PayPal Fees, Invoices and Transfers in Your Books

Which PayPal amount is my income, the sale or the net I receive?

The gross sale price, before the PayPal fee, is your income. Sales tax imposed on the buyer that you collect and pay over is not income, and refunds reduce sales. The PayPal fee is a separate expense, and the transfer to your bank is not income at all. The IRS describes the gross amount on Form 1099-K as not adjusted for fees, credits, refunds or shipping, and says those items can be deducted from it.

How to categorize each amount on one payment:

Sales tax imposed on the buyer, which you must collect and pay over, is not income (Publication 334). Keep it out of sales. Tax imposed on you as the seller and charged to the buyer is part of gross receipts (same publication). Which case you are in depends on the law that imposes the tax; see Reconciling sales, payouts and Form 1099-K.

Gross sales are the figure that goes to the return's gross receipts line: Schedule C for a sole proprietor (IRS) or an individual's single-member LLC, Form 1065 for a partnership or an LLC with two or more owners, and Form 1120 or 1120-S for a corporation or an LLC that elected corporate tax (IRS). A single-member LLC owned by a corporation or partnership is reported on that owner's return (IRS). The tax side is in Online seller income tax and How an LLC is taxed.

Five things make a case not simple:

• A PayPal balance and bank account that do not tie after a month's check.
• An invoice and its payment both booked as income.
• Personal payments received in the same account.
• Money left in the PayPal balance on December 31, or held back.
• Past years booked from net deposits, or a Form 1099-K far from the books. A new routine does not change months already booked net. Those months may need to be rebuilt from the activity reports (see bookkeeping).

Gather before you start: the PayPal activity report for every month (not only the bank feed), your invoice list, the bank statements, and the year's Form 1099-K.

How do I record PayPal fees in my accounting?

Book each fee as its own business expense on the day the account shows it, never as a smaller sale. The IRS lists fees among the amounts you subtract from gross payments (IRS), so the books should show both: the full sale and the fee.

• One expense account for payment fees. Fees on sales, on currency conversion and on disputed payments can share it, or each can have its own line if you want to track them. That is a choice, not a rule.
• Take the fee from the activity report, one fee per payment, not a monthly estimate.

Booking only the net deposit leaves profit the same on the books but understates gross receipts and expenses, and anything measured on gross receipts, and the books can no longer be compared with Form 1099-K. Which return line a processing fee takes is for your preparer. The books only need the fee in its own account.

How do I keep a PayPal transfer to my bank from counting twice?

Treat the PayPal account as its own account in your books, like a second bank account. Sales and fees post to it, and a transfer to your bank moves money between the two. It is never a sale.

1. Create one account in your books for the PayPal balance.
2. Post each sale to income and to the PayPal balance at the full amount. Post each fee as an expense out of the balance.
3. Post each move to your bank as a transfer from the PayPal balance to the bank.
4. When the bank feed shows that deposit, match it to the transfer. Do not code it to income. If the deposit is smaller than the transfer because the move itself carried a fee, book the difference as a fee expense, not as a smaller transfer.

Counting twice happens when the sale is posted from the PayPal report and the matching deposit is also coded as income. Publication 583 says records should identify the source of each receipt, so that business and nonbusiness receipts and taxable and nontaxable income can be separated.

For a sole proprietor, a move to your personal account is an owner's withdrawal, not a business expense. For a partnership or corporation, how it is recorded depends on what it is (a draw, pay, a distribution or a loan): see Recording owner's draws and ask your preparer. If duplicates are already in the books, see Duplicate income in your books.

When is PayPal income counted: in my PayPal balance or when I move it to the bank?

PayPal income counts when it reaches your PayPal balance and you can use it, not when you move it to your bank. Under the cash method, income counts when you actually or constructively receive it, including when an agent you authorize receives it for you. Constructive receipt means the amount is credited to your account or made available to you without restriction. You do not need to withdraw it (Publication 334; Publication 538). Moving the money to your bank later does not change the year.

Money a customer pays before the work or delivery is generally income in the year received, even on the accrual method, unless the business elected the limited one-year deferral (Publication 538). Ask your preparer before leaving a December prepayment out of income.

A hold or reserve (money the processor keeps back for a time) is a restriction question. Publication 538 says income is not constructively received if your control of its receipt is subject to substantial restrictions or limitations. A restriction does not by itself undo receipt by an authorized agent, and the sources do not settle every kind of hold. When part of a balance was held back at year-end, give your preparer the processing agreement and the reports showing when the customer paid, when the processor received the money and when it became available. Cash method: income counts when you get it. Accrual: income counts when you earn it and the amount is known, even if unpaid. A C corporation, or a partnership with a C corporation partner, may be barred from the cash method; the methods are covered in Cash or accrual for a small business.

