Most IRS reviews are avoidable. And for eCommerce sellers, knowing what draws attention is half the battle.
Online businesses come with more moving parts than traditional retail — inventory across multiple platforms, sales tax in many states, and money flowing through Amazon, Shopify, and PayPal all at once. The good news is that the sellers who stay clean aren't doing anything complicated. They're just organized, consistent, and know where to focus.
Here are the five most common triggers for eCommerce sellers, and exactly what to do about each one.
#1: Your Income Doesn't Match What the IRS Already Has on File
Why This Matters
Every 1099-K sent to you also goes to the IRS. Following the passage of the One Big Beautiful Bill Act (OBBBA), the federal reporting threshold has been permanently set to $20,000 in payments AND more than 200 transactions per platform, per year. That means Amazon, eBay, Etsy, Shopify Payments, and PayPal all report directly to the IRS once you cross that threshold.
If you're based in Vermont, Maryland, Virginia, or Massachusetts, your state threshold is $600 — so you may receive a 1099-K well before hitting the federal level.
The IRS uses an Automated Underreporter Program that compares 1099-K totals to what appears on your return. When the numbers don't align without explanation, it gets flagged. This program catches millions of mismatches every year.
A Real Example
Maya sold handmade jewelry on Etsy and her own Shopify store. Etsy sent a 1099-K showing $32,000 in sales. Shopify sent one for $28,000. But Maya reported $45,000 on her return — she assumed refunds and returns didn't need to be included in the gross figure.
The IRS identified a $15,000 gap between the 1099-K totals and what was reported. Maya had to document her refunds using bank statements and platform reports. It took six months and cost $2,400 in accountant fees to resolve — all because of a recordkeeping gap, not intentional error.
How to Stay Ahead of This
Report the full gross sales shown on your 1099-Ks, then subtract refunds and fees as separate line items. This way, your numbers align with what the IRS already has on file, and the differences are clearly documented.
Keep a simple monthly log: gross sales per platform, fees paid, and refunds issued. Download all 1099-Ks from your platforms every January and compare them to your own records before filing. Tools like Link My Books connected to QuickBooks make this reconciliation automatic — so by the time January arrives, your numbers are already clean.
#2: Your Cost of Goods Sold Looks Out of Range
Why This Matters
Cost of Goods Sold (COGS) is typically the largest expense for eCommerce sellers. The IRS has a general sense of what profit margins look like by product category. When COGS seems unusually high relative to sales, it draws a closer look.
They also verify that COGS is mathematically consistent with inventory changes, using this formula:
Beginning Inventory + Purchases − Ending Inventory = COGS
When the math doesn't hold, or when expenses are placed in the wrong categories, discrepancies show up quickly.
A Real Example
Mike ran an Amazon FBA business selling phone cases. He started the year with $10,000 in inventory, purchased $40,000 more, and ended with $15,000 — which puts his COGS at $35,000. But his return showed $55,000. He had included Amazon fees, packaging, and shipping in his COGS figure, which are legitimate expenses — they just belong in different categories.
The IRS reviewed his return. He didn't owe more tax, but untangling the categorization cost him $3,500 in CPA fees and required a restated return.
How to Stay Ahead of This
Use a consistent inventory accounting method from the start — FIFO (First In, First Out), LIFO (Last In, First Out), or Average Cost. Most eCommerce sellers use FIFO because it reflects how products actually move. Pick one method and stay with it; changing requires IRS approval.
Count inventory at least twice a year — at the start and end — and take dated photos. Keep receipts for every purchase. QuickBooks tracks inventory automatically and keeps expenses in the right categories, so your COGS calculation is always accurate.
Remember: COGS includes only what you paid for products and inbound shipping to receive them. Amazon fees, outbound shipping, storage, and packaging are operating expenses — they go on separate lines.
#3: Personal and Business Money Are Mixed Together
Why This Matters
Business expenses are an area the IRS reviews carefully, and mixed finances make everything harder to document. When one account or card handles both personal and business spending, it becomes difficult to clearly prove which transactions were business-related — even when they genuinely were.
A Real Example
Jennifer sold beauty products through her Shopify store using her personal credit card for everything — business supplies alongside groceries, gas, and personal purchases. At tax time, she reported $12,000 in business expenses.
During the review, the IRS asked for documentation for every expense. Jennifer worked through 14 months of statements and found receipts for $7,000. The remaining $5,000 couldn't be clearly tied to business use. She owed $1,400 in additional taxes plus penalties and interest — not because she was dishonest, but because the records weren't there.
How to Stay Ahead of This
Open a dedicated business bank account and route all business income and expenses through it. Most banks offer free business checking, and the separation alone makes recordkeeping significantly easier.
A business credit card adds another layer of clarity — transactions are automatically categorized, and many cards offer cash back on purchases. QuickBooks connects directly to your business accounts and imports transactions automatically, so your books stay current without manual entry.
If you ever pay a business expense personally, write a reimbursement check from the business account promptly and keep the original receipt with a clear note on what it was for. That creates a clean paper trail.
