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Let me start off by saying I have no idea what I'm doing here. The context is, I am making a game, and every month I make $400 or so from Patreon (people are my patrons, and they are paying me because they want to see the game be created). This money goes into my paypal account (there is no way to avoid this), and then i send this money to a business checking account I've created.

Starting this month, I've decided to partner with somebody on my game (an artist), and we are going to split the profits 50-50. Unfortunately, Patreon has no concept of splitting income. Every month, 100% of the profit will go to my PayPal. From PayPal (or maybe from my personal business checking account), I plan to send 50% of what I earn into my partner. This personal business account isn't anything special. It's just a separate checking account that I only use for business.

I'm worried about the tax implications of getting 100% of the income and then sending 50% to someone. Will the IRS look at this and say I should be taxed on 100%? It's seems like there should be a way to only pay on the income that I keep at the end of the day.

How do I avoid paying taxes on 100% of the income when I only keep 50%?

I do not have and LLC... I don't even have a DBA. I live in California.


**Follow-up questions: **

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    You say it's not possible to avoid it going into your paypal account, but wouldn't it be possible to create a business paypal account and receive the payments there? – BrenBarn Sep 3 '20 at 5:00
  • @BrenBarn yes that is possible. What I meant to say is it has to go to a paypal account. – Clueless Investor Sep 3 '20 at 21:21
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    it is COMPLETELY NORMAL that your bank account receives, say, $1000, and you have to pay out $500 on parts, equipment, or paying a freelancer. This is COMPLETELY NORMAL. You do not have to do ANYTHING, AT ALL. Your income in the example is $500. The confusion on this question and the answers is really beyond belief. 100.0000000000000000% of folks who get some income from Patreon, have expenses. TaxAct and the other software totally takes care of it. There's a field where you type in "expenses" ("500" in the example). The whole thing is an absolute, total, non-issue guys!! – Fattie Sep 4 '20 at 17:00
  • If your partner does not live in CA, I'd recommend creating the partnership in that state. Full disclosure I am not an accountant, and IANAL (I am not a lawyer). I do know a number of people who have moved from CA, and so far none of them have moved back :-) – J. Chris Compton Sep 4 '20 at 17:52
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What you have there is a General Partnership.

You already have a General Partnership. You didn't need to do anything to create it, it just arose when you agreed to share revenue. In this situation you split income and expenses as far as the IRS is concerned. You don't get much flexibility in how this is done, because you have a General Partnership and not an LLC. Read Publication 525 for guidance. If you want to do something unusual with asset allocation, shares, etc., you can't do that in a General Partnership; that's what LLCs are for.

Your expenses pass through onto your individual tax returns, as does your income.

Yes, Patreon and PayPal will report income to the IRS as your income. Your taxes, however, will show you disclosing only half that income, and they'll see that you have a partnership with 1 other person (via the Form 1065 the partnership files and each partner includes with their taxes). IRS will go "OK, that makes sense". It's not the first time they've seen a partnership, and they are familiar with the janky way Patreon and PayPal want one partner to be the reportee for tax purposes. I mean yeah, it'll trigger a review ("audit"), but they'll figure it out without ever needing to contact you.

It might be wiser to open a bank account in the name of the General Partnership. The bank will want your personal info and your partner's personal info. They won't care what name the partnership uses and it won't have a separate legal identity. You'll both be liable for overdrafts etc.

In fact, each partner will have unlimited liability for the debts of the partnership. So if the partnership gets sued and loses, they will go after all of you until they are paid. To fix that get an LLC or corporation, and don't be grossly negligent.

