return

Selling products online means your income needs to be reported to the IRS, but figuring out exactly how to do that can get complicated. Between understanding tax forms, navigating state sales tax rules, and tracking your expenses, it’s easy to feel unsure about the process. This guide provides a clear path for reporting your online sales, covering how to identify your reportable income, the forms you’ll need, your sales tax responsibilities, and the essential deductions that can lower your tax bill.

What Income From Online Sales Do You Need to Report?

A common misconception is that if you don’t receive a tax form for your online sales, the income doesn't need to be reported. This is incorrect. As a general rule, you must report all income earned from your business, whether you operate through platforms like Etsy, Amazon, Shopify, or your own website.

The first step an online seller should take is to determine whether their activity qualifies as a business or a hobby. The IRS has guidelines to help make this distinction. A hobby is an activity you do for sport or recreation, not to make a profit. A business, on the other hand, operates with the intention of making a profit. If you are operating a business, you can deduct your expenses from your income, which is a powerful tool for reducing your taxable profit. Hobbyists can only deduct expenses up to the amount of income they earn from the hobby itself.

The IRS considers several factors to determine if your online selling is a business, including:

• Whether you carry on the activity in a businesslike manner and maintain complete and accurate books and records.
• Whether you depend on the income from the activity for your livelihood.
• Whether your losses are due to circumstances beyond your control or are normal in the startup phase of your type of business.
• Whether you change your methods of operation in an attempt to improve profitability.
• Whether you or your advisors have the knowledge needed to carry on the activity as a successful business.

If you're putting consistent time and effort into your online store with the goal of being profitable, you are almost certainly running a business, and all your net income is reportable to the IRS.

Understanding Form 1099-K and What It Means for You

If you accept payments through third-party platforms like PayPal, Stripe, Shopify Payments, or Amazon, you may receive a Form 1099-K, Payment Card and Third Party Network Transactions. This form reports the gross amount of payments you processed through that network during the year. It does not account for refunds, returns, platform fees, or shipping costs you paid.

Federal reporting thresholds for Form 1099-K have been in a state of flux. While a new, lower threshold was planned, the IRS issued a delay. For the 2023 tax year, the reporting threshold remains over $20,000 in gross payments and more than 200 transactions. However, some states have lower reporting thresholds, so you might receive a 1099-K even if you don’t meet the federal requirements.

The most important thing to remember is that the 1099-K reports gross sales volume, not your profit. Your accounting records are the true source of your business income and expenses. If the gross revenue number on your 1099-K is $25,000, but your business records show $3,000 in customer refunds, your actual gross receipts are $22,000. You will report your actual gross receipts on your tax return, not the number from the 1099-K. Always keep thorough records to reconcile any differences.

How to Report Your Online Sales: A Step-by-Step Guide

The method you use to report online sales income depends entirely on your business structure. Here’s a breakdown of the process.

Step 1: Know Your Business Structure

The way you've set up your business dictates which tax forms you'll use. For many online sellers just starting, the default structure is a sole proprietorship.

• Sole Proprietorship: You and the business are considered the same entity. You’ll report business income and expenses on Schedule C (Form 1040), Profit or Loss from Business, filed with your personal tax return. Your net profit is subject to both income tax and self-employment tax.
• Partnership: If you run the business with one or more partners, you’ll file Form 1065, U.S. Return of Partnership Income. The partnership itself doesn’t pay tax, but it "passes through" profits and losses to the partners via a Schedule K-1. Each partner then reports this information on their personal tax return.
• S Corporation: An S Corp also passes income through to its shareholders. The business files Form 1120-S, and shareholders receive a Schedule K-1 to report income and losses on their personal returns. This structure can sometimes offer self-employment tax savings for established businesses.
• C Corporation: A C Corp is a separate legal and tax entity from its owners. The corporation pays tax on its profits by filing Form 1120. If it distributes dividends to owners, the owners pay tax on those dividends as well. This structure is less common for small online sellers.

Step 2: Gather Your Financial Data

Before you fill out any forms, you need accurate numbers. Do not rely solely on the 1099-K. Use an accounting system like QuickBooks or Xero to track every transaction. Your e-commerce platform dashboard (e.g., Shopify Analytics, Etsy Payments summary) is also a fantastic resource for sales data, refunds, and platform fees.

Step 3: Complete the Correct Tax Forms

Let’s focus on the most-common scenario: a sole proprietor using Schedule C.

