Photo by Jernej Furman - Paypal Logo On Screen Under Magnifying Glass


Balance Pro Staff

posted on

April 6, 2023

If you're an eBay seller, generating income through your website, or managing multiple clients as a freelancer, chances are you'll receive payments via PayPal.

As you navigate the world of self-employment taxes, you may wonder, "How does using a third-party payment processor impact my taxes?"

The good news is that using a service like PayPal doesn't significantly alter the process. The primary aspect to be aware of is that you may receive a 1099-K form from PayPal, which records the earnings you've obtained through the platform.

In this guide, we'll explain who gets a PayPal 1099-K, what to do with it, and how to file your self-employment taxes.

What Is a Paypal 1099-K Form?

The 1099-K is an income summary that payment processors like PayPal provide to anyone who meets specific criteria for business transactions conducted on the platform.

Initially, the threshold for receiving a 1099-K was $600, which is quite common for gig workers, independent contractors, and small business owners.

However, the IRS recently revised the rules for 2022 transactions. Now, PayPal is only obligated to send you a 1099-K if you:

  1. Generated at least $20,000 in sales on the platform
  2. Completed at least 200 business transactions

In effect, these are the "old rules" for 1099-Ks, which have been in place for years. The IRS intended to lower the threshold to $600 this year but decided to postpone the change.

What does this entail? For example, imagine you operate an online vintage clothing store that depends on PayPal for processing payments. If you earned $21,000 in 2022, PayPal would send both you and the IRS the same 1099-K form documenting those transactions.

What About Personal PayPal Transactions?

Rest assured, your PayPal 1099-K won't encompass any funds received from personal situations, such as reimbursement from a friend for lunch. So, you won't be taxed on these types of payments.

Ultimately, your PayPal 1099-K form will only cover transactions that are either:

  1. Processed through a business or merchant account
  2. Processed through a personal account and labeled as "goods and services."

Any payments labeled as "friends and family" won't appear on your PayPal 1099-K.

How to Set up a Paypal Business Account

To avoid any confusion, it's a good idea to maintain your personal account solely for friends and family transactions and set up a separate business account for commercial transactions.

Setting up a PayPal business account is quite straightforward:

  1. Log in to your account
  2. Click on the gear icon to access your settings
  3. Choose "Upgrade to Business account"
  4. PayPal will prompt you to answer a few questions about your business, starting with its "type" (e.g., sole proprietorship, partnership, or corporation)
  5. You'll be asked if you want to upgrade your personal account to a business one, or if you prefer to create a business account with a different email. (Note: You cannot have a personal and business account under the same email; they must be separate)
  6. Provide your business information

When Does Paypal Send the 1099-K?

PayPal will mail the 1099-K form to you no later than January 31st. Following that, you can also access the form directly from your PayPal account.

It's essential to verify that your account details are accurate, including the:

  • Business name
  • Address
  • TIN (Taxpayer Identification Number)

This verification will ensure that your 1099-K form arrives on time and with all the necessary information. If you do not receive your form by January 31st, get in touch with PayPal's customer support for assistance.

Filing Your PayPal 1099 Taxes

When you have all of your 1099 forms in hand, you are ready to file your self-employment taxes.

Here is a quick summary of the steps:

Use Your 1099 Forms to Determine Your Gross Income

To calculate your gross income for the year, you'll need to refer to your 1099-K from PayPal, along with any 1099-Ks from other payment apps, credit cards, debit cards, or gift cards. You'll also need to factor in any 1099-NECs (formerly 1099-MISCs) you received from clients or companies that paid you $600 or more directly, via electronic fund transfer, direct deposit, cash, or checks.

For example, let's say you're a freelance writer who earned $1,000 through PayPal transactions and an additional $1,000 through direct deposit from a single client. In this scenario, you will receive a 1099-K from PayPal and a 1099-NEC from your client. These forms will help you determine your gross income for the year.

Additionally, it would be best if you added up any income that you didn't receive either a 1099-K or a 1099-NEC for. For instance, if clients paid you less than $600 throughout the year, you would not have received a 1099-NEC. In this case, you should look through your bank accounts for the deposits to determine your income accurately.

Make a List of Your Write-Offs

Most business owners and freelancers are aware that their taxes are determined by their income. However, it's essential to note that taxable income isn't the same as gross income, and it is usually lower. You can deduct a portion of your business expenses from your gross income, which lowers your taxable income. This method enables you to retain more of your hard-earned income from sources such as PayPal, and it applies to all your income sources and not only those from PayPal.

