The Internal Revenue Service wants its share of all money you take in during the tax year. The IRS might not know you won a $20 bet with your best friend, or that he paid you $300 to save his crashed hard drive because you're a computer whiz, but technically, these sorts of things are still income. You're supposed to confess to receiving them on your return, no matter how minimal they are.
The $600 Rule
The $600 rule applies to the business paying you money, not to you. The IRS requires that if a business remits $600 or more to you during the tax year, it must issue you a Form 1099-MISC for that amount. You'll receive a copy of the 1099, and the IRS will receive a copy as well. If you perform work for a local business and the owner pays you $550, he doesn't have to give you a 1099, but you still have to report the income – you earned it.
If you work for someone as an employee, the $600 rule doesn't apply. The employer usually must issue you a W-2 for any earnings, even if you worked only one day and your income was negligible. If he withheld any Social Security, Medicare or income tax from your pay, he must report this to the IRS too. He must also issue you a W-2 if he didn't withhold any income tax because you claimed enough allowances to prevent it. You'd report this as regular income on your return. If you're self-employed, all your business earnings should appear on Schedule C. The good news is that you also get to subtract your business expenses on Schedule C, then you enter the result as your income on your 1040. If you take in money for some other reason, such as the $300 your friend paid you to fix his computer, you'd enter it as "other income" on Line 21 of your 1040 return.
How the IRS Finds Out
The IRS will probably never know about that $20 bet you won, nor is it likely to spend government dollars trying to track it down. If you're self-employed, however, and if you fail to report earnings because you didn't really keep track of cash payments or because you weren't aware you had to report small amounts, the IRS can find out. This is particularly true if all those little payments add up. They might show as deposits to your bank account, and those deposits total more income than you've declared. If you don't report cash payments but use them to pay your bills, this might trigger an IRS audit as well. For example, if you report income of $30,000, but you serviced $36,000 in fixed living expenses, this might alert the IRS that something's wrong – that extra $6,000 has to have come from somewhere.
If the IRS suspects that you've failed to report income, and if you can't prove that you didn't, the fallout can be significant. You'll have to pay taxes on the income you neglected to mention, plus interest. You could lose the right to claim certain tax credits and deductions. If your oversight was an honest mistake – you just didn't know you had to report all those little $100 payments – you might get away with a 20 percent penalty. If the IRS suspects that you intentionally set out to cover up that income, it becomes tax fraud. This can bring criminal charges and a whopping 75 percent penalty.
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