Most people are familiar with how income taxes work when you are an employee. Your employer issues paychecks to you showing your gross wages or salary, the amounts deducted for Federal Income Tax, Social Security tax, Medicare tax, and any state or local taxes. You receive the net amount of your wages less the amount withheld for taxes. Each year you file a tax return where your actual tax is calculated, and you pay any additional tax owed or get a refund if too much was withheld from your paychecks.
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.