Do You Have to Claim Taxes on Money Earned with PayPal?

1099-K
Starting in 2012, PayPal will be required to submit a 1099-K form to merchants whose payments exceed a certain threshold. This new rule applies to any sales made and payments received beginning on Jan. 1, 2011. If you receive payments through PayPal and have gross sales of $20,000 or more and receive 200 or more PayPal transactions during the year 2011, you can expect to receive one of these 1099-K forms in the mail in 2012. You will then use that 1099-K information, along with information about your allowable expenses and deductions, to complete your tax return.
Self-Employment Income
Many freelancers and self-employed individuals are paid through PayPal. For instance, freelance writers often accept PayPal payments, from individual clients and from large companies who outsource their online and traditional print content. Today even the largest of companies use freelance workers to do everything from web design and development to secretarial services, and those companies often pay their workers through PaPal deposits. If you receive PayPal income for freelance work, be sure to carefully track each payment, and any expenses associated with earning that money. Accounting for each payment makes it easier to prepare your taxes and get the deductions to which you are entitled. If you receive more than $600 in payments from any one client, that client is required to issue you a 1099 Form. You will then use that 1099 information to prepare your tax return.
Business Income
Many people who run small businesses derive part of their income through PayPal payments. It is often much easier for individuals and other small businesses to pay through PayPal, and Paypal can also be preferable to a standard merchant account for online purchases. No matter what percentage of your business comes from PayPal, it is important to carefully track all of the expenses associated with that income. Tracking everything you spend to run your business will make it much easier to prepare your tax return and get the deductions you deserve. You can use a spreadsheet if you want, or you can purchase a small business accounting program. But no matter which method you use, you need to keep all of your receipts in case the IRS challenges or questions a deduction on your tax return.
Track Costs
Chances are not everything coming in to your PayPal account was pure profit. If you are a seller on eBay for instance, you have expenses such as listing fees and final value fees, as well as the original cost of the items you sold. If you are a freelance worker or someone who runs a home business, you might be able to write off the cost of your home office, your Internet service, your office supplies and other legitimate business expenses.If you receive part of your income through your PayPal account, now is the perfect time to start tracking your expenses as well as your payments. Keep a spreadsheet that lists the original purchase price of each item you sell on eBay, along with the listing fees and final value fees. Also track any fees PayOal takes out of your account, since all of these items can be deducted when you do your taxes.