Sign Up

Why sign in to the Community?

  • Submit a question
  • Check your notifications
or and start working on your taxes
cancel
Showing results for 
Search instead for 
Did you mean: 
emh1969
Returning Member

Do I have to pay taxes on income from a business that I didn't materially participate in?

Hi,

 

I received a 1099-K from PayPal for a business that I didn't materially participate in. When I enter the information in TurboTax (including checking that I didn't materially participate in the business), Turbo Tax shows me as owing money on that income.

Is that correct? Seems like if I didn't materially participate in the business, I shouldn't owe any taxes on the income. Maybe I'm doing something wrong, not sure.

Thanks!

13 Replies
VolvoGirl
Level 15

Do I have to pay taxes on income from a business that I didn't materially participate in?

What business?  Why didn't you participate in it?   Maybe you did.   I assume you are filling out a Schedule C for it?  If you got income you owe tax on it.   

emh1969
Returning Member

Do I have to pay taxes on income from a business that I didn't materially participate in?

"Why didn't you participate in it?"

It's not my business so I didn't do any of the work. I was simply helping someone out because I have a PayPal account and they don't.

"If you got income you owe tax on it."

 

None of the money that was earned in the business went to me. All of it was passed on to the business owner.

VolvoGirl
Level 15

Do I have to pay taxes on income from a business that I didn't materially participate in?

Oh,   That's different I don't know how you should report that.  Someone else will have to reply.   

Critter-3
Level 15

Do I have to pay taxes on income from a business that I didn't materially participate in?

Well you’re being helpful for a friend is causing a big issue on your tax return. You must report the income on a schedule C and then 1099 the friend for the income they need to report on their schedule C. This is the only way you can move the income from your return to their return properly. You need to send them a 1099 – NEC form which was due out at the end of January So you were late getting that form out and the 1096 form filed with the IRS.

emh1969
Returning Member

Do I have to pay taxes on income from a business that I didn't materially participate in?

Thanks, I appreciate the information. Actually, the situation is more complicated than what I described. The business and the money are my wife's. She's not from the US and we don't live in the US, we live in her country. She has no connection to the US (no social security number or any other US identification number).

So what can I do in a situation like that???

Mike9241
Level 15

Do I have to pay taxes on income from a business that I didn't materially participate in?

are you a US citizen or are you a nonresident alien?

emh1969
Returning Member

Do I have to pay taxes on income from a business that I didn't materially participate in?

I'm a US Citizen.

 

After doing some digging, it looks like the best way to handle it is to report the income on Line 11 of Schedule C as Contract Labor. And then have my wife fill out form W-8BEN. Still need to do some more reading but that seems the best way to handle the situation based on the link below and some others that I found.

 

https://www.letsdeel.com/blog/all-you-need-to-know-when-hiring-independent-contractors-2020

Opus 17
Level 15

Do I have to pay taxes on income from a business that I didn't materially participate in?

@emh1969 

I see two basic options.

 

1. You file a joint return with your wife. Then, it doesn’t matter that the PayPal account is attached to your Social Security number.  You would include a schedule C for the business in your wife’s name, reporting the gross income, and deducting any legitimate expenses, and paying income tax and self-employment tax on the net profits. On a joint return, you will have to include all of your wife’s worldwide income including her non-US income. You can claim a credit or deduction for foreign income tax is that she pays on the same earnings.  To file a joint return, you would have to apply for an ITIN for your wife. This requires that you mail the IRS a form W-7 ITIN application along with proof of identity as required in the instructions. You would mail the W-7, the proof of identity documents, and the completed tax return all to the address used for the W-7. After an ITIN is issued, the IRS will process the tax return. Because the W-7 and tax return will require your wife’s actual signature on paper, and you must gather identity documents, this may require a trip to your home country or the use of an express service.

 

2. The alternative is to take the position that this is not your income because it is not your business.  If you don’t file a joint return with your wife, you must file as married filing separately, you are not allowed to file as single. If your wife does not have an ITIN, you won’t be able to file your return electronically, you will have to print it and mail it in. Leave the space for your wife’s tax number blank and when you get the print out, write “NRA“ in the space for her tax number, meaning non-resident alien.  You will also attach a copy of the 1099-K form and a letter of explanation, in which you will explain that this was your wife’s income for your wife’s business and that she will report the income on her tax return.  Meanwhile, your wife will file a nonresident tax return form 1040-NR.  She must report her US sourced income and pay tax on it just as if she was an American citizen. TurboTax does not support form 1040-NR, you will have to find another software provider.

 

Now, you have never specified what your wife does to get money from PayPal. It may or may not be US-source income, or it may only be partly US-sourced income.  You can review this IRS chart.

https://www.irs.gov/individuals/international-taxpayers/nonresident-aliens-source-of-income

 

It may be a viable option for you to report a PayPal business on schedule C and then report the entire gross proceeds as pass-through income to your subcontractor. However, because your wife is a non-resident alien, you as the payer of the pass-through income would usually be required to withhold taxes and pay those to the IRS, to your wife’s account. If your wife does not file a US tax return, the IRS gets to keep this “backup withholding”. If your wife does file a US tax return, the taxes that you withheld will go to her credit and she will either owe additional taxes or get a refund depending on the rest of her tax return.  You may be subjected to substantial penalties for not taking backup withholding.