Part I: Income. Line 1, "Gross receipts or sales," is where you report your total sales revenue for the year. This is your gross revenue after you've subtracted any customer returns and allowances. This figure should align with your own bookkeeping records, not necessarily the 1099-K.

Part II: Expenses. Here you will list all your business deductions, which we will cover in a later section. The total expenses are subtracted from your gross income to determine your tentative profit or loss.

Part III: Cost of Goods Sold (COGS). If you sell physical products, calculating your COGS is fundamental. This represents the direct costs of the merchandise you sold. It's calculated as: (Beginning Inventory + Purchases) - Ending Inventory = COGS. Costs can include the price of raw materials, the cost of finished goods you purchase for resale, and shipping costs to acquire the inventory.

Your Gross Profit is your Gross Receipts (Part I) minus your COGS (Part III). Your Net Profit (or Loss) is your Gross Profit minus your total expenses (Part II). This net profit figure flows from Schedule C to your personal Form 1040, where it’s added to your other income and taxed.

Don't Forget Sales Tax: A Separate But Critical Obligation

Many online sellers confuse income tax with sales tax. Income tax is a tax on business profits paid to the federal government (and sometimes state/local governments). Sales tax is a tax on the sale of goods and services that you collect from your customers and remit to state and local governments. They are completely separate systems.

Your responsibility to collect and remit sales tax depends on a concept called "nexus." This is simply a connection between your business and a state that gives the state the right to require you to collect sales tax. After the 2018 Supreme Court case South Dakota v. Wayfair, nexus can be established in two ways:

1. Physical Nexus: Having a physical presence in a state, such as an office, warehouse, or employees.
2. Economic Nexus: Exceeding a certain threshold of sales revenue or number of transactions in a state. Each state sets its own threshold (e.g., $100,000 in sales or 200 separate transactions).

If you only sell through a marketplace like Amazon, Etsy, or eBay, they are likely considered "Marketplace Facilitators" and are responsible for collecting and remitting sales tax on your behalf. However, if you sell through your own website on platforms like Shopify or WooCommerce, you are responsible for managing your own sales tax compliance. Tools like Avalara and TaxJar can help automate the process of tracking nexus and calculating the correct sales tax rates.

Maximizing Deductions: The Key to Lowering Your Tax Bill

Reporting your income accurately is only half the battle. Diligent expense tracking is how you ensure you're only paying tax on your actual profit. Any expense that is "ordinary and necessary" for your online business is generally deductible. Here are some of the most common deductions for e-commerce sellers:

• Cost of Goods Sold (COGS): As mentioned earlier, this includes your product inventory and the shipping costs to get it to you.
• Platform and Payment Processing Fees: Your monthly Shopify subscription, transaction fees from Stripe, and selling fees on Etsy are all deductible.
• Shipping and Packaging Costs: The cost of postage, shipping labels, boxes, tape, bubble wrap, and other packaging materials are fully deductible.
• Website Costs: This includes domain registration, web hosting, themes, plugins, and any payments to web developers or designers.
• Marketing and Advertising: Expenses like Facebook ads, Google Shopping campaigns, payments to influencers, and email marketing service fees are deductible.
• Home Office Deduction: If you use a part of your home exclusively and regularly for your business, you can deduct a portion of your rent or mortgage interest, utilities, and insurance. You can use the simplified method or the actual expense method.
• Software and Subscriptions: Costs for accounting software, inventory management tools like Cin7, professional photo editing software, and other online tools are deductible.
• Professional Fees: The cost to hire an accountant, bookkeeper, or business lawyer is a deductible expense.

Final Thoughts

Successfully reporting your online sales is a matter of process and diligence. By understanding if your venture is a business or a hobby, gathering all income data beyond just the 1099-K, correctly reporting on forms like Schedule C, and remembering your separate sales tax obligations, you can confidently manage your tax duties. Pairing this with thorough expense tracking ensures you pay only what you owe and keep more of your hard-earned profit.

When specific tax questions arise about state nexus rules, the eligibility of a unique business expense, or how to interpret IRS guidance, the answers must be quick and precise. We built Feather AI to give tax professionals instant, citation-backed answers from authoritative sources. Instead of spending hours hunting through IRC sections and revenue rulings, our users can ask a question in plain language and get a defensible answer in seconds, freeing them up to focus on client strategy.