Individuals who sell goods through direct sales may be susceptible to audits from the IRS due to the potential “tax gap” in income reporting (i.e., the difference between what taxpayers should pay and what they actually pay). Therefore, it is very important that direct sellers follow IRS guidance on reporting income, properly claiming deductions, recording inventory, and recordkeeping, to limit complications with the IRS as a result of your sales activities.
Direct sellers are persons who are paid based on sales, rather than hours worked, and sell consumer products in a place of business other than a permanent retail establishment. They must report income received in the form of sales, commissions, prizes, awards, etc., regardless of whether they received an information return. Direct sellers can generally deduct ordinary and necessary business expenses, such as business mileage, cell phones, depreciation, legal and accounting fees, professional dues and subscriptions, equipment, and start-up costs. Additionally, inventories of products taken at the beginning and end of each tax year are necessary to correctly reflect income.
Generally, a direct seller will receive a Form 1099-NEC, Nonemployee Compensation, reporting payments of nonemployee compensation (NEC) previously reported in box 7 of Form 1099-MISC, from the payer under any contract. However, if this information return is not provided, the direct seller is still required to report all of the income received on their income tax return. Additionally, if consumer products totaling $5,000 or more are sold to a buyer for resale, the direct seller is required to report the amount of the sale on Form 1099-NEC.
Individuals who earn income as direct sellers may not realize that they will be responsible for both income and self-employment taxes on their earnings and may need to pay quarterly estimated taxes.
If you have a direct selling business, contact the Crosslin tax team at (615) 320-5500 with any questions you may have regarding income tax issues or recordkeeping requirements.