Apparently prostitutes report their income on a 1040 Schedule C, just like I have since I started freelance writing five years ago. Thanks to the Fifth Amendment, they're allowed to avoid incriminating themselves by being vague about what their actual business is — Slate's Brian Palmer says they could write something like "sale of leisure services." But they do have to enter a code for their business — ACORN apparently suggested 711510 ("independent artists, writers, and performers"), which is the same code I use.
Unlike a prostitute, I don't have to worry about balancing the penalty for being caught doing my job against the penalty for reporting income from it (in most states, says Palmer, punishments for tax evasion are stiffer). Nor do I need to know about laws that prevent police from using tax returns as the initial tip in a criminal investigation. But I do have some advice for anyone filing a schedule C — don't report a loss more than two years in a row. The recession may be hitting prostitutes just as hard as it's hitting writers, but if you lose money for a third year, the IRS could determine that having sex is your hobby, not your job — and then your expenses aren't deductible.
If you're a john, though, you could try writing off the money you pay prostitutes as a health expense. A tax attorney recently tried to deduct $100,000 in prosecution and porn expenses as "sex therapy." Unfortunately for him, he lost.
How Do Prostitutes Pay Their Taxes? [Slate]
Tax Court Writes Off Lawyer's Deduction For Prostitutes [Legal Blog Watch]