I have been actively selling on Ebay for nearly 10 years, and using PayPal for about 7 of those years. Of course, I report my sales and income for my state, but I never leave money in my PP account that exceeds what I owe for Ebay fees (auto withdrawl). I transfer those "profits" to a separate bank account (business only), and report any business related income and interest using that account.
I use the PP debit card (also for the 2.5% instant cash back feature!) for any and all purchases related to my business (items to sell, packing supplies, etc.), and at the end of the year can print out all of my records (from PP) as a summary with all of the receipts I saved (in a large shoe box) throughout the year.
If you are actively selling on Ebay, you should do the same, and set a completely separate business account with your bank. It makes things much less confusing come tax time!
at 9:08 AM on Jul. 8, 2009