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[Stinger31]

Update 10/27/09: I am no longer trading so will not be updating or monitoring this thread.

It's the time of year for people to start thinking about their taxes, and as most of you are aware, our activities in the freebie world do have tax consequences. I've put this thread together as a FAQ to hopefully cover all major areas of question/concern relating to taxes and freebie trading. I will keep this maintained so please feel free to respond or PM with additional questions, especially if you feel a section is unclear.

One important note: as a CPA I can not advise anyone to break the law, so some of these questions I approach more from a legal standpoint than a practical one. Just keep that in mind.

Also please note that these questions apply to US citizens only. My apologies for being completely clueless about the Canadian tax system.

What makes Stinger31 qualified to write this anyway?
I'm a licensed Certified Public Accountant (Oregon license #11116) with a large practice in complicated individual taxation. I do a lot of my firm's internal training in this area. I have a great deal of knowledge about arcane sections of the tax code--and very little social skills to speak of as a consequence.

Freebie trading is just a hobby, not my job. Do I have to pay taxes?
If you have a hobby that generates a cash profit to you, you are required to report it on your taxes as business income. If you generate a cash loss, you would not want to call freebie trading a hobby because your loss would not be deductible (more on that later).

Can I report freebie income as prize winnings instead of business profit?
I believe this is a defensible position though it is not a guaranteed win with the IRS. This would involve reporting the gross payments you receive (from other traders and freebie sites) and taking no deductions, and then you would not be subject to SE tax (SS & Medicare) on the profit. This would only be beneficial in a situation where even adding the gross to your household's total income still results in taxable income of zero (after itemized deductions and exemptions).

Does the IRS know what I made from freebie trading?
If a network pays you $600 or more in a calendar year, they are required to issue you a 1099 for the year, and required to send it to you by January 31. These 1099s are also sent to the IRS. Note that the $600 threshold is at the network level (i.e. all GiftMonster sites combined, not just ____monster.net). Otherwise nothing is reported to the IRS.

Do I have to report my income from a network if I made less than $600 there?
Yes--the law requires you to report all income on your taxes regardless of whether it is reported to the IRS. This is despite the language of some sites that offer a $599 prize because "If it was more, you would have to pay taxes on it."

Do I have to report anything if I made less than $600 total?
Yes--see above.

OK fine, I'll report it. What forms do I use?
Unless you are reporting it as prize winnings, you will report on a Schedule C. If your total expenses were less than $5000 and you are reporting a profit, and you (or your spouse if a joint return) file no other Schedule C's, you can use Schedule C-EZ. Gross receipts should include all money you received from other traders for greens, as well as the total of all site cashouts received. You will also need Schedule SE to calculate self-employment tax. If you report as prize winnings, you report the gross as Other Income on page one of Form 1040 and no additional forms are necessary.

What information do I put for type of business?
I can't say for sure, not having been through an audit of this yet, that there's a silver bullet for the best description. I might suggest "incentive market trading" or something similar that sounds legitimate. Don't put something like "freebie trading" that would make the IRS scratch their head too much. The business code to use is very much up for debate--just don't use 999999 as that's an enormous red flag. 541800, advertising services, might be the most appropriate (remember your cashouts are the result of you advertising specific freebie sites to others). I would be interested to know what description and code some of the freebie site owners use.

What deductions can I take?
You can deduct the cash paid out to referrals for greens. If you want to be aggressive and it's worthwhile to you, you could deduct a portion of your Internet connection costs (I wouldn't recommend more than 50%). If you've incurred miscellaneous fees to advertise your trading activities (say you pay BlogToolKit for a monthly membership strictly to advertise your trading) those would be deductible. If you paid the Project Payday fee rather than completed an offer, or paid the FLR2 verification fee, those are deductible. There are really no other deductions available; any attempt to claim something like a home office deduction or a full write-off of a new computer would be overturned by the IRS without question.

Can I deduct the cost of doing offers?
Absolutely not, and here's why: you don't do offers for free. With every offer you receive a good or a service unrelated to the freebie trading industry, and the good or service's value is automatically assumed to be what you paid for it--and you are not reporting that value as income, therefore you can not take a matching deduction. As an example, I paid $10 for a book from Zooba. I can not deduct that because if I did, I would have to report $10 as income in the form of a book (goods in lieu of cash are still income). No matter how much or little you think the offers are worth, in the eyes of the IRS they automatically become worth whatever you paid for them. You also receive benefit in the form of offer credit, but that is worthless until you cash it out (and then the cashout becomes income). The only time an offer could ever be deductible is if it was directly related to the development of your freebie trading business (i.e. the BlogToolKit example above).

What if I lost money doing freebie trading?
It is perfectly acceptable to report this as a deductible loss as long as you are taking the position that you have a legitimate profit motive. If you report a loss for three years in a row you will get a question from the IRS, but I think most of us would give up long before that.

Do I include pending/accepted trades in my income and deductions?
No--you report strictly on the cash basis. Cash in, cash out as of the end of December 31.

What if I never take any money out of Paypal?
Money becomes legally yours when it hits your Paypal account; Paypal is just another place to hold your funds, no different than a bank account or a jar on your dresser. If for some reason you prepaid refs for trades on December 31, those are deductible that year (as long as it's reasonable, not just a fraudulent $500 paid to your friend to generate a deduction).

What will happen if I choose not to report this even though I got a 1099?
Since the IRS also has a copy of the 1099, they will almost certainly issue a notice of deficiency within six months and will assess tax on the gross amount of the 1099, along with interest and penalties that can't be waived.

What's really the risk if I didn't get a 1099 and I don't report any of this?
If you are selected for a detail audit by the IRS or your state taxing authority (and audit rates increase every year) then they would likely ask for detail of all your bank deposits and would match them all to reported income. They can also subpoena your Paypal records and auditors are getting smart enough to do that now.

As noted above I am no longer updating this thread and will not be answering questions via reply or PM. There are plenty of others around here who can offer some help, but please remember: there is no substitute for qualified professional advice. Good luck to everyone!

Professional standards require me to inform you that the information in this thread is not intended to be used, and can not be used, for the purpose of avoiding any tax-related penalties that may be imposed on you or any related person under the Internal Revenue Code.

Evan B. Dickens, CPA
Information updated as of 10/27/2009

[sullx]

This is exactly what I have been looking for! Thank you!!!!!!

Sticky?

[ldybug1752]

This needs to be a sticky. This is great information. Thank you for taking the time to make this thread!

[Lucky777]

This is the absolute best post on this issue I have come across yet...way to go...and I would like to know the few things that you were unsure of like what number to file under if you do figure it out!!!! Thank you so much for writing this!!!

[yebel89]

Thank you!

[weebles_five]

Great info!!!! Thanks for taking the time to post it!

[sefhop71]

this is waaaay awesome!! (thanks Lucky for putting the link in my thread!;)

[grtpyrlvr]

Great job! I think this will really help a lot of people!

[Gladiator]

Awesome!!

Excellent advice all over.

[showmecpa]

This is a totally excellent post. You put it in the written word so well.