The PayPal Loophole

I was reminded of PayPal recently when a WSJ “Heard on the Street” column suggested eBay might be an undervalued way for investors to bet on Internet commerce. It seems eBay’s PayPal is doing pretty well, growing fast, surpassing one sixth of all online payments, and counting almost three quarters of online buyers among its customers. My question is whether PayPal’s popularity is mostly a sign of tax avoidance?

PayPal is justly popular with cottage industry vendors, allowing them to accept Internet payments without the hassle of convincing a bank to trust them accepting credit cards. Clearly, PayPal is a key component of parent eBay’s auction business, used by millions of part time online entrepreneurs, the Internet equivalent of a medieval trade fair or farmer’s market. That’s a good thing, both for such micro-entrepreneurs and for the economy.

However, PayPal’s popularity is growing by leaps at a time when eBay auctions are not. My guess is that PayPal’s popularity has always had more to do with tax avoidance than payment convenience or safety. PayPal’s growing popularity suggests a lot of people have unreported PayPal income to spend, earned in a growing variety of ways. Even some beggars apparently accept PayPal these days.

My business has long had a PayPal account, which we use only to buy or sell when vendors or customers so demand. I avoid using PayPal because we did convince a bank to process credit card payments for us, but also because we cannot track taxable PayPal sales and deductible PayPal expenses very easily. Unless I’m missing something, PayPal simply does not provide good reports separating yearly payments and sales for tax purposes. I wonder why? I usually have to get out a calculator and add up the transactions by hand.

Worse, we cannot even easily pay via PayPal with a credit card, which would at least allow us to track those expenses on our credit card statements. PayPal has a nasty policy of deducting payments from our balance (that is from our few PayPal sales) before they will tap a credit card. PayPal policies are seemingly custom tailored for cheating on taxes. Sales, what sales? Income is easy to ignore when your balance disappears into purchases.

It seems my business is one of the few that worries about PayPal tax accounting. We must sometimes pay royalties to other small businesses, and always offer to mail a check. Yet those vendors usually insist we send them money via PayPal. I wonder why? You cannot buy groceries on eBay. But maybe keeping the income secret for IRS purposes makes up for having to spend it on eBay trinkets.

PayPal is effectively a bank, keeping your funds in the Internet analogue to a checking account, but an unregulated bank, not reporting to the IRS. So just maybe PayPal’s real appeal is avoiding taxes, allowing anyone to run a huge 24/7 cash garage sale. Local PayPal transactions even avoid state sales taxes.

Here are two selected posts from an online forum on eBay tax reporting:

“I’m 99.9% sure eBay doesn’t keep SSNs/TaxIDs. I never give that number out, and wouldn’t have joined eBay if I had to.”
“I am a long time seller on eBay and user of PayPal … I am not in favor of telling you NOT to report, but at the same time I have no grounds to judge your situation and tell you TO report.”

Others have begun to wonder about PayPal tax avoidance in these tax hungry days of government binge spending, including Congress. Buried in the 2008 Housing Rescue Package (yes, housing), is a provision requiring online processors like PayPal to begin reporting to the IRS in 2011, but only for sellers over $10,000 and 200 transactions yearly. $10,000 seems like a lot, so clearly our politicians were sensitive about the little guy and his not so little 24/7 “garage sale”, maybe the same little guy (and his vote) who favors increased spending funded by someone else’s taxes. I foresee an upcoming opportunity for PayPal alternatives; with multiple payment systems, each with a $10,000 limit, one could earn some real money.

Of course, you never could legally avoid paying taxes on PayPal income. It has been a question of whether you are likely to be caught. A recent scandal involved a real live IRS agent failing to report $36,000 of eBay “garage” sales, and owing almost $15,000 in taxes and penalties.

Being a libertarian, I am even more concerned than most about rising taxes. But tax avoidance is not the solution, seeming more like the sign of a sick society. Nor is selective tax law enforcement, applying tax laws to everyone except most voters. Call me a spoil sport, but it bothers me that millions of fellow citizens may use online pseudo banks like PayPal to avoid the same taxation they created by electing big-government politicians.

Comments

[scott massey]

i invite you to read Paulo Firere's essay called PEDAGOGY OF THE OPRESSED .
Pedagogy of the Oppressed is the most widely known of educator Paulo Freire's works. It was first published in Portuguese in 1968 as Pedagogia do oprimido and the first English translation was published in 1970. The book examines the struggle for justice and equity within the educational system and proposes a new pedagogy.

Dedicated to what is called "the oppressed," Freire includes a detailed Marxist class analysis in his exploration of the relationship between the colonizer and the colonized. From his own experience helping Brazilian adults to read and write, the book remains popular among educators in developing countries. According to Donaldo Macedo, a former colleague of Freire and University of Massachusetts professor, Pedagogy of the Oppressed is a revolutionary text, and people in totalitarian states risk punishment reading it. The book has sold over 750 000 copies worldwide and is one of the foundations of critical pedagogy.