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  • How will the IRS see you have a partnership with another person? – Robert Sep 3 '20 at 7:00
  • This is the correct answer - OP has already described that they are in a partnership relationship, and tax filings should reflect that. If OP wants the tax impact to be different, they should consider how to make that new form legally effective, rather than just filing taxes however they feel suits them. Many dangers in misaligning tax filing status from legal reality. – Grade 'Eh' Bacon Sep 3 '20 at 13:09
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    Now we have already seen the limits of how well my business trivia knowledge transfers to the USA, but if a General Partnership is anything like its European counterparts you might want to point out more explicitly that there are good reasons the OP (and the artist) might not want to be one: All partners are individually liable for the full amount of any debt the partnership accumulates, so for example if the partnership and OP accumulates debt the debt collectors might go after the artist for all of the money, even if it's mainly OP's fault. Or the other way around. – Nobody Sep 3 '20 at 19:36
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    @CluelessInvestor Please note that while you probably do have a General Partnership right now based on how you phrased it, you can have a simple vendor-customer relationship with the artist, and especially if you want to stay anonymous that would probably be easier. That way you would be the "boss", kind of, as in that you would be the sole owner of the video game (single person) "company", but you could still decide to give the video game art company (i.e. your online artist friend) that you contracted all the artistic freedom you want. – Nobody Sep 4 '20 at 7:52
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    Also another downside of a partnership (I am in one too) is if one of the partners passes away, the entire partnership account and all of the assets get frozen and becomes (in part) part of the estate. So the existing partner cannot access those funds until the estate is wrapped up. So I highly advise getting advice from a professional regarding if a partnership/something else is appropriate for your situation. – stanri Sep 4 '20 at 10:10
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Let me first say that I am not an accountant. I recommend that you do meet with an accountant; he or she will be able to tell you the best way to handle this. That having been said, I'm going to offer you one idea for handling this.

Probably the least complicated way to structure this is as a separate sole proprietorship for each of you. You would claim the entire amount from Patreon as revenue for your business on your Schedule C. Your partner in this scenario would be a vendor that you are paying for his art services. You would deduct the amount that you pay him on the Schedule C. You can also deduct other expenses that you have in producing this game.

Your partner would have his own Schedule C business, and claim the amount you paid him as revenue for his business.

In addition to the Schedule C, you would probably need to file a 1099-MISC that you would give him if you paid him $600 or more in a year.

There are other options, such as a partnership, LLC, or corporation, but they are more complicated.

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  • oh that makes sense. Let me see if I understand this at a conceptual level: imagine I lost half my patrons and only made 50% of the income I make now. From a tax perspective, that would be the same as earning 100% and deducting 50% of it? as for "an accountant" would that be a CPA or something else? – Clueless Investor Sep 1 '20 at 20:42
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    Yes, you understand it. Let's say that you pull in $5000 from Patreon. Your business would have $5000 of revenue, but when you send $2500 to your partner, you have $2500 of deductible business expenses, which means that you only pay tax on $2500 business profit. Your partner's business revenue is $2500, so that's what he pays tax on. (Of course, you probably have other business expenses which will reduce your taxable profit even further.) – Ben Miller - Remember Monica Sep 1 '20 at 20:48
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    I agree with most of what Ben wrote here, with one exception -- being a sole proprietor. The trouble with being a sole proprietor is that should the company be sued and lose, your personal assets can also be at risk. Whereas, should you form an LLC, only the asset of the corporation are at risk. The costs are not a whole lot more to be an LLC, and I think that the legal protections are worth it. As usual, going over all this with a professional is probably the best idea. – R. Hamilton Sep 1 '20 at 20:49
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    @CluelessInvestor You have until January 31st to file 1099's. That ensures that the recipients have enough time to get their taxes in order before April 15th. The only real difference with having an LLC is that you must keep books, expenses, and accounts separate. The IRS doesn't really care so long as you file and pay the same as if you didn't have an LLC. But if you commingle assets, you could lose the protection of keeping them separate should someone sue you. – David Schwartz Sep 2 '20 at 0:29
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    @R.Hamilton you should probably put this suggestion into an answer, since Comments cannot be voted/commented on like answers. It is de facto an alternative answer, and should get the same amount of critical review - since I think with $200 revenue for the OP per month, before any expenses even "sitting down with an accountant and ceate an LLC" is not a negligible expense for a business earning him maybe $1.4K a year – Falco Sep 2 '20 at 9:42
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I'd form an LLC, with the partner (or not). (I used Legal Zoom to do this, a few years ago. Today it costs $79. (There may be some minor state fees, no capital requirements in my state.))

Get a bank account in the name of the LLC.

Connect bank account to Patreon/Paypal.

Have funds go into bank account.

Transfer funds from bank account to your account and your partner's personal accounts.

Keeps the accounting very clean, the money trail very clean, and very cheap. I did just this once for a consulting gig I had many years ago, with a similar situation.

