PayPal is not in a position to be running money for someone else's "dirty books" (which is a rather strongly negative term, but you have to realize that that is how PayPal is going to be seeing this specific pseudo-charity, and is the mental framework from which they are going to be dealing with this likely hostile person on the phone), and to the extent to which it "shouldn't concern them" (and it starts to, such as with 1099-K) it is a fair assumption that companies that are operating with "dirty books" are a "high-risk transaction" (one fraught with disputes, chargebacks, and investigations), something which PayPal simply refuses to traffic in (likely, as their entire concept of letting random people keep money and move it around is already "high-risk" enough ;P).

I don't know about you but I would never do business with a financial service provider that would essentially decide if I was running "dirty books" by your loose definition and cut off services. The problem is here you have a major problem:

1) You can't prove bad bookkeeping practices without an audit and

2) I am not consenting to an audit if that removes me from 4th Amendment search protections (meaning the auditor can be compelled by the government to turn over info without a warrant, when they'd normally be required to get a warrant to search my business).

No bank I do business with is going to just decide "oh you might not be collecting sales tax, so we are suspending your account and keeping your money for six months." There's no ethical justification for that. I am sorry.

I realize that you like to look only at my statements regarding sales tax, but these people were literally selling the promise of shipping an undisclosed good and a sweaty wad of cash to a random third party for an arbitrarily large sum of "donated" money as an unlicensed charity.

Remember: this money they were using for these purposes is actually /not/ their money, nor is it PayPal's: you don't really own money transferred over credit or ACH for six months, which is the window of time during which the money can be nearly unilaterally taken back.

This is a high risk transaction class, and if they had a normal merchant account they would have been required to do all kinds of paperwork verification, accept super-high fees, and pay massive retainers, and in the end likely have a hold enforced on their money anyway until they were considered a good credit risk (and we really are talking "credit risk" here: PayPal is loaning people money until such point as it clears).

Claiming that PayPal should not be looking into these things is about as silly as claiming that you shouldn't be denied a post-pay phone contract just because you don't ever pay your electric bill: this company is exactly as much of a risk (in dollars) to PayPal as PayPal is to this company.

Then don't use PayPal. Pay to process credit cards. As stated elsewhere, PayPal's business model is to provide point-to-point transactions between people, betting that they can prevent enough fraud to remain profitable. If what you're doing is unusual enough that you trigger their warning bells, then you're not worth the risk to them.

Paypal's fraud detection routines have been extremely, extremely overinclusive. They are worth using for some unimportant stuff but you don't have to be doing anything unusual to trigger a warning (I was just selling IT services), so they aren't worth betting your business on.