Companies are only required to send a 1099 when they pay you $600 or more during a year. However, any income you earn as a mystery shopper should be reported. Failing to report income is the biggest no-no on the IRS’s list of sins. Of course, you can and should only pay the amount of tax you owe, not any more, so take every legitimate deduction you can.

Your mystery shopping income and expenses are reported on Schedule C of your tax return. You can learn more about Schedule C and what you can deduct at the IRS website: http://irs.gov

The standard mileage rate for 2010 was $.50 per mile. You can learn more about deducting car and travel expenses in Publication 463: http://www.irs.gov/publications/p463/index.html

Did you owe money this year? You may be subject to an underpayment penalty if you owe more than $1000 when you file your tax return. Employees have tax withheld from every paycheck and pay their taxes through the year in that way. As independent contractors, we are not subject to withholding, but there are two ways to pay income taxes over the course of the year so we are not faced with the double whammy of owing a bunch of taxes AND having to pay a penalty. If you or your spouse have a job where your pay is subject to withholding, you can increase the amount of tax taken from each check. Talk to your human resources department about how to do this. The other way to avoid a penalty is to pay quarterly estimated taxes. The first quarterly payment for 2011 is due on April 12, 2011. For more information on quarterly estimated taxes, see http://www.irs.gov/pub/irs-pdf/f1040es.pdf (PDF)

Start by doing a quick tax calculation. You may not have every bit of information you will need to file your tax return, but you should have enough data that you can do a rough estimate of how much tax you owe for the year. Compare that to how much you paid, via withholding if you or your spouse are employed, and estimated tax payments.

If it appears that you have underpaid your taxes by $1000 or more, you may be charged a penalty by the IRS. The penalty is waived if (1) you paid at least 100% of the amount owed on your previous year’s tax return or (2) you paid (via withholding and /or estimated tax payments) at least 90% of the present year’s liability. Remember that there is still one more estimated tax payment due on January 18, 2011, if you make estimated tax payments.

Look for deductions. To minimize your income tax liability, look for every legitimate deduction. You should NEVER spend money to get a tax deduction. That is a bad deal. However, if you spent money on your business, be sure to deduct the expense. Legitimate business expenses for mystery shoppers may include computers, printers and supplies, Internet access, cell phones and service, office supplies, a home office, automobile expenses or mileage, etc. Some of these expenses may be for things you do not use exclusively for business, but in general you may deduct the business usage. That means if your computer is used for business 60% of the time and personal things 40% of the time, you can deduct 60% of the cost. (Note: Some purchases, such as computers, are typically amortized over multiple years. That means that you may not be able to deduct the entire cost in one year, but would take a portion each year for a number of years. Ask your tax preparer for more information.)

Time your income and expenses, when you can. We can not always control when we get paid, but if you expect to be in a lower tax bracket next year, you might want to defer income until January where it is possible, so that the income will be taxed at a lower rate. This probably will not apply to your mystery shopping income, but might to a bonus payable at a job or to other contractor income, such as money you earn as a consultant.

We definitely have control over many of the expenses we incur. If you expect to be in a higher tax bracket next year, you may want to arrange to defer expenses until next year. That makes the deduction more valuable to you. If you expect to be in a lower tax bracket next year, you may want to accelerate some expenses into this year. Prepay bills due in January, or buy that equipment you are planning to buy soon. (Once again, NEVER buy something just to get a tax deduction. We are talking about the timing of a necessary purchase.)

If you are expecting a tax refund, get your tax return ready ASAP after the first of the new year. You do not have to have all of your 1099s in hand to file your return, as it is not necessary to send copies of 1099s with your return. You will, however, need good records of your income so that you report everything you earned.

Keeping good records of your mystery shopper income and expenses during the year will make your life easier when tax time rolls around. And, you may save money because you will avoid mistakes that result in penalties and you will not forget any of your allowable deductions.

Mystery shopper taxes are different. Mystery shoppers are usually considered Independent Contractors (IC), not employees. That means that taxes are not withheld from the pay we receive from secret shopping companies, and we are responsible for paying the taxes on our profits directly to the Treasury Department.

So how does it work when you are both an employee and an Independent Contractor? In many ways it is the same as when you were only an employee. You file everything on one tax return and pay taxes calculated on your total income. However, like everything else in the tax code, it isn’t quite that simple.

Before we go any further, I need to say that I am not an accountant or a tax attorney, and I have never worked for the IRS, so this should not be considered professional advice. This is a simplified explanation of the tax code and you should seek qualified advisors if you need assistance in completing your tax return.