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  • What does it cost to form a LLC in the US? From context I would guess the OP doesn't know either. Me, I'm interested to know because where I live, the cheapest limited liability corporation that you can form needs around US$ 20'000 of capital (i.e. at the time when you form the corporation, you need to move that amount of capital into the corporation, be that actual money, or other assets - the corporation can then immediately spend or sell that capital, but the point is that personal you needs to give it to the corporation, presumably to make it harder to commit fraud using the corporation). – Nobody Sep 3 '20 at 10:47
  • @nobody your state is weird, or the legal advice you have received is rubbish. Most other places all the state wants is the filing fee and registered agent. – Harper - Reinstate Monica Sep 3 '20 at 14:31
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    @Harper Nobody might be talking about a country in Europe, like Switzerland: businesssetup.com/ch/… – DavWEB Sep 3 '20 at 15:19
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    @Nobody I live in the US and formed an LLC around 10 years ago with a partner. It cost us around $250 (~$100 for the filing fee and $150 to a lawyer who was our friend). Nowadays, I'm seeing online that it will cost you more like $350 to form an LLC in my state. – DanK Sep 3 '20 at 15:59
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    Note that in California, forming a LLC can be done entirely online, costs $100 to file, and for a basic single-member entity, a lawyer is not really necessary. However — and this is very important — California LLCs are required to pay a franchise tax which is a minimum of $800 per year. (See FTB1060.) For someone making $400/month, an LLC might be overkill. – josh3736 Sep 3 '20 at 21:03
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Since you are receiving 100% of the income all you need to do is spend / pay your partner for consulting expenses. 50% as an expense to your partner as professional services for their work. You'll need to file 1099-NEC (Non Employee Compensation) form with the IRS. Once to account for the expense you do not pay taxes on your expenses they are ALL tax-deductible.

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  • interesting. What is the difference between a 1099-NEC and a 1099-MISC (suggested by the accepted answer)? – Clueless Investor Sep 3 '20 at 0:26
  • @CluelessInvestor: 1099-NEC is new for 2020 up; in prior years non-employee comp was box 7 on 1099-MISC. Nit: only expenses that are 'ordinary and necessary' for your type of business are deductible, and for commonly-abused categories like entertainment and travel only if you have documentation meeting regulatory requirements; see Schedule C instructions and pubs 535 and 463. But labor vital to creation of your product certainly qualifies. – dave_thompson_085 Sep 3 '20 at 1:53
  • @dave_thompson_085 can I choose whether to do a 1099-NEC or MISC, or is the latter obsolete? – Clueless Investor Sep 3 '20 at 2:33
  • @Clue: for nonemployee comp -NEC is now mandatory and -MISC no longer applies. There are about a dozen other types of payments that were and still are reported on -MISC. See irs.gov/instructions/i1099msc especially the introductory section "What's New". – dave_thompson_085 Sep 3 '20 at 20:04
  • The actual answer is this simple. It is beyond comprehension that anyone would suggest partnerships, etc, for a thousand dollars of app store income. (It's truly amazing how misguided and impractical the voting is on this site sometimes!) – Fattie Sep 4 '20 at 16:55
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If you really don't want to deal with forming an LLC or doing other business-y things, then you can do math with your partner to include the taxes in your 50-50 split.

Math, let:

  • X = Amount you get paid, without taxes
  • Y = Amount your partner gets paid, without taxes
  • X = Y

Therefore:

  • total_earned = X + Y + (taxX * total_earned) + (taxY * Y)
  • total_earned - taxX * total_earned = X + X + taxY * X
  • total_earned(1 - taxX) = X(2 + taxY)
  • X = total_earned(1 - taxX) / (2 + taxY)

For example, if:

  • totalEarned = 1000
  • taxX = 25% (your tax rate)
  • taxY = 25% (your partner's tax rate)

Plug in the numbers and you get:

  • You both get paid $333.33
  • Amount you get paid, including taxes: 333.33 + 1000 * .25 = $583.33
  • Amount your partner gets paid, including taxes: 333.33 + 333.33 * .25 = $416.67

But, if you use this method, then you are double-paying taxes (333.33*.25=$83.33) on part of the income. Except, if your partner makes under the threshold for paying taxes, then you can set 'taxY = 0' and solve again. (solution would be payouts of $625 (375 + 1000*.25) and $375)

Math!

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