UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C. 20549
                                   FORM 10-KSB
(Mark  One)

[X]  ANNUAL REPORT  UNDER  SECTION  13  or  15(d) OF THE SECURITIES EXCHANGE ACT
     OF  1934  FOR  THE  FISCAL  YEAR  ENDED  DECEMBER  31,  2005.

[ ]  TRANSITION REPORT  UNDER  SECTION  13  or  15(d) OF THE SECURITIES EXCHANGE
     ACT  OF  1934  FOR  THE  TRANSITION  PERIOD  FROM  ______  TO ________

                          COMMISSION FILE NO. 000-30152

                           PAYMENT DATA SYSTEMS, INC.
                 (Name of small business issuer in its charter)

             NEVADA                                               98-0190072
(State or other jurisdiction of                               (I.R.S. Employer
 incorporation or organization)                              Identification No.)

              12500 SAN PEDRO, STE. 120, SAN ANTONIO, TX     78216
             (Address of principal executive offices)     (Zip Code)

         Issuer's telephone number, including area code: (210) 249-4100

Securities registered under Section 12(b) of the Exchange Act:        NONE.

Securities registered under Section 12(g) of the Exchange Act:    COMMON STOCK,
                                                                    PAR VALUE
                                                                   $0.001 PER
                                                                     SHARE.
                                                                (Title of class)

Check  whether the issuer is not required to file reports pursuant to Section 13
or  15(d)  of  the  Exchange  Act.  [ ]

Check  whether  the issuer (1) filed all reports required to be filed by Section
13  or  15(d) of the Exchange Act during the past twelve months (or such shorter
period  that the registrant was required to file such reports), and (2) has been
subject  to such filing requirements for the past 90 days. Yes [X]  No [ ]

Check  if there is no disclosure of delinquent filers in response to Item 405 of
Regulation  S-B  contained in this form, and no disclosure will be contained, to
the  best  of  registrant's  knowledge,  in  definitive  proxy  or  information
statements  incorporated  by  reference  in  Part III of this Form 10-KSB or any
amendment  to  this  Form  10-KSB.  [ ]

Indicate  by check mark whether the registrant is a shell company (as defined in
Rule  12b-2  of  the  Exchange  Act).  Yes [ ]    No [X]

State  issuer's  revenues  for  its  most  recent  fiscal  year:  $1,180,753.

State the aggregate market value of the voting and non-voting common equity held
by  non-affiliates computed by reference to the price at which the common equity
was  last  sold, or the average bid and asked price of such common equity, as of
March  10,  2006:  $5,124,221.

State  the  number  of shares outstanding of each of the registrant's classes of
common  stock  as  of  March  10,  2006:  39,417,088  common  shares.

Documents  incorporated by reference: Portions of the Definitive Proxy Statement
for  the  2006  Annual  Meeting  of  Stockholders

Transitional  Small  Business  Disclosure  Format  (Check  One): [ ] Yes  [X] No

                                       1
<PAGE>
<TABLE>
<CAPTION>

                           PAYMENT DATA SYSTEMS, INC.

                                   FORM 10-KSB
                      FOR THE YEAR ENDED DECEMBER 31, 2005

                                      INDEX

<S>         <C>                                                                                                          <C>
                                                                                                                         Page

                                     PART I

Item 1.     Description of Business.                                                                                        3
Item 2.     Description of Property.                                                                                        6
Item 3.     Legal Proceedings.                                                                                              7
Item 4.     Submission of Matters to a Vote of Security Holders.                                                            7

                                    PART II

Item 5.     Market for Common Equity and Related Stockholder Matters.                                                       8
Item 6.     Management's Discussion and Analysis or Plan of Operation.                                                      9
Item 7.     Financial Statements.                                                                                          16
Item 8.     Changes In and Disagreements With Accountants on Accounting and Financial Disclosure.                          31
Item 8A.    Controls and Procedures.                                                                                       31
Item 8B.    Other Information.                                                                                             31

                                    PART III

Item 9.     Directors, Executive Officers, Promoters and Control Persons; Compliance With
              Section 16 (a) of the Exchange Act.                                                                          32
Item 10.    Executive Compensation.                                                                                        32
Item 11.    Security Ownership of Certain Beneficial Owners and Management and Related Stockholder Matters.                32
Item 12.    Certain Relationships and Related Transactions.                                                                32
Item 13.    Exhibits.                                                                                                      32
Item 14.    Principal Accountant Fees and Services.                                                                        33