With that disclaimer out of the way, let’s look at how taxes are calculated. In January of each year, you receive a W-2 form from your employer that lists your gross salary, your taxable income (gross adjusted for tax deductible contributions to a 401(k) or Flexible Spending Account, for example), and how much was withheld for various Federal, state and local taxes.

If any company paid you at least $600 as an Independent Contractor, they are required to send you a Form 1099, listing how much they paid you. Because typical mystery shoppers work for many secret shopping companies during a year, they may receive multiple 1099s. Even when you do not receive a 1099 (i.e., you earned less than $600 from some companies) you are required to declare the income you received.

The good news is that you get to deduct your reasonable and necessary costs of doing business—expenses such as mileage and required purchases—before adding your mystery shopper income into your employee income. In some cases, expenses that you would pay whether or not you were mystery shopping (e.g., Internet access, cell phone use, etc.) may become at least partially deductible once you are an Independent Contractor and using those things for business. That means that being an Independent Contractor can provide tax advantages.

Your Independent Contractor income is reported on Schedule C. That is also where you deduct your reasonable and necessary business expenses, such as mileage, computer and Internet expenses, ink and toner, education, required purchases, etc. Profit is calculated as the income you received minus your expenses.

Self-Employment tax is calculated on the amount of your profit. The Self-Employment tax is what self-employed persons (such as Independent Contractors) pay for Social Security and Medicare.

All of your income is then reported on the first page of the 1040 form. That includes your W-2 earnings, self-employment income, interest and dividends, capital gains (or losses) and other income. Certain types of expenses, including one-half of the Self-Employment tax for which you are liable, are deducted and the net is your Adjusted Gross Income.

What if the Schedule C shows a loss? It is possible, especially in your first year of mystery shopping, that you will show a loss instead of a profit. That can happen because you are aggressively (but legally) deducting a lot of expenses. In many cases, the amount of that loss can be used to offset income from other sources (such as your job).

Once you have your Adjusted Gross Income, you continue calculating your taxes just as you did when you only had income from your job. The exception is that when you list the amount of tax due, you must remember to fill in the line for the amount of Self-Employment tax you calculated.

This is an overview of how mystery shopping income may affect your tax return. Of course, the tax code being the tax code, there are other issues that can come in to play. For information about the current tax code and how it applies to you, consult your tax advisor or review the publications and other information available from the Internal Revenue Service.

Most mystery shoppers are not required to pay quarterly estimated taxes, because mystery shopping represents a small portion of their overall family income. However, if mystery shopping and other independent contractor or small business income makes up a significant part of your income, you should determine if you need to pay quarterly.

Not sure if you have to pay? You can figure it out by consulting the IRS web site at http://www.irs.gov/publications/p505/ch02.html

Need to know more?

Here are some general rules about who has to pay estimated taxes:

If most of your income is from being an employee, and you have tax withheld from your paychecks at your primary job, you may not need to pay estimated taxes. (This could also apply if your spouse is the primary wage earner and s/he has taxes withheld from his or her check.)

You must pay estimated tax for 2009 if both of the following apply.

1. You expect to owe at least $1,000 in tax for 2009, after subtracting your withholding and credits.

2. You expect your withholding and credits to be less than the smaller of:
1. 90% of the tax to be shown on your 2009 tax return, or
2. 100% of the tax shown on your 2008 tax return. Your 2008 tax return must cover all 12 months.

Keep in mind that because of a change in the withholding schedules during 2009, the amount of income tax withheld from paychecks decreased. That means that many people who expect refunds will be surprised with a tax bill when they file.

You can download the 1040-ES form for paying your estimated income taxes, along with the instructions and more information about estimated taxes at http://www.irs.gov/pub/irs-pdf/f1040es.pdf

You should never purchase something just because the expense can be deducted. Deductions reduce your taxable income, and therefore you pay less in tax, but it is not a one-for-one deduction. That means if you spend $100, you do not pay $100 less in taxes. Your “savings” may be about $25 – $50, depending on your overall income level. It is a nice savings for those necessary expenses, but buying something you do not need just to get a tax deduction doesn’t make sense.

It does make sense, however, to time your purchases to make the best use of tax deductions. If you want to reduce your taxable income for this year, you still have some time to buy things you need. For example, if you had more independent contractor income than expected this year, and want to reduce your tax bill, now is the time to stock up on some supplies, or make a purchase you have been considering, such as a laptop computer or mystery shopper certification.

