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Online Tax Laws and Paypal: What You Need to Know

In 1998, Congress promised to keep the internet tax free when it passed the Internet Tax Freedom Act. However, that promise was quickly forgotten, just a few years later, when Senate approved online tax legislation. This law states that, starting in 2011; online sellers would have to report their sales information to the IRS for taxation. This created a huge inconvenience for many vendors and their online clientele.

Summary of Online Tax Legislation

Congress passed a law stating that, beginning in 2011, payment processing sites like Paypal will be required to send the tax information of their US sellers to the Internal Revenue Service (IRS). A copy is also sent to the seller.  The IRS is a US government agency that is responsible for the enforcement of tax laws and tax collections. This law is applicable to sellers who process 200 or more payments a year and received a total of $20,000 or more for goods or services in the same year. Under this legislation, Internal Revenue Code Section 6050W, Paypal is required to report the amount of money received by certified US sellers and those international Paypal vendors who are subject to taxation by the US.  It is always best to check with someone who has an online llm before changing any of your tax forms.

How this Tax Law Affects Vendors on Paypal

Paypal is an international e-commerce business that can also be classified as an acquirer. This means that they process payments for online sellers, auction websites like Ebay, and other types of businesses. These transactions are convenient alternatives to traditional methods utilizing checks and money orders. Paypal, and other sites like it, are quite convenient for both the vendor and the customer. Paypal charges a small percentage of the sale price as a transaction fee. This fee is proportionate to the amount received by the vendor. Other factors that might affect the transaction fee are the type of currency used the type of account that the vendor has with Paypal.

Since the implementation of the online tax law, Paypal now monitors all US accounts, and applicable international accounts, in order to track payment volume. When a seller is close to meeting the taxation criteria, they will receive tax Form 1099-K from Paypal. A copy will also be sent to the IRS.  

If a seller hasn’t certified their status by the time this happens, their Paypal account may be penalized. These vendors will not be able receive funds from customers or close down their Paypal accounts. Paypal will remove restrictions on the account when the vendor has verified their status; whether US or non-US.

Certification is achieved by providing Paypal with a social security number, tax ID number, individual tax identification number, or employer identification number. US sellers that use an international Paypal account are also required to provide this information for those accounts.

This law doesn't apply to the majority of Non-US sellers.  If the seller is not a US citizen, doesn’t live in the US, isn’t a US resident or owns a non-US business, they are exempt from this legislation. They are also excluded if they meet any of the following criteria:

  • Their company was incorporated outside of the United States
  • Any states, partnerships, and trusts were registered outside the US
  • If seller is a person or a legal entity that US tax laws do not affect.

Non-US sellers are required to comply with this legislation in another fashion. These vendors must prove that they are international vendors and, therefore, cannot be taxed under US law.  Once their information is verified, these vendors can continue business as usual.

Trends in online sales transactions have changed since the recently implemented online tax law was put into effect. This legislation greatly affects the income of many US sellers, and consequently, the purchasing decisions of their customers. No longer will these vendors be able to provide cheaper products or services to their clients. Instead, they must raise their prices in an effort to afford the taxes that they now have to pay.

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