</TABLE>

                     FACTORS THAT MAY AFFECT FUTURE RESULTS


This  Annual  Report  on  Form  10-KSB  and the documents incorporated herein by
reference  contain  certain forward-looking statements within the meaning of the
Federal  Securities  Laws. Specifically, all statements other than statements of
historical  facts  included  in  this Annual Report on Form 10-KSB regarding our
financial  performance, business strategy and plans and objectives of management
for future operations and any other future events are forward-looking statements
and  based  on  our  beliefs  and assumptions. If used in this report, the words
"anticipate," "believe," "estimate", "expect," "intend," and words or phrases of
similar  import  are  intended  to  identify  forward-looking  statements.  Such
statements  reflect  our  current  view  with  respect  to future events and are
subject to certain risks, uncertainties, and assumptions, including, but without
limitation,  those risks and uncertainties contained in the Risk Factors section
of  Item  6, Management's Discussion and Analysis, of this Annual Report on Form
10-KSB. Although we believe that our expectations are reasonable, we can give no
assurance  that  such expectations will prove to be correct. Based upon changing
conditions,  any  one  or  more of these events described herein as anticipated,
believed,  estimated,  expected  or  intended  may  not  occur.  All  prior  and
subsequent  written  and  oral  forward-looking  statements  attributable to the
Company  or  persons  acting  on  its  behalf  are  expressly qualified in their
entirety  by  this  cautionary  statement.

                                       2
<PAGE>

                                     PART I


ITEM  1.  DESCRIPTION  OF  BUSINESS.

General

Payment  Data  Systems, Inc. was founded in July 1998 and is incorporated in the
State of Nevada. Our primary operations consist of functioning as a processor of
electronic  payments  for  other  companies.  We  provide  integrated electronic
payment  processing services to merchants and businesses, including all types of
Automated  Clearinghouse  processing  and credit and debit card-based processing
services.  The  Automated Clearinghouse Network is a nationwide electronic funds
transfer  system  that  is regulated by the Federal Reserve and provides for the
clearing  of  electronic  payments between participating financial institutions.
Our  Automated  Clearinghouse processing services enable merchants or businesses
to  both  disburse  or  collect  funds electronically using e-checks to transfer
funds  instead of traditional paper checks. An e-check is an electronic debit to
a bank checking account that is initiated at the point-of-sale, on the Internet,
over  the telephone or via a bill payment sent through the mail and is processed
using  the  Automated  Clearinghouse network. Our card-based processing services
enable  merchants  to  process  both  traditional  card-present,  or  "swipe,"
transactions,  as  well  as  card-not-present  transactions.  A  traditional
card-present  transaction  occurs  whenever  a  cardholder physically presents a
credit  or  debit  card  to  a merchant at the point-of-sale. A card-not-present
transaction  occurs  whenever the customer does not physically present a payment
card  at  the  point-of-sale  and  may  occur  over  the  Internet, mail, fax or
telephone.  Our  electronic  payment  processing  may take place in a variety of
forms and situations. For example, our capabilities allow merchants to convert a
paper  check  to  an e-check or receive card authorization at the point-of-sale,
have  their  customer service representatives take e-check or card payments from
their consumers by telephone, and enable their consumers to make e-check or card
payments  directly  through  the  use of a web site or by calling an Interactive
Voice  Response  telephone  system. We also operate an online payment processing
service  for  consumers  under  the  domain  name  www.billx.com,  formerly
www.bills.com,  through  which  consumers  can  pay  anyone.

We  generate  revenues by charging fees for the electronic processing of payment
transactions  and  related  services.  We  charge  certain  merchants  for these
processing services at a bundled rate based on a percentage of the dollar amount
of each transaction and, in some instances, additional fees are charged for each
transaction.  We charge other merchant customers a flat fee per transaction, and
may also charge miscellaneous fees to our customers, including fees for returns,
monthly minimums, and other miscellaneous services. We charge consumers that use
our billx.com online payment service a flat monthly fee that allows them to make
a  certain  number  of  payments  in  a month. We also charge these consumers an
additional fee for each payment that exceeds the allowed number of payments in a
given  month.  We  operate  solely  in  the  United States as a single operating
segment.

