You must report any earned income (on your tax returns to the IRS) through PayPal). PayPal will include any receipts you have that are reported to the IRS on your tax return.
Under a law passed in 2012, third-party payment services must report income received by taxpayers. If you receive payments through PayPal you may or may not receive IRS form 1099-K (the 1099 form designated specifically for third-party payment services).
- $20,000 in gross payment volume from sales of goods or services in a single calendar year, AND
- 200 payments for goods or services in the same year (except Vermont and Massachusetts, where the threshold is lower, irrespective of the number of transactions).
IRS Rules on PayPal Income
As a general rule:
- Any income you receive you are required to report to the IRS on your income tax return.
- But many independent contractors and small businesses receive some, most, or even all their income through PayPal. It is, after all, a payment service, and a very convenient one.
- For that reason, it’s become a very common payment method, particularly for anyone who transacts business on the Internet. But there are two complications with this arrangement.
1. Not all PayPal funds come from income
It’s very possible that not all of the funds collected in your PayPal account represent income.
For example, payments are often received from family and friends. This is typically not income, but rather a simple transfer of funds, perhaps to settle an obligation, such as splitting a dinner tab.
2. Multiple Form 1099s
The bigger complication, however, may affect freelancers and subcontractors.
Clients may also issue IRS form 1099-MISC, which is the form the client uses to report the income paid to the contractor. It also provides a paper trail of the deductible expense for the client.
Form 1099-K issued by PayPal may very well include payments collected through the service from clients who also issue their own 1099s.
For example, you may receive 1099s from five different clients reporting a total of $50,000 in payments. If all the payments are made through PayPal, PayPal may then issue form 1099-K, also for $50,000.
In this situation, the taxpayer will be looking at 1099s totaling $100,000, when in fact only $50,000 in income was received.
The duplication may be easy to prove if the client 1099s match the PayPal 1099-K exactly. But if there is any difference in the two amounts, it could cause the IRS to conclude you’ve under-reported your income.
What Does this Mean for Your Taxes
Naturally, you only want to pay tax on the amount of income you’ve actually earned.
But with the possibility of PayPal issuing form 1099-K, the actual amount of income reported to the IRS may be higher than what you actually received during the course of the year.
If you aren’t able to successfully reconcile the difference in income, you could be liable for tax on duplicate sources.
For that reason, you’ll need to keep detailed records of your income, especially any received through PayPal. This will involve obtaining a printout of your PayPal receipts for the entire year. You will then need to identify payment sources.
For example, if Client A paid you $10,000 through PayPal during the year, you’ll have to identify those payments in the PayPal receipts record. Unfortunately, you’ll have to do that with every client who pays you through the service.
If you have detailed records matching PayPal receipts with client-issued 1099s, you’ll have the documentation needed if the IRS asks you to prove the income you’ve declared on your income tax return.
How do I Pay My Federal Income Taxes with PayPal?
If you’re a U.S. taxpayer, you can pay your individual or business taxes to the IRS with PayPal.
- Go to payUSAtax.com by April 15 and select Make a Personal Payment.
- Select the relevant tax payment category, enter your information, and choose PayPal for payment.
- Log in to your PayPal account to confirm your payment and get a confirmation number.
NOTE: payUSAtax.com charges a convenience fee of 1.96% for payments paid with PayPal.
Can I use PayPal Credit to pay my federal income taxes over time?
Yes, qualifying U.S. customers can use PayPal Credit to pay federal income taxes over time to the IRS through payUSAtax.com, on tax payments of $99 or more. If you use this option, the IRS will receive your tax payment right away.
What if You Don’t Receive 1099 from PayPal or Anyone Else?
There is a real possibility:
You won’t receive 1099 from PayPal. You may not even receive one from other parties, like clients. However, if whatever funds you have received represent income, you’ll be required to report that information on your income tax return.
It’s important to remember that one of the major reasons the IRS audits income tax returns is because of income discrepancies.
If there’s any evidence whatsoever that you may have received income, and it doesn’t show up on your tax return, you may receive an IRS notice requesting further information.
The fact that you do not receive 1099 does not mean the income is not taxable.
For example, the IRS does not require a business to file 1099 if the total payment is less than $600, or if you as the payee are incorporated.
But even apart from those two exceptions, there’s always the possibility of one or more clients simply not filing 1099.
Even if you don’t receive 1099, or if the income you earn from a client is less than $600, you’re still required to report the income on your tax return.
Taking Deductions Against Your PayPal or 1099 Income
If you file Schedule C for the income you receive from PayPal and other sources, you can then deduct related expenses.
You can do this regardless of the amount of income earned, or the expenses claimed.
For starters, you can deduct PayPal fees. These are considered like bank fees and are part of the process and expense of collecting income from clients and other sources.
PayPal fees typically range from about 3% on domestic source income receipts to well over 4% on income received from international sources.
But you can also deduct any other expenses related to the production of that income.
That can include:
- Use of your computer and/or cellphone.
- Rent or business use of your home.
- Supplies or inventory purchased in connection with your business.
- Purchase of necessary business equipment.
- Travel in connection with your business.
- Marketing and advertising costs.
- Internet or web hosting expenses.
- Other expenses necessary to the production of the income received.
It’s also possible or even likely you have at least some business-related expenses paid through PayPal.
As discussed earlier, PayPal fees are one example. But if you paid any business-related expenses through the service, they will also be deductible.
However, it’s important that you keep receipts related to those expenses. The simple fact that they show up in your PayPal account doesn’t make them deductible.
Written receipts from the merchants or service providers will be needed to document the business nature of expenses claimed.
If you receive any income whatsoever from PayPal, it’s best to make sure you thoroughly document it. You should also keep meticulous records of any expenses connected to that income.
Report both on your tax return, no matter how small the amounts are. Even if that doesn’t affect your tax liability, it will keep you clear with the IRS.
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