As a freelancer or merchant, you can benefit from various write-offs that help you reduce your taxable income. Some of the most common deductions include:

  • Your computer
  • The home office deduction
  • A portion of your Wi-Fi bill
  • Business-related meals
  • Seller fees
  • Vehicle expenses if the vehicle is used for work
  • A portion of your phone bill
  • Business loan interest
  • Business-related travel
  • Professional services such as legal advice and consulting
  • Website, Advertising, and Marketing expenses
  • Education and courses
  • Payment processor fees

Fill Out a Schedule C

When it comes to reporting your write-offs and determining your taxable income, Schedule C is an essential form to know. It's specifically designed for small business owners, sole proprietors, and freelancers to report their expenses, profits, and losses to the Internal Revenue Service (IRS).

If you're not familiar with Schedule C or need assistance in completing it, our comprehensive guide on Schedule C is an excellent resource for you. This guide will take you through every step of the process, from understanding your business structure to calculating your net profit or loss. By following this guide, you can rest assured that you're accurately completing your Schedule C form and maximizing your eligible deductions.

Pay Taxes On Time

For most individuals, filing taxes only occurs once a year, in April. However, if you're self-employed and are projected to owe the IRS over $1,000 during tax season, you will need to file your taxes quarterly.

Here are the typical due dates for each quarter:

  • Quarter 1: April 15th
  • Quarter 2: June 15th
  • Quarter 3: September 15th
  • Quarter 4: January 15th

It's important to remember that underpaying can lead to penalties for your quarterly taxes. To help estimate the amount you owe, you can use our free quarterly tax calculator, which provides reliable estimations.

It's essential to note that business expenses are not deductible on your quarterly taxes. You'll need to wait until you file your annual tax return to claim those expenses.

What happens if you don’t file your taxes on time?

It's important to file your taxes on time, as even a one-day delay can result in a 5% penalty on your original tax bill. This penalty will increase each month up to 25%. Keep in mind that the penalty is for filing, which means submitting your paperwork, even if you don't send the IRS any money.

If you owe taxes to the IRS and are late in paying, you'll face a failure-to-pay penalty of 0.5%. This penalty will continue to accumulate for every day that you don't pay.

If you do find yourself falling behind on your taxes, consider e-filing your taxes. This is the fastest way to submit your tax return and prevent any further penalty accumulation. By submitting your taxes promptly, you can avoid any additional fees and penalties.

How to Prevent Double Reporting of Paypal Income

Double reporting occurs when some of your income is inadvertently reported twice to the IRS. This mistake can result in a higher tax bill and create unnecessary complications.

How does double reporting of PayPal income happen?

Imagine that you're a freelance writer who wrote for multiple clients in a year and received several small PayPal payments of approximately $200 each. In total, you received $40,000, which is above the $20,000 threshold. If you received more than 200 payments, PayPal will send you a 1099-K form.

However, if one of your bigger clients is unaware of the correct form to use, they might mistakenly issue a 1099-NEC for that money. The 1099-NEC is meant to report payments made to freelancers through ACH and direct deposit, not through platforms like PayPal. Although the IRS explicitly states that payments "made with... third-party network transactions" are "not subject to reporting on Form 1099-NEC," not all clients are aware. Consequently, they might send you an extra form, resulting in double reporting on your income.

In this case, your actual income is $40,000, but due to the double reporting, the IRS will assume that you earned $40,000 plus the amount that the confused client paid you. As a result, you will be subject to higher taxes.

What do you do if a client accidentally double reports?

If a client accidentally double reports your income, there's no need to worry. When filling out your Schedule C, include your actual total income, which, in this case, is $40,000. If the IRS raises any questions, explain the error to them. There's no need to worry as you have done nothing wrong, and you won't be penalized.

If you're considering incorporating PayPal into your business, don't worry about the potential tax complications. The only thing you need to keep in mind is the 1099-K form that PayPal sends you. Ensure that all your information is correct on PayPal and keep your clients informed to avoid any confusion. By taking these precautions, you can rest assured that incorporating PayPal into your business won't complicate your taxes.

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This post is for informational uses only and is not legal, business, or tax advice. Please consult with an attorney, business advisor, or accountant with concepts and ideas referenced in this post. Balance Pro assumes no liability for actions taken in reliance upon the information contained in this article.

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