Industry  Background

The  use  of non-paper based forms of payment by consumers in the United States,
such  as  credit  and  debit cards, has steadily increased over the past several
years.  According  to  the  2004  Federal  Reserve Payments Study, the number of
electronic payment transactions totaled 44.5 billion in 2003 while the number of
checks  paid  totaled  36.7  billion. This marked the first time that electronic
payment  transactions  in  the  U.S.  exceeded check payments. If current growth
rates  are  sustained,  payments  made by credit cards and debit cards will each
exceed  the number of paid checks by 2010. The growth of electronic commerce has
made  the  acceptance  of  card-based  and  other  electronic forms of payment a
necessity  for businesses, both large and small, in order to remain competitive.

We  believe  that  the  electronic  payment processing industry will continue to
benefit  from  the  following  trends:

Favorable  Demographics

As  consumers  age,  we  expect  that  they  will  continue  to  use the payment
technology  to which they have grown accustomed. More consumers are beginning to
use  card-based and other electronic payment methods for purchases at an earlier
age.  According  to  the  Federal  Reserve  Survey  of  Consumer  Finances,  the
percentage  of  households  with consumers under the age of 30 years using debit
cards  increased  from  24.5%  in  1995  to 60.6% in 2001. As consumers who have
witnessed  the  wide  adoption  of  card  products, technology, and the Internet
comprise  a greater percentage of the population and increasingly enter the work
force,  we  expect that purchases using electronic payment methods will comprise
an  increasing  percentage of total consumer spending. Because of the Internet's
increasing  adoption  rate,  businesses  have  a  growing opportunity to conduct
commerce  with  their  consumers  and  business  partners  over  the  Internet.

Increased  Electronic  Payment  Acceptance  by  Small  Businesses

Small  businesses  are a vital component of the U.S. economy and are expected to
contribute  to the increased use of electronic payment methods. According to the
U.S.  Small  Business Administration, small businesses generate more than 50% of
the nonfarm private gross domestic product in the United States. The lower costs
associated  with  electronic  payment  methods  are  making  these services more
affordable  to  a  larger  segment of the small business market. In addition, we
believe  these  businesses  are  experiencing  increased  pressure  to  accept
electronic  payment  methods in order to remain competitive and to meet consumer
expectations. As a result, many of these small businesses are seeking to provide
customers  with the ability to pay for merchandise and services using electronic
payment  methods,  including those in industries that have historically accepted
cash and checks as the only forms of payment for their merchandise and services.

                                       3
<PAGE>

Growth  in  Online  Transactions

Market  researchers  expect dramatic growth in card-not-present transactions due
to  the  rapid  growth of the Internet and electronic commerce. According to the
U.S.  Census  Bureau,  retail  e-commerce  sales for 2005 were $86.3 billion, an
increase of 25% from $69.2 billion in 2004. The prevalence of the Internet makes
having  an  online presence a basic consideration for those operating a business
today.  To  remain  competitive,  many  companies  are  seeking  to leverage the
Internet  to  provide operational efficiencies, create new revenue opportunities
and  maximize  the  longevity and profitability of their customer relationships.

Products  and  Services

Our  service  offerings  are  supported  by  our  systems  infrastructure  that
integrates  certain proprietary components with processing systems outsourced to
third  party  providers  to  offer  our  customers a flexible and secure payment
process.  We  utilize a secure sockets layer so that connections and information
are  secure  from  outside  inspection.  We  also use 128-bit encryption for all
electronic  transactions  that  we  process to make information unreadable as it
passes  over the Internet. Our systems infrastructure allows us to work with our
customers  to build a customized electronic payment service offering tailored to
their  specific  needs.  We have designed and implemented our integrated payment
systems  to  function  as  gateways  between  our  customers and our third party
processing  providers.  Our  systems  provide  for interfaces with our customers
through  which  payment  data is captured electronically and transferred through
the  connections we have with our processing providers. Our systems also provide
a  data  warehousing  capability so that all of a customer's payment data can be
stored  in  one  place  to  facilitate efficient data retrieval and analysis. We
outsource  our  Automated  Clearinghouse  transaction  processing and card-based
transaction  processing  to  third  party  providers.  Our card-based processing
system  is  capable of connecting with all of the major card-based processors in
the  United  States.