Keep in mind that if the expense is incurred (e.g., put on your credit card) in 2009, it may be deducted this year, even if you pay the bill in 2010. Many stores are offering zero-interest financing on major purchases (such as computers) so you could charge the purchase now and deduct it this year, but take the maximum time allowed by the promotional rate to pay off your purchase.

Making planned purchases during this tax year can be a good strategy if your mystery shopper income along with other employee or contractor income could cause you to pay a penalty because you didn’t make quarterly estimated tax payments. (Estimated tax payments are usually required if you expect to owe at least $1000 more than was withheld from your family members’ paychecks.) Or if you expect to owe taxes or penalties due to underpayment of your 2009 taxes.

On the other hand, if you expect that your tax rate will be higher next year, you may wish to defer some purchases until after the first of the year. Your tax rate may be higher if your family income increases next year (e.g., someone was unemployed for much of this year, but expects to be working next year) or if Congress increases tax rates.

Timing your deductible expenses can save you money and smooth out your cash flow. Before making a major purchase for your business (such as a computer) consider how the timing of your purchase will affect your tax liability.

Unfortunately, many of the people who got more money in their paychecks this year may find Uncle Sam waiting with his hand out when they file their taxes next year. Some may even find that they will have to pay a penalty for the underwithholding, in addition to the tax they owe.

It is estimated that 15.4 million taxpayers had too little tax withheld and will owe money to the government. So who are these taxpayers?

Those most likely to be affected are those with more than one income, such as single people with more than one job and married couples who both work. This could include independent contractors, such as mystery shoppers. Many people secret shop for “extra income,” to supplement the wages they or a spouse earn at a job where their employers withhold taxes. Because no taxes are withheld from independent contractor income, it is possible to underpay taxes, especially this year.

Although it is expected that the IRS may waive penalties for underpayment due to the withholding change, taxpayers will still be required to pay any tax they owe. If you think you may owe money to the IRS, start planning now so you can pay any taxes due by April 15, 2010, and avoid penalties and interest for late payment. If possible, you might even want to make an estimated payment on January 15, 2010 to avoid any possibility of an underpayment penalty.

This may not affect you, but you should be prepared. Calculate your taxes as soon as possible so that you can plan to pay any tax you owe. Although you can not file your taxes until you have received your W2 form(s), you can estimate your taxes based on your pay stubs. The forms and instructions for 2009 tax returns are available now at the IRS website. Http://irs.gov/

You may also wish to adjust the amount of tax withheld by your (or your spouse’s) employer. The same withholding schedules will be used in 2010, so if you owe money for 2009, you will probably owe again in 2010.

Not sure if you have to pay? You can figure it out by consulting the IRS web site at http://www.irs.gov/publications/p505/ch02.html

Need to know more?

Here are some general rules about who has to pay estimated taxes:

If most of your income is from being an employee, and you have tax withheld from your paychecks at your primary job, you may not need to pay estimated taxes. (This could also apply if your spouse is the primary wage earner and s/he has taxes withheld from his or her check.)

You must pay estimated tax for 2009 if both of the following apply:

• You expect to owe at least $1,000 in tax for 2008, after subtracting your withholding and credits.
• You expect your withholding and credits to be less than the smaller of:
  1. 90% of the tax to be shown on your 2009 tax return, or
  2. 100% of the tax shown on your 2008 tax return. Your 2008 tax return must cover all 12 months.

Seem complicated? Well, the tax code certainly can be complicated. Here is one easy way to determine how much you should pay: If you expect your income to about what you earned last year or more, you can simply make sure that the taxes withheld from your paycheck, plus any amounts you pay in estimated taxes, equal your tax liability for 2008. If you earn more money this year you may end up owing more in taxes, but you will not owe any penalties if you pay the taxes by April 15, 2010.

You can download the 1040-ES form for paying your estimated income taxes, along with the instructions and more information about estimated taxes at http://www.irs.gov/pub/irs-pdf/f1040es.pdf

Will I get a 1099 from every mystery shopping company I did work for in 2008?
You will not necessarily receive a 1099 from every company for which you mystery shopped. Companies are required to provide a 1099 if they paid you at least $600 over the course of the year. Some companies include all payments they made to you when calculating the $600 threshold, and others exclude amounts paid for reimbursements and other expenses.

There were several mystery shopping companies that paid me less than $600 each during the year. Do I have to pay taxes on that money? How do I account for it without a 1099 form?
You are required to report all of your income. You will take deductions for reasonable and necessary business expenses, and pay income and self-employment taxes on your profits.

You must report income, even if you do not receive 1099 forms from some companies. You should have records of your income and expenses for the year, so you can rely on those records when calculating the amount of tax you owe.

