Some who use Paypal to receive freelance writing payments may have noticed them asking for your Tax ID number. That’s so they can meet the new the IRS rule that requires third party payment processors to send IRS notification if you receive more than $20,000 in gross payments and exceed 200 payments for goods or services in a calendar years. This goes for part-time and full-time freelancers who meet the minimum requirements.
If you’ve been paying taxes on all your income all along, this new 1099-K (see the draft) will just add more paperwork. For those who've neglected to report certain payments, it could be mean an unexpectedly high tax bill.
To fulfill Paypal’s request, you can provide your Social Security Number or EIN. If you use an EIN, Paypal will require you to upgrade to a Business account.
This new requirement might cause some confusion. If you have clients who pay via Paypal and send Form 1099-MISC because they’ve paid you more than $600, you could end up double reporting income. Not sure how the tax forms will compensate for this, but be aware that this could be a problem. The IRS says Form 1099-K is to “improve voluntary tax compliance,” so maybe they’re just using gross receipts on the form to match what you’ve listed on your tax return.
Because Form 1099-K will report gross sales without any adjustments, you’ll have to claim deductions for returns, fees, and chargebacks elsewhere on your Schedule C.
Simplify Your Paypal Account(s)
If you have just one Paypal account that you use for both personal and business transactions, this is a great time to separate the two. Create a personal Paypal account that’s linked to your personal checking account and leave business Paypal account linked to your business checking account.
Figuring out your taxes for 2011 may be a little messy if you’ve been using just one Paypal account. You can use Paypal’s reporting feature (History > Payments > Monthly Sales Report) to print a list of transactions for each month and note which ones were personal. e.g. gifts, money transfers, and other non-business payments. These personal transactions you would leave off your tax return. Once you receive your 1099s from clients, highlight the payments that are accounted for via 1099, so you’ll know what income gap to account for on your tax return. Your invoices should help confirm this number.
The new Form 1099-K isn’t limited to Paypal. All third-party credit card processors will send this form. Companies that are required to file Form 1099-K with the IRS are required to also notify the taxpayer either by mail or electronically.
The new rule only asks for credit card payments, so I’m assuming that eCheck and payments from a Paypal balance won’t be included. But, to be on the safe side, I’d suggest including all taxable payments in your tax return. An audit would reveal this income one way or another.
I want to disclaim that I am not a tax professional. If you have questions about what this means for your business, be sure to talk to your accountant, tax attorney, or tax preparer.