The  components  of  our  service  offering  include  all  forms  of  Automated
Clearinghouse  transaction  processing,  such  as Re-presented Check, which is a
consumer  non-sufficient  funds  check  that  is  re-presented  for  payment
electronically  rather  than  through  the  paper  check  collection system, and
Accounts  Receivable  Check  Conversion, which is a consumer paper check payment
that  is  converted  into  an  e-check.  Our  customers  can  initiate Automated
Clearinghouse  transactions directly using an online terminal accessible through
a  web  site  or  we  can initiate Automated Clearinghouse transactions on their
behalf.  Our  service  offering  also includes merchant account services for the
processing  of card-based transactions through the VISA and MasterCard networks,
including  online  terminal  services  accessed  through  a  web  site or retail
services  accessed  via  a  physical  terminal. We offer a proprietary web-based
customer service application that combines both Automated Clearinghouse and card
processing  capabilities  and allows companies to process one-time and recurring
payments  via  e-checks  or  credit  cards at the request of their consumers. In
addition,  we  offer an Interactive Voice Response telephone system to companies
that  accept  payments directly from consumers over the telephone using e-checks
or  credit  cards.

In addition to these acquiring services, we are also aggressively developing and
marketing  prepaid  gift  cards  and  personal spending debit cards. In December
2005,  we signed an agreement with MetaPayments Systems, a division of MetaBank,
a federally chartered bank, to be our issuing bank for select prepaid debit card
programs  running  on  the various card associations and debit networks. We also
entered  into  an  agreement in February 2006 with Symmetrex, Inc. to provide us
with backend card processing services for our debit card processing platform. We
are  working  with  MetaPayments  to  develop a series of competitive celebrity,
gift,  and  personal spending card programs. We have already announced our first
celebrity  card  program,  which will involve Carmen Electra, and we also have a
private  labeled  ATM  card  program  currently  in  development.

We  also  operate a consumer web site focused on providing bill payment services
under  the  domain  name  www.billx.com  and  manage all of the related back-end
processing through our own proprietary processing engine. Consumers subscribe to
the  payment  service  and are allowed to make a certain number of payments each
month  for a flat monthly fee and are assessed a separate fee for any additional
payments  made  over  the  limit. Our online payment processing service seeks to
provide consumers with an efficient and secure interface for paying and managing
bills  via  the  Internet. We also sell this payment portal service as a private
label  solution to online financial services providers looking to provide online
bill  payment  capabilities  as  part of their service offering to consumers. We
also  offer  this service to other debit card issuers, as we are able to utilize
the  bill payment component of this service for payments made via debit cards, a
process  for  which  we  have  applied  for  a  patent.

                                       4
<PAGE>

Relationships  with  Sponsors  and  Processors

We  have agreements with several processors to provide to us, on a non-exclusive
basis,  transaction  processing  and  transmittal, transaction authorization and
data capture, and access to various reporting tools. In order to provide payment
processing services for Automated Clearinghouse transactions, we must maintain a
relationship  with  an  Originating  Depository  Financial  Institution  in  the
Automated  Clearinghouse  Network  because  we  are not a bank and therefore not
eligible  to be an Originating Depository Financial Institution. The third party
provider  that  handles  our  Automated  Clearinghouse  processing  maintains  a
relationship  with  several Originating Depository Financial Institutions on our
behalf.  Similarly, in order to provide payment processing services for Visa and
MasterCard transactions, we must be sponsored by a financial institution that is
a  principal  member  of  the  Visa and MasterCard card associations. We have an
agreement with TriSource Solutions, LLC through which their member bank sponsors
us  for membership in the Visa and MasterCard card associations and settles card
transactions  for  our  merchants.  This  agreement  may  be  terminated  by the
processor  if  we  materially breach the agreement and we do not cure the breach
within  30  days,  or  if  we  enter  bankruptcy  or  file  for  bankruptcy.

