Do You Have to Report PayPal Income to IRS? Understanding the Rules
– Do You Have to Report PayPal Income to IRS? –
Do You Have to Report PayPal Income to IRS? Most PayPal users find themselves in a dilemma and they wonder if they have to report PayPal income to IRS on their tax returns. If you are one of those asking this question, please read on to find the answers you need.
Do You Have to Report PayPal Income to IRS?
Yes, report any income received (on your tax returns to the IRS) through PayPal. If you’re using PayPal to collect income from retail customers, whatever receipts you have that are reported to the IRS by PayPal need to be included on your tax return.
The complication arises primarily for contractors and other small businesses that receive payments from clients through PayPal.
In order for those clients to deduct payments made to you on their own tax returns, they must file an IRS form 1099-MISC. But if you also receive a 1099-K from PayPal, it creates the potential for duplicate reporting of income.
PayPal Reporting Rules
If you didn’t know PayPal reports your transaction data to the IRS, it’s possibly because the legislation is relatively new. IRC Section 6050W became law in 2012 and only went into effect in 2014 as people began submitting tax returns.
The new law states that PayPal will report details of your account directly to the IRS if you meet the following limits in a calendar year:
- $20,000 in gross payment volume from sales of goods or services in a single year
- 200 payments for goods or services in the same year
Once you cross those thresholds, PayPal will send Form 1099-K to the IRS, with a copy issued to you. Be aware that the figure provided will be a gross amount.
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 of their income through PayPal. But there are two complications with this arrangement.
1. Not all PayPal Funds come from income
It’s very possible that not all the funds collected in your PayPal account represent income.
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.
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 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 getting a printout of your PayPal receipts for the entire year. You will then need to identify payment sources.
Reporting 1099 Income and Non-1099 Income
Any income you receive through PayPal, whether or not it’s reported on Form 1099, must be included on your tax return.
If you file as a sole practitioner, income will need to be reported on Schedule C. If your business is run as a corporation, you’ll need to report the income on IRS form 1120 or 1120S. And if you operate your business as a partnership, the income will need to be included in IRS form 1065.
Even if you don’t operate a formal business, you will still be required to report the income on Line 21, “Other Income” on IRS Form 1040, Schedule 1.
However, it will be to your advantage to report the income on Schedule C, so that you can deduct business expenses related to the production of that income.
Taking Deductions from 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.
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 the expenses claimed.
Reporting Hobby Businesses
There’s one other situation that’s unique to PayPal, and that’s hobby businesses. This is the type of business you engage in primarily for pleasure and not profit. In fact, it may not be profitable at all.
However, even if it’s a hobby, you’ll need to report any income received from PayPal on your tax return.
If you cannot report it, the IRS can consider it to be under-reported income, and assess a tax on the income, plus penalties and interest.
By filing the income on your return, you will also write off expenses against that income. If your expenses exceed the income, then none of it will be taxable.
If you receive any income 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.
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