When are companies required to send out 1099 forms?
The due date for providing 1099 forms is January 31st. That does not mean that you will receive all 1099 forms by that date. It does mean that the forms must be properly addressed and mailed no later than that date, except that when the due date is on a weekend or holiday, the due date is the next business day.

In 2009, January 31st falls on a Saturday. That means that 1099 forms must be properly addressed and mailed by Monday, February 2, 2009.

What if a secret shopping company paid me more than $600, but I do not receive a 1099 form?
Be sure to allow time for the form to reach you by mail. If you have not received an expected 1099 by mid-February, you should contact the mystery shopping company and ask if a 1099 form was mailed to you.

Whether or not the company provides a 1099 form, you are required to declare the income and pay any tax owed. You can file your tax return without the 1099, as you are not required to include the 1099 with your tax return. Refer to your accounting records to determine the amount of income you must declare.

The 1099 form I received included amounts for reimbursements of required purchases and even some travel expenses the mystery shopping company paid me for. How do I account for that?
You may want to address this with your tax professional, but it is important that you show all of the moneys reported on 1099 forms on your tax return. Amounts you received as expense reimbursements should be deductible as business expenses. That means that you include them in your gross income, then deduct the expenses and pay taxes on the net income.

Not sure if you have to pay? You can figure it out by consulting the IRS web site at http://www.irs.gov/publications/p505/ch02.html

Need to know more?

Here are some general rules about who has to pay estimated taxes:

If most of your income is from being an employee, and you have tax withheld from your paychecks at your primary job, you may not need to pay estimated taxes. (This could also apply if your spouse is the primary wage earner and s/he has taxes withheld from his or her check.)

You must pay estimated tax for 2008 if both of the following apply.

1. You expect to owe at least $1,000 in tax for 2008, after subtracting your withholding and credits.

2. You expect your withholding and credits to be less than the smaller of:
1. 90% of the tax to be shown on your 2008 tax return, or
2. 100% of the tax shown on your 2007 tax return. Your 2007 tax return must cover all 12 months.

You can download the 1040-ES form for paying your estimated income taxes, along with the instructions and more information about estimated taxes at http://www.irs.gov/pub/irs-pdf/f1040es.pdf

You recently wrote about doing mystery shopper jobs while traveling on vacation. I think that might be a good way to make my trips more affordable, and I also had this thought:

If I mystery shop on my vacation, may I deduct the cost of my trip from my taxes?

I am not a CPA or tax professional, so this should not be considered legal or professional advice. In fact, the best thing to do is to consult with your tax professional to get his or her opinion. However, here are some portions of the tax code that seem to apply to this question.

According to IRS Publication 463:

Travel in the United States

The following discussion applies to travel in the United States. For this purpose, the United States includes the 50 states and the District of Columbia. The treatment of your travel expenses depends on how much of your trip was business related and on how much of your trip occurred within the United States.

Trip Primarily for Business

You can deduct all of your travel expenses if your trip was entirely business related. If your trip was primarily for business and, while at your business destination, you extended your stay for a vacation, made a personal side trip, or had other personal activities, you can deduct your business-related travel expenses. These expenses include the travel costs of getting to and from your business destination and any business-related expenses at your business destination.

Example.

You work in Atlanta and take a business trip to New Orleans. On your way home, you stop in Mobile to visit your parents. You spend $1,070 for the 9 days you are away from home for travel, meals, lodging, and other travel expenses. If you had not stopped in Mobile, you would have been gone only 6 days, and your total cost would have been $920. You can deduct $920 for your trip, including the cost of round-trip transportation to and from New Orleans. The deduction for your meals is subject to the 50% limit on meals mentioned earlier.
Trip Primarily for Personal Reasons

If your trip was primarily for personal reasons, such as a vacation, the entire cost of the trip is a nondeductible personal expense. However, you can deduct any expenses you have while at your destination that are directly related to your business.

A trip to a resort or on a cruise ship may be a vacation even if the promoter advertises that it is primarily for business. The scheduling of incidental business activities during a trip, such as viewing videotapes or attending lectures dealing with general subjects, will not change what is really a vacation into a business trip.

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My reading of this is that squeezing in a few mystery shops on your vacation does not make your vacation tax deductible. (You expected another answer? Sorry.) However, you could be reimbursed for some of your expenses as part of the mystery shopper jobs, and some or all of those reimbursements would likely be deductible as reasonable and necessary business expenses.

You can read more about this in IRS Publication 463.