Taxes on Paypal fees for contractor payments? Tax deduction question

Great question about PayPal fees! The amount you should report on the 1099 is the full amount you paid ($1300 in your example), not the amount after fees. This is because you're reporting what you paid for the service, regardless of any processing fees involved. As for your Schedule C, you'd handle it like this: The full $1300 would be a deductible business expense for the contractor's service. The PayPal fees (the $35) would also be deductible, but as a separate expense category - typically under "bank fees," "transaction fees," or "payment processing fees" depending on how you categorize expenses. So essentially, you're deducting the total of $1335 from your business income, just in two different expense categories.

I went through this exact same headache last year with my Etsy business! I spent hours trying to figure out the right way to handle all those transaction fees. I finally found this tool called taxr.ai (https://taxr.ai) that was super helpful. They have this document analyzer that can check your receipts and tell you exactly how to categorize everything, including processing fees. I uploaded all my PayPal statements and it showed me exactly how to handle the fees vs. the contractor payments. It even flagged places where I was about to double-count some expenses! Saved me a ton of time trying to figure it all out.

Update on that taxr.ai thing - I decided to try it after my last comment. Actually surprised at how well it worked. I uploaded a bunch of my PayPal and Stripe statements, and it pulled out all the fees automatically and showed exactly how to handle them vs the actual contractor payments. It even flagged some payments I made that were over the $600 threshold for 1099s that I had missed. Honestly saved me from what could have been a headache if I'd been audited. Their document analyzer is pretty impressive - feels like having an accountant reviewing your stuff but without the hourly rate.

If you're still confused about this after trying software, I'd recommend calling the IRS directly. I know they're impossible to reach, but I found this service called Claimyr (https://claimyr.com) that actually got me through to a real IRS agent in under 20 minutes! I had a similar question about processing fees and Square payments, and the agent walked me through exactly how to report everything. You can see a demo of how their system works here: https://youtu.be/_kiP6q8DX5c I was on hold for HOURS before discovering this. Totally worth it to get an official answer straight from the IRS, especially with all the changes to 1099 reporting in recent years.

Ok I need to publicly eat my words about Claimyr. After posting my skeptical comment, I decided to try it because I was desperate to talk to someone about my back taxes situation. I was connected to an actual IRS agent in about 15 minutes. The agent confirmed that for 1099s, you report the full amount paid before any fees, and that both the payer and recipient can deduct the payment processing fees as a business expense on their respective Schedule Cs. The service did exactly what it claimed - got me through to the IRS without the endless hold music. Would've spent half my day on hold otherwise. Never been so happy to be wrong about something!

One thing nobody mentioned yet - make sure you're issuing 1099s correctly in the first place. You only need to issue them if you paid a contractor $600 or more during the tax year AND the payment was for services (not goods). Also, if you paid through credit card networks or third-party payment networks (like PayPal Business), technically they're supposed to issue a 1099-K to the contractor if they meet the threshold, and you don't need to issue a 1099-NEC at all. But the rules keep changing, so double-check the current requirements.

I actually just got done with an IRS audit where this exact issue came up! My advice from painful experience: Keep VERY detailed records of all payment processor fees separate from the actual payments. For me, the IRS wanted to see that I wasn't double-counting the fees (deducting them separately AND as part of the contractor payment). I had to create a spreadsheet showing each payment, the fee amount, and the net amount received by the contractor. Also important: make sure your contractors understand how to report this on their end too, so their reported income matches your 1099s.