How do I apply a PayPal payment to an invoice so it is not counted twice?

Record the invoice once and apply the payment to it. The payment settles the invoice. It is not a second sale.

1. Create the invoice once. On accrual books it records the sale and an amount owed to you.
2. When the customer pays, apply the gross amount the customer actually paid to the invoice, before fees. Post the fee as its own expense line, and the rest goes to the PayPal balance. A partial payment leaves the rest of the invoice open.
3. Treat the later bank deposit as a transfer, not another receipt.
4. Keep paid dates on the invoice list. A cash-method return follows when money was received, even if the books also track invoices.

A fee taken out of the payment is the usual trap. If you apply only the net amount to a gross invoice, a small balance stays open as unpaid. Apply the gross payment, not the net, and book the fee separately; clear the whole invoice only if it was paid in full.

Check by matching each gross payment on the PayPal activity report to its invoice payment or direct sale in the books, using transaction IDs and dates, after taking out buyer-imposed sales tax and personal payments. A payment with two sales behind it may be posted twice. On accrual books, a payment can settle an earlier month's invoice without creating a sale this month, so reconcile sales to payments through the unpaid invoices at the start and end of the month, and any customer prepayments, before calling a difference a duplicate.

Already coded wrong? Work one month at a time: re-code each bank deposit booked as a sale to a transfer, and re-apply each payment to its invoice at the gross amount paid with the fee on its own line.

How do I record PayPal refunds, chargebacks and currency conversions?

Record a refund as its own line that reduces sales, in the month it happens, not netted against the original sale. For where it shows on the return, and refunds that fall in a later year, see Recording refunds in the books.

• Chargebacks. A chargeback is a customer disputing a card payment so the money is taken back. Book the fee when charged. The sale stays in income while the dispute is open, the amount the processor pulled from your balance is tracked as a disputed amount, a lost dispute is recorded like a refund of the original sale, and a won dispute returns the money to the balance. The IRS sources give no booking method, so ask your preparer which return line applies.
• Currency conversions. Amounts on a US return must be in US dollars. If the dollar is your functional currency (your business books are kept in US dollars, as most small businesses do), translate each item at the exchange rate prevailing when you receive, pay or accrue it (IRS). A separate conversion fee goes in the fee account like any other fee. If there is more than one exchange rate, use the one that most properly reflects your income. When the payment app converts at its own rate, the cost may sit inside that rate instead of a fee line; ask your preparer how to book the gap. A foreign-currency balance held for a while can produce an exchange gain or loss: see Foreign currency accounts in US books.

How do I keep friends-and-family and personal PayPal payments out of business income?

Money from friends and family as a gift or as repayment of a personal expense is not taxable income, so never post it as a sale (IRS). The IRS also says to note these payments as non-business in payment apps when possible.

• Cleanest fix: keep business and personal payments in separate accounts. Publication 583 says to keep your business account separate from your personal checking account.
• If one account holds both: a sole proprietor can post a personal payment to an owner account, not to sales, and keep the message that shows it was personal (see the example below). A partnership or corporation should ask its preparer how to record it (Recording owner's draws).
• What the payment is for decides. Payments for goods you sell or services you provide are income, whether or not a form arrives (IRS).

If the Form 1099-K includes personal payments, ask the issuer for a corrected form. That is covered in Gifts and split bills on a payment-app Form 1099-K. If customers paid into your personal account, see Business income in a personal account.

How do I reconcile my PayPal balance to its activity report and my bank each month?

Prove three things each month: the balance in your books equals the balance the account shows, the sales and fees equal the activity report, and every transfer matches a bank deposit. Publication 583 says you should reconcile the business checking account each month, and the PayPal account needs the same check.

1. Download the month's full activity report and note the account's closing balance.
2. Start with last month's closing balance. Add everything that came in: sales including any sales tax, personal payments, and money you moved in from the bank. Subtract everything that went out: fees, refunds, chargebacks and held disputes, tax the processor withheld (Form 1099-K box 4, backup withholding), payments you made from the balance (suppliers, contractors, purchases) and transfers out. The result must equal the closing balance.
3. Compare the payment and fee entries in the books with the report totals. On accrual books, a payment can settle an earlier invoice, so bridge sales to payments through the unpaid invoice balance.
4. Match each transfer out to a bank deposit. A transfer that leaves on the 31st and arrives next month is in transit, not missing.
5. Fix every difference before closing the month.

A connected bank feed is not a reconciliation: see Bank feeds are not reconciliation.

