Tax-Free Mystery Shopping Income?

I recently got an email from a shopper that said in part:

If you are careful not to go over making $500 per company you’ll never have to pay a penny for taxes. By taking enough jobs to make $500 from 30 or 40 companies you can make an extra $20,000 a year, tax free. Who couldn’t use an extra 20 grand, especially tax free?

Wow. There is so much wrong here I hardly know where to begin.

First let’s look at where he may have gotten the $500 number. The law says that anyone who pays a contractor $600 (not $500) or more per year has to file a 1099 for that contractor. The 1099 is sent both to the contractor and to the Internal Revenue Service (IRS). You might think of it as the contractor equivalent of the W2 form your employer files each year, showing how much you were paid and the taxes withheld. Only in the case of a 1099, taxes typically have not been withheld so it shows the gross amount paid to the contractor.

One purpose of the 1099 is that the IRS can run automated programs to match what was reported on 1099s to what taxpayers report as income. (When you file taxes you do not list all of your income by payer, so they can’t necessarily match exact amounts. What they look for is whether someone with 1099 income has filed a Schedule C for income from self-employment or a small business at least equal to what was reported on 1099s.) If a company sent you a 1099 and you did not show self-employment income, you will probably get a letter from the IRS.

Here is the important part: Even if you do not receive a 1099 you are responsible for reporting your income and paying any taxes due. This is true even if a particular company paid you less than $600 during that year, and even if every company you worked for paid you less than $600.

There isn’t some awesome tax loophole that says that as long as you only make a little bit of money from a bunch of companies you do not have to pay taxes on any of it. Whether you made $20,000 from an employer at your regular job or $500 each from 40 different mystery shopping companies, you have to report that income and pay any taxes due.

Whether this shopper is ignorant of tax law or actively cheating on his taxes doesn’t matter to the IRS. The fact is that he is breaking the law. If (when?) he gets caught he is going to be in a world of hurt. But wait—if the mystery shopping companies aren’t reporting it to the IRS, how will they find out? Here are a couple of possibilities.

The shopper could be the subject of a random audit and the auditor might discover this unreported income. It is not likely that he will be audited, but it is certainly possible.

The fraud could also be uncovered as a result of an audit of a mystery shopping company. One shopper told me she was audited because one of the mystery shopping companies she worked for got audited. In the course of that audit they compared the company’s records of payments made to the tax returns of the people who received the payments. Her return did not include a Schedule C (where Independent Contractor income is reported) so they assumed she was hiding income and she got audited.

The good news for her was that she had reported the income, she just hadn’t done it correctly. She had listed the money as wages instead of filling out the Schedule C. As a result, she hadn’t taken any deductions against her contractor income and had actually overpaid her income taxes. It turned out that she was due a refund. Had she been trying to cheat the government by not reporting income the outcome could have been quite unpleasant, as she would have owed not only the taxes due on the income but interest and penalties, too. There are lots of things you can do to run afoul of the IRS, but hiding income is the one that makes them maddest.

As an Independent Contractor, you are responsible for paying your taxes. It is not all that complicated to understand, and there is help available if you need it. The IRS has lots of publications and training information at their website, IRS.gov. At tax filing time, many libraries and community organizations have volunteers to help with tax return preparation. There are software programs, such as TurboTax, you can use to complete and file your tax return. Or you can hire a tax preparer or CPA to handle it. You may have to explain mystery shopping to your tax preparer, because most of them are not familiar with it, but they can help you navigate any issues you may face related to taxes.

In short, it is your legal and ethical responsibility to properly file your taxes. That means declaring all of your income and paying all of the tax you owe. Of course, as an Independent Contractor you are also entitled to deduct all of your reasonable and necessary expenses of doing business in determining how much of your mystery shopping income is taxable. But that is a topic for another day…

[Note: This post deals with tax laws in the U.S. However, you may find similar provisions in other countries. Check with the taxing authority in your country for details.]