 

I would definitely recommend having the entire situation reviewed by a professional before you do anything.  (You may also be in violation of PayPal‘s terms of service, and this situation could be viewed as a tax avoidance scheme by the IRS since you are disguising the true recipient of the money. Especially if the amount is more than $10,000. That is a legal matter that I am not qualified to comment on, other than to suggest that it may be an additional problem for you as you work through your situation.)

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
emh1969
Returning Member

Do I have to pay taxes on income from a business that I didn't materially participate in?

Thanks, I appreciate the reply. So to clarify:

 

1) My wife is a Spanish teacher. She used to do 100% in-person classes but with COVID she had to move her business online. She now has students throughout the world, hence the need to accept payments via PayPal.

 

2) 100% of the work was done outside of the US. As far as I understand, that means that all of the money would be considered non-US source (also, many of the payments come from people outside of the US).

 

3) Personally, I don't see why this money would be considered taxable. So my goal is to avoid paying taxes on it in the simplest way possible.

Seems like what I outlined above (expense the income as contractor expense and have my wife fill out a W-8BEN would work) but I'm not 100% sure.

Opus 17
Level 15

Do I have to pay taxes on income from a business that I didn't materially participate in?

@emh1969 

The money is not taxable income to you if you file married filing separately.  Your problem is going to be how to convince the IRS of that fact. The money is certainly taxable income to your spouse for services rendered under the laws of your spouse’s home country, and if you filed a joint return in the US, it would definitely be US taxable income on your joint return. 

 

One of your problems is that your wife should have registered the PayPal account. If she does not have an ITIN, PayPal would be required to withhold 24% for backup withholding.  Your wife would get that money back by filing a 1040NR tax return. If none of her income is US-source, then she would owe no tax and would get a full refund of the backup withholding.  Because you registered the account with your Social Security number, you avoided the backup with holding rules.  That may be illegal, or at least improper.

 

There are many situations where a 1099K might be issued for money that is not taxable, such as gifts received after an appeal for financial assistance.  The IRS procedure in such cases is to file by mail, and attach a copy of the 1099K at a written explanation as to why it is not taxable income. If the IRS wants additional proof, they will send a request for more information.

 

That’s what I suggest for you. And you should also change the registration of the PayPal account or get your wife a new account, even if it is difficult or requires her to get an ITIN or requires her to pay backup withholding. Otherwise, you are at substantial risk of tax and penalties every year that this arrangement continues.

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
emh1969
Returning Member

Do I have to pay taxes on income from a business that I didn't materially participate in?

The PayPal account is mine which is why it's registered to me. I use it for my business. My wife can't have a PayPal account because she's Colombian and PayPal doesn't operate in Colombia. So I send out the bills to her students from my account. The website domain for her business is registered in my name so technically her business is "mine". Normally this isn't a problem because we don't receive anywhere near the $20,000 level which triggers a 1099-K. Unfortunately, my address in PayPal was accidentally listed as Virginia which now has a $600 reporting limit which is why I received a 1099-K. (it should have been California).

"There are many situations where a 1099K might be issued for money that is not taxable, such as gifts received after an appeal for financial assistance. The IRS procedure in such cases is to file by mail, and attach a copy of the 1099K at a written explanation as to why it is not taxable income."

Okay good to know. Was hoping to avoid sending it by mail since I'm outside the US and would have to have a family member send it. Don't really want anyone seeing how much (or little) I make but I might not have a choice. 🙂

Opus 17
Level 15

Do I have to pay taxes on income from a business that I didn't materially participate in?


@emh1969 wrote:

The PayPal account is mine which is why it's registered to me. I use it for my business. My wife can't have a PayPal account because she's Colombian and PayPal doesn't operate in Colombia. So I send out the bills to her students from my account. The website domain for her business is registered in my name so technically her business is "mine". Normally this isn't a problem because we don't receive anywhere near the $20,000 level which triggers a 1099-K. Unfortunately, my address in PayPal was accidentally listed as Virginia which now has a $600 reporting limit which is why I received a 1099-K. (it should have been California).

"There are many situations where a 1099K might be issued for money that is not taxable, such as gifts received after an appeal for financial assistance. The IRS procedure in such cases is to file by mail, and attach a copy of the 1099K at a written explanation as to why it is not taxable income."

Okay good to know. Was hoping to avoid sending it by mail since I'm outside the US and would have to have a family member send it. Don't really want anyone seeing how much (or little) I make but I might not have a choice. 🙂


If you already have a schedule C business using the same PayPal account, you may be better off treating your wife as a subcontractor, at least for 2020 (if you have not filed yet), since this 1099-K includes your business income as well.  However, I would be concerned that failing to withhold backup withholding could subject you to penalties and I think you should get professional advice.  I would definitely set up a separate account for your wife's business as soon as possible and keep the funding separate.

*Answers are correct to the best of my ability at the time of posting but do not constitute legal or tax advice.*
emh1969
Returning Member

Do I have to pay taxes on income from a business that I didn't materially participate in?

I haven't filed yet but I'm in the process of doing so and time is running out. I'm curious why you think I would need to withhold backup withholding? I've looked and don't see anything that would imply needing to do that.

 

I'll definitely look into setting up a separate account for the future.

Dynamic AdsDynamic Ads
Privacy Settings
v