Note: I’m not a tax professional. I have no education in tax law. I’m not giving explicit advice. Do not do what I say, or what I do, or what I say I do.
Nothing super sexy about today’s post, but it is one I’ve been batting around in my head for quite some time. Today we’re going to take on a topic as old as civilization itself. Taxes.
Taxes are a very real problem in the game we play. There are Fuel Surcharges (which I would argue are a form of tax), Entry and exit visas, Tourism taxes, and all kinds of hidden taxes on airline tickets. Today we’re going to tackle the “Capital T,” Taxes; today we’re talking about income tax. We’ll start with a description of what Income tax is, and what it isn’t:
Income tax is a Tax On…Income
No surprise there, income tax is a tax on the amount of income you earn in a year. Different forms of income can be taxes in different amounts. Also different levels of income can be taxed at different rates as well. The history of income tax in the United States is an interesting one. Not until 1913 and passage of the Sixteenth Amendment was the legality of a direct income tax settled in the US.
Income Tax is not a Tax on What You Consider to be Income
The issue becomes that a tax on income is not a tax on what you consider to be income. It is a tax on what the government considers to be income. Someone cuts your yard and you pay them, they’re receiving income from you. Whether you issue that person tax paperwork or not they should report all their income at the end of the year.
What if you traded a stock, made a few clicks online and the stock went up? When you sold the stock your profit would be income, specifically capital gains. Capital gains are taxed at a different rate than employment wages, but they’re considered income of sorts.
What if someone borrowed money from you, and you agreed that they would pay you back with interest? The interest would be taxable income, again capital gains.
The 1099-K, Wonderfully Messy
What about income online? This wasn’t a problem at all until about 15 years ago. All those ebay sellers who were making sales via Paypal were running credit cards (like a business), shipping orders (like a business), and paying for inventory (like a business). Their profit should be taxed as income, shouldn’t it? These businesses were mandated to report everything at the end of the year even though no 1099 was ever issued. But how do you know if these online sellers were reporting the correct amount of income? You create a new type of 1099:
Whereas the threshold for a standard 1099 is $600, a 1099-K is specific to online payment processors. The threshold for mandatory issuing of one is $20,000 and 200 transactions. This means if you earned $19,999 online by selling 200 items you would not necessarily receive a 1099-K. Similarly if you sold 10 items and brought in $25,000 you wouldn’t necessarily receive one either.
Only if you had 200 transactions and over $20,000 in income from those transactions would you be guaranteed to receive a 1099-K.
But remember, even though you may not be issued a 1099-K any income you receive you’re expected to report. And herein lies the issue for Churners and people who Resell goods for points/miles. We use services which deal with legitimate users and issue legitimate 1099s all the time. Paypal doesn’t care that you’re buying reloads with a CC and sending the money to your roommate anymore than they would if your roommate was paying you for goods or services via paypal.
Like playing Russian Roulette with a 12 Month Delayed Trigger
Keeping poor records, or no records of cards used for services which could be considered income is a quick way to make your life awful. As you can see from the above discussion you can receive a 1099 for any amount of income. You’re only mandated to receive them at certain levels. So assuming you’ll never go over 200/$20k and therefore not keeping good records is a terrible way to operate.
Come January when one of your online processors decides this is the year they 1099 everyone, you’ll be forced to explain away your income with expenses you don’t have any record of. Should you be audited you’d have a hard time explaining what you were doing.
Forced to issue and Choose to Issue. There is a Difference
Some services like Flint (I hate you flint), have taken the stance that they want to issue as many 1099’s as possible. Send $100 to someone using flint, and you’d find a beautiful 1099 in your mailbox come January. Are they mandated to send these 1099s? No, the federal threshold for issuing a 1099-K is $20k and 200 transactions.But there’s no floor for issuing them, and so you’re left reading about what companies did last year, in threads like this one, to find out if you can expect a 1099 in Jan/Feb.
