Tax Lawyer's Blog

In a summary opinion issued yesterday the Tax Court held that an IRS revenue officer failed to substantiate expenses she claimed in her eBay business.¹ 

Below is an excerpt from the Court’s opinion in Orellana v. Commissioner, T.C. Summ. Op. 2010-51 (Apr. 20, 2010). The IRS agent/taxpayer’s admissions are stunning (emphasis added):

Petitioner argues that she was just taking things in her home and her garage and selling them online; she characterized it as an “on-line garage sale”. Petitioner explained that she liked to shop for and buy designer clothes, some of which “were sitting in her closet”.

She testified that while the clothes were “used most of them; some are new,” so she “would put them on eBay”. She might sell a $350 pair of shoes for $50 but that was better than having them sitting in her closet “wasting space”, she testified.

Petitioner testified that she did not understand why respondent so persistently asked for proof of her costs and expenses. She testified that she purchased personal items and never kept a receipt. “That would be ridiculous, unheard of. Unless there was some really bizarre reason why I kept a receipt, there were no receipts”, according to petitioner. To address respondent’s claim that she was operating a business, petitioner said she put together two charts, based on her bank statements and PayPal records, showing her “business” expenses. “I didn’t have receipts. I sold wedding gifts.” “I had gift cards. I said well, I didn’t pay anything of [sic] these gift cards from my wedding, so I guess I just take all of that as a loss. They said no. The basis is the gift card.”

On the other hand, petitioner admitted that she “occasionally” purchased items for sale in the ordinary course of her eBay sales activity that would still “have tags on them”. When she was reminded that most of the items she sold were “advertised” as new, petitioner responded: “I always advertise as new only because you can get a better price for that.” And she added, “So basically when you’re asking these questions about why things are new, I document them as new if it appears new. Is that wrong?”

Petitioner explained that she sold clothing and shoes of various sizes because she contracted plantar fasciitis and was unable to keep up her exercise routine. Lack of exercise caused her dress size to increase, according to petitioner, and the use of orthotics caused her shoe size to increase….

Petitioner has not produced any coherent evidence from which the Court can determine the bases for the hundreds of items she sold in 2004 and 2005 or the expenses she may have paid in the pursuit of her eBay sales activity beyond those respondent already allowed. …

Petitioner’s attitude toward the preparation of her tax returns appeared to be cavalier. During his examination of petitioner, respondent’s counsel asked her if she noticed that line 21 of her income tax returns provides for reporting “other income” and refers the taxpayer to page 29 of the instruction booklet. Petitioner testified that she “had prepared 1040s since she was 16″ and that she would “never look at the instructions.”

The judge rightly reprimanded Ms. Orellana and sustained the IRS assessment:

Petitioner is a revenue officer with the IRS. With this background, she has a wider range of knowledge of tax matters than do members of the general public. Petitioner is, or certainly should be, familiar with the recordkeeping requirements of § 6001, and she had access to a wide range of tax resources relating to the reporting of income and deductions.

The Court might not expect for a taxpayer to keep records for a few small items sold on eBay. In view, however, of the large number of transactions in 2004 and 2005 in which petitioner engaged, she should have realized that her activity might be subject to question.

Accordingly, respondent’s determination is sustained.

We are awaiting word from the IRS as to what sanctions, if any, will be levied against Ms. Orellana² and word from eBay as to whether her selling privileges will be terminated.³

Footnotes:

¹ Because Internet sales currently escape state sales taxes many people believe that they also exempt from the federal income tax. We’ve had several clients tell us that they didn’t think they had to report their online sales. This, of course, is incorrect. Taxpayers are taxed on their worldwide income regardless of the source of that income, including the Internet.

²  The IRS Office of Professional Responsibility  (OPR) regularly sanctions tax professionals for failure to comply with the federal tax laws. We recently wrote about an OPR hearing officer who doubled the IRS’s suspension of a New York tax lawyer for failing to timely file his federal income tax returns and being cavalier about the OPR proceeding. Let’s see if Ms. Orellena, who claimed tax deductions for which she had no corroboration and was “cavalier” about the Tax Court proceedings, receives a similar sanction.

³  Ms. Orellana admits that she lied about the condition of the merchandise she sold on eBay listing her used merchandise as new because “you can get a better price for that.” I would assume this level of deception constitutes a violation of eBay policy.

(Hat Tip: Paul Caron)

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