For tax year 2011, the IRS did something very interesting: they required payment settlement entities to file Form 1099-K for payment transactions. This includes PayPal accounts that received at least 200 transactions and $20,000 total during the calendar year.
If you’re a blogger, the majority of payments are made via Paypal, so this adds a completely new hassle to the income reporting equation. The two biggest problems are:
  • Not everyone uses their PayPal account solely as a business account. For sole proprietorships, some payments from businesses should be marked as income. However, payments made from friends shouldn’t be. The IRS requirement doesn’t differentiate the different payments (unless they are made as personal payments). Therefore, in some cases, the 1099-K issued by PayPal may over-report income.
  • This also raises the issue of being taxed twice on the same income. If someone pays me over $600, they are required to file a 1099-MISC. If they pay via PayPal, PayPal then records that payment on the 1099-K. We shouldn’t be required to pay taxes twice on the same income!
The 1099-K changes are designed to prevent tax evasion, which amounts to over $300 billion a year in the U.S. I like the idea of holding people responsible for their taxes, and this holds people accountable for their online business ventures which in the past may have gone under the radar. For example, eBay re-sellers are required to report their online income, but it’s been easy to avoid it in the past.
However, this puts a large burden on taxpayers. eBay sales of used goods will still show up on the 1099-K, even though they shouldn’t be considered taxable income (if you sell something for less than it’s worth, it’s generally not taxable).
Because this is so confusing, the IRS did something smart. Really smart. On December 6th, the IRS released the 2011 Instructions for Schedule C, the form to mark profit or loss from business, and in it they gave all business owners a little reprieve and helped us prepare for our 2012 taxes as well.
First, while the 1099-K requirement still stands for 2011, the IRS has deferred the requirement to report the amounts on the 1099-K.
“However, for 2011, the IRS has deferred the requirement to report these amounts.”
What this means is that while you may get a 1099-K from PayPal, you don’t have to record that number on your taxes. You are, of course, still responsible to pay taxes on your income that you received through PayPal, but you can do it the same way it’s been done in the past, by recording only the actual business income on line 1b. You can simply enter ’0′ on line 1a.
Additionally, the 1099-K reporting requirement eliminates the need for some 1099-MISC filings,according to Don Frank, partner-in-charge of outsourcing with CliftonLaronAllen. The 1099-MISC indicates (in a not-so-straightforward way) that businesses should not complete Form 1099-MISC if the payment will already be reported on a 1099-K. So if someone pays you via PayPal and you will be issues a 1099-K, you won’t need to be issued a 1099-MISC as well. This avoids the double taxation issue.
Kudos to the IRS for realizing what a hassle this would be for 2011. I’ve started to prepare for 2012 by separating my personal and business PayPal accounts and by tracking PayPal transactions separately so I won’t have to go through at the end of the year and figure out which transactions were included on the 1099-K and which need to be recorded on the schedule C separately.