#4: Your Home Office Deduction Seems Larger Than Expected
Why This Matters
The home office deduction is one of the most closely reviewed tax breaks, simply because it has historically been misapplied. For it to qualify, the space needs to meet two conditions: it must be used regularly and exclusively for business, and it must be your principal place of business.
eCommerce sellers can also claim storage space for inventory — but only if it's a separate, identifiable area used solely for that purpose.
A Real Example
Ryan ran a home-based business selling collectibles on eBay. His 2,000-square-foot home included a bedroom office (150 sq ft), a garage he used for storage (400 sq ft), and a basement packing area (250 sq ft). He claimed 800 square feet — 40% of his home — resulting in an $8,000 deduction.
During a review, an IRS agent visited. The garage held his car, bikes, and holiday decorations alongside inventory. The basement packing area had a couch and television. Only the bedroom office qualified. His deduction dropped to $1,500, and he owed back taxes, penalties, and interest totaling $2,800.
How to Stay Ahead of This
Be accurate about the space you're claiming. Measure the actual square footage used exclusively for business. Take dated photos showing the space set up for work only. If you claim storage space, it should hold inventory and nothing personal.
The simplified method is a reliable option: $5 per square foot, up to 300 square feet, for a maximum $1,500 deduction. It requires minimal documentation and works well for many sellers.
If you use the regular method, keep records of all home expenses — mortgage or rent, utilities, insurance, repairs — and calculate your business percentage by dividing business square footage by total home square footage. Save all receipts and bills.
#5: Your Business Reports Losses Year After Year
Why This Matters
The IRS has a hobby loss rule. If a business reports losses in three or more of five consecutive years, the IRS may classify it as a hobby rather than a business. Hobby losses can't be deducted against other income — which means taxes could be owed retroactively on years of claimed losses.
The IRS considers factors like whether you operate in a businesslike way, whether you have the expertise to make the activity profitable, and how much time you invest in it.
A Real Example
Lisa started an Etsy shop selling hand-knitted items. Over four years, she reported losses: $3,000, $4,500, $2,800, and $3,200 — which she used to offset income from her day job, saving roughly $4,000 in taxes.
The IRS reviewed her return in year five. She worked on the business only a few hours per week, had no business plan, didn't track which products were profitable, and had never adjusted pricing to cover costs. The IRS reclassified it as a hobby. Lisa owed back taxes on all four years of losses, plus penalties and interest — a total of $5,600.
How to Stay Ahead of This
Run your business like a business. Write a simple plan with clear profit goals. Keep separate books and a dedicated bank account. Track your time and document decisions you make to improve profitability — adjusting pricing, cutting costs, taking courses, expanding to new platforms.
If you're running at a loss, dig into why. Are margins too thin? Are costs too high? Make changes and document them. The IRS wants to see genuine effort toward profitability, even if you haven't reached it yet.
If you need more time to establish a track record, Form 5213 allows you to defer the hobby loss question. This is worth discussing with a tax professional before filing, as it also extends the IRS's window to review those years.
Your Action Plan
Staying clean isn't complicated. Here's where to focus:
This week: Open a dedicated business bank account if you don't have one. Route all business transactions through it starting now.
This month: Set up QuickBooks and connect it to your selling platforms via Link My Books. Count your inventory, take photos, and set a calendar reminder to do it every six months.
Before filing: Download all 1099-Ks from your platforms. Compare them to your own records and confirm your reported income matches or exceeds the combined totals. Document any differences clearly.
Each quarter: Review your books. Are you tracking toward profitability? If not, what will you adjust? Write down your decisions — this documentation matters.
Numbers Worth Knowing
For the most recent period on record (FY 2024–2025), the overall individual audit rate remains historically low — around 0.4%. Filers who report business income on Schedule C consistently see higher rates, between 1.3% and 2.1% depending on total income level. As an eCommerce seller, knowing you're in a more closely watched category is exactly why clean, well-documented books make such a difference.
On record retention: keep all business records for at least three years after filing. If income is underreported by more than 25%, the IRS has six years to review. For fraud, there's no time limit. Seven years is a safe general rule that covers most scenarios.
When Professional Support Makes Sense
Some situations benefit from specialized guidance. If your eCommerce business earns over $50,000 per year, the complexity usually justifies the cost. If you're exploring an S-Corp election, have inventory worth over $20,000, or have received an IRS notice, working with someone who understands eCommerce specifically makes a real difference.
At Tall Oak Advisors, we work exclusively with eCommerce sellers — so we understand FBA fees, multi-state sales tax, inventory tracking, and 1099-K reconciliation as part of our everyday work. If you want a clear picture of where your books stand, we're happy to take a look.
The Bottom Line
The five areas we covered — income matching, COGS accuracy, separated finances, home office documentation, and consistent profitability — account for the large majority of eCommerce audit triggers. Address these, and your risk drops significantly.
Keep good records, keep your finances separate, report your income accurately, and run your business with intention. Do those things, and you can put your energy where it belongs: growing your eCommerce business.
Ready to make sure your books are working for you? Schedule a free consultation with Tall Oak Advisors and we'll walk through your specific situation together:
Disclaimer: This article is for educational purposes only and does not constitute tax, legal, or financial advice. Tax laws change frequently and individual circumstances vary. Always consult with a qualified tax professional before making decisions that affect your taxes.