As my Flint example above shows there is no firm floor on when a 1099 can be sent. Instead assume your tax implications before you go into a mile earning scheme. For someone like Square you might be able to squeeze a few pesky $100 cards through without a 1099 being issued. Or square might decide tomorrow that they’re going to 1099 everyone who used their service anytime during this year.
Amazon Payments Has Spoiled Many of Us
Amazon Payments (May she Rest in Peace), has really spoiled us. AP never filed a 1099 on any of our activities even though she could have. With a $1k max per month and 12 transactions per year the 200/$20k threshold was never really in danger of being crossed. I don’t know if merchants who used Amazon payments for legitimite business ever receieved 1099’s but I would assume someone did 200 transactions and $20k with the service, and someone, somewhere got a 1099 for it.
There isn’t a safe way to proceed at any level with any service. As I mentioned earlier just because a firm didn’t issue 1099s last year doesn’t mean they won’t wake up this year and say “hey, we should issue 1099s!” and come January/Feb 2015 you’ll find one in your mailbox.
Today I’ll implore you to consider the following philosphy:
Always Assume a 1099 Is Coming
For any service you sign up with, and process payments, sell goods or transfer funds always assume they’ll 1099 you. If you’re buying GiftCards and liquidating them in person they go ahead and toss them when you’ve balanced everything. But for online payment processors don’t be so quick to throw them out.
Marriage for the Sake of Tax Avoidance?
I posed an academic question on twitter a few weeks ago; Assume a husband works as a waiter, and his wife shows up to the restaurant, eats a meal, and tips him. Is that tip considered taxable income? Since the money is being transferred from her wallet to his (in esssence from their wallet to their wallet) would it then be tax exempt? To make the exercise more complicated, assume they live in a community property state.
I’m pretty sure the tip is taxable, but I never got a clear answer. It seems since the tip is going from one spouse to the restaurant via their merchant account and then from there to the server it would be taxable as income.
The angle I was working was to find a restaurant which participates in the iDine network, get hired there, and have my wife drop a $10k tip on me while working. If the tip was not taxable I’d be looking at a solid 100,000 miles for said tip (along with any dining bonuses that tip would qualify me for).
I’ll admit this is more of a moonshot type idea, and I don’t think I’d be successful in the process, but these types of academic ideas are great ways to try to earn more miles. However being Married does have one advantage over being single, and that comes from the Unlimited Marital Deduction.
Being Single means Gifts *Are* Taxable
Consider a payment company, I’ll take one of the ones that’s out there: Paypal. Let’s say you somehow figured out a way to load your paypal account with a credit card, and then you sent that money to a friend who cashed it out, and then your friend did the same. Paypal gives you a few options for sending money, some of which charge fees:
The solution is easy, right? Send it as a gift–which paypal doesn’t charge any standard fees for:
Even for those of you who are married I would seriously consider documenting as well as possible what exactly you’re doing. And for anyone sending money to a friend/non spouse I would really think twice about doing so. If you were to send $3k every month for 12 months as a “gift” to a friend, and t hen your friend went out and sent you $3k ever month for a year as well you’d each end up with a gift tax liability of $22,000. The reason is you’d have sent $22,000 more than your $14,000 Gift tax exemption.
I’m actually advocating marriage for the sake of earning Miles and points here! So go on out there and get hitched! But you’ll also maybe want to consider the tax implications of marriage before you do. 😉
What To Do With All These 1099’s?
Come Januaray if you open your mailbox and find a pile of 1099’s you’re going to have to do something besides pay the tax on the whole amount as income.
You have a few options, but your best option is to keep detailed records during the year, and discuss the issue with your tax professional. You’ll likely offset the reported income with expenses, and/or claim a Unlimited Marital Deduction if you were sending the money to your spouse. But these options have risk, and you could be opening yourself up to a future audit. Things to consider when you reach for those Paypal Reloads or sell a few laptops online.
– Written by Sam Simon. All ideas are my own, but I encourage you to see my point of view and I promise I’ll try to do the same. Connect with me on Twitter @Milenomics.