Does my PayPal 1099-K match my books, and why not?

Compare box 1a of Form 1099-K with your gross sales, not with deposits. The form shows the gross amount of reportable payments without regard to fees, refunded amounts, shipping, discounts or any other amounts, and each transaction is valued on its own date (instructions).

To bridge the two: start with box 1a, subtract payments that are not sales (personal payments, buyer-imposed sales tax collected for remittance), adjust for timing and currency, and add receipts outside PayPal. The result should equal gross sales in the books.

Under the federal rule, a payment app is required to send the form when payments for goods or services exceed $20,000 in more than 200 transactions transactions, and may send one below that. A card processor reports at any amount for payment card transactions. Whether or not a form arrives, all business income is reportable (IRS). Box 4 shows federal backup withholding, which the instructions say goes on the payee's return as tax withheld: it is not a fee or a reduction of sales, so give it to your preparer (instructions). Do not post the form itself as sales: the payments are already in the books.

If a gap remains after these items, do not plug it to income. A month, an account or an entity may be missing from the books. The full bridge, including a duplicated form or the wrong payee, is in Reconciling sales, payouts and Form 1099-K. If a client also sent a Form 1099-NEC for the same payments, see Same income on two tax forms.

When do PayPal books need a professional?

A monthly routine works while there is one account, one currency and each month ties. It stops working in these cases:

• The balance and the bank never tie after the checks above, or months were never reconciled.
• Income and fees were booked net, or deposits were booked as sales, in a filed year. Whether a filed return needs correcting depends on how gross receipts and expenses were reported.
• Form 1099-K is far from the books after fees, refunds, sales tax and timing are explained. A sole proprietor's personal return can draw a CP2000-series notice when third-party income information does not match it, and the notice sets a reply date (IRS).
• Many channels. PayPal plus other processors, marketplaces and invoices: see Card-processor payouts in the books.
• Volume, many currencies or open disputes at year-end.
• A partnership or corporation using an account opened in an owner's name, or with owner money mixed in.
• Past years untouched. See Catching up on overdue books.

Past months can be fixed by adding what is missing from the activity reports or by re-posting the year. Which fits depends on what was filed and what the books already show. Bring the activity reports, invoice list, bank statements and Form 1099-K to bookkeeping.

Example

These examples are illustrative; all amounts are in US dollars.

An invoice paid through PayPal

A freelance designer invoices a client $5,000. The fee is $175, so $4,825 reaches the PayPal balance, and the designer moves it to the bank.

Income is $5,000, the fee is $175 and the bank deposit is a transfer, not a second sale. The invoice is fully paid. On cash-method books, skip the first row and credit Sales $5,000 in the second.

Money still in PayPal on December 31

A calendar-year, cash-method online seller receives $2,000 of sales in December, available to withdraw that month, with no fees, sales tax, refunds or earlier balance. The money stays in the PayPal balance on December 31 and moves to the bank on January 4. Those sales count as received in December when the money is available without restriction. Money first received in an earlier year belongs to that year. The January move is a transfer, not income. The books show $2,000 in the PayPal balance at year-end, matching the account's closing balance. If part of it was on hold, ask the preparer whether that part was received.

Friends-and-family payments in a business account

A designer's PayPal account also receives $300 of friends-and-family payments toward a shared rent bill. The $300 is not sales if it is a gift or repayment of a personal cost. For a sole proprietor it goes to an owner account: money in from the owner when it arrives, money out to the owner when it moves to the personal bank. Sales and fees do not change. If the year's Form 1099-K counts the $300, the designer asks the issuer for a corrected form.

Different for you?

• Your PayPal balance and bank never tie, the Form 1099-K is far from your books, or income and fees were booked net for years: take the activity reports, invoice list, bank statements and Form 1099-K to bookkeeping for a catch-up and a view on whether a filed return needs correcting.
• You also take payments through other processors: see Card-processor payouts in the books and Reconciling sales, payouts and Form 1099-K.
• The same payments appear on a Form 1099-NEC and a Form 1099-K: see Same income on two tax forms.
• The Form 1099-K includes gifts or split bills: see Gifts and split bills on a payment-app Form 1099-K.
• Customer payments landed in a personal account: see Business income in a personal account.
• Income is counted twice from synced invoices and deposits: see Duplicate income in your books.
• You withdraw to a bank account outside the US, or your business is run from abroad: a US business's accounts abroad can bring their own reporting; see FBAR: which accounts count (it covers payment-app balances) and FBAR for company accounts abroad, and book the conversion as in Foreign currency accounts in US books.
• You want the income tax on an online shop: see Online seller income tax.