Under  our  processing  agreement  with  TriSource Solutions, we are financially
liable  for  all  fees,  chargebacks  and  losses related to our card processing
merchant  customers.  If,  due  to  insolvency  or  bankruptcy  of  our merchant
customers,  or  for  another  reason, we are unable to collect from them amounts
that  have  been  refunded  to  the cardholders because the cardholders properly
initiated  a  chargeback transaction to reverse the credit card charges, we must
bear  the  credit  risk  for  the  full amount of the cardholder transaction. We
utilize a number of systems and procedures to evaluate and manage merchant risk,
such  as  obtaining  approval  of  prospective  merchants from our processor and
sponsor bank, setting transaction limits and monitoring account activity. We may
also  require cash deposits and other types of collateral from certain merchants
to  mitigate any such risk. We maintain a reserve for losses resulting from card
processing  and  related  chargebacks.  We  estimate  our  potential  loss  for
chargebacks  by  performing  a  historical  analysis  of  our  chargeback  loss
experience  with  similar  merchants  and  considering  other factors that could
affect  that  experience  in  the future, such as the types of card transactions
processed  and  nature  of  the  merchant  relationship  with  their  consumers.

We also maintain a separate allowance for doubtful accounts for estimated losses
resulting  from  the  inability  or  failure  of  our merchant customers to make
required  payments  for  fees  charged  by us. Amounts due from customers may be
deemed  uncollectible  because  of  merchant  disputes,  fraud,  insolvency  or
bankruptcy.  We  determine  the  allowance  for  doubtful  accounts  based on an
account-by-account  review, taking into consideration such factors as the age of
the  outstanding  receivable,  historical  pattern  of collections and financial
condition  of  the  customer. We closely monitor extensions of credit and if the
financial  condition  of  our  customers  were  to  deteriorate, resulting in an
impairment  of their ability to make contractual payments, additional allowances
may  be  required.

Sales  and  Marketing

We market and sell our products and services through direct contact by our sales
personnel,  as  well  as through non-exclusive resellers that act as an external
sales  force,  with  minimal  direct  investment  in  sales  infrastructure  and
management.  Our  direct  sales  effort  is coordinated by a sales executive and
supported  by  other  employees  who  function  in sales capacities. Our primary
market  focus  is  on  companies  generating  high volumes of electronic payment
transactions. We tailor our sales efforts to reach this market by pre-qualifying
prospective  sales  leads  through  direct contact or market research. Our sales
personnel typically initiate contact with prospective customers that we identify
as  meeting  our  target  profile. We also plan to market and sell our celebrity
card programs, such as the Carmen Electra card, directly to consumers, primarily
through  the  Internet.  We  will  continue  to  analyze our sales and marketing
efforts  in  order  to  control  costs,  increase the effectiveness of our sales
force,  and  broaden  our  reach  through  reseller initiatives and advantageous
alliances.

Customers

Nearly  all  of  our customers are consumers geographically dispersed throughout
the  United  States  utilizing  our billx.com Internet bill payment service on a
recurring monthly basis to pay household bills. The service relationship between
our  billx.com customers and us is not contractual and the fee we charge for the
service is not negotiable. We seek to retain customers by providing high service
levels.  Customers  are  also more likely than not to continue using the service
once  activated  due  to their investment of time in setting up the service with
their  personal  banking  and payment information. The monthly average number of
billx.com  customers using our online payment service increased to 2,419 in 2005
from  2,190  in  2004.

Our  other  customers  are  merchants  and  businesses  that  use  our Automated
Clearinghouse  and/or  card-based  processing services in order to provide their
consumers  with  the ability to pay for goods and services without having to use
cash  or  a paper check. These merchant customers operate in a variety of retail
industries  and  are under contract with us to exclusively use the services that
we  provide  to  them.  Most  of  our  merchant  customers have signed long-term
contracts,  with  generally  three-year  terms,  that  provide  for volume-based
transaction  fees.  We  provided  services  to  119 and 51 merchant customers at
December 31, 2005 and 2004, respectively. Services provided to Lexicon Marketing
and  NII Communications accounted for approximately 33% and 7%, respectively, of
our  total  consolidated revenues for the year ended December 31, 2005. Services
provided  to  Credit  Payment Services, Inc. accounted for approximately 11% and
13% of our total consolidated revenues for the years ended December 31, 2005 and
2004,  respectively.  Revenue  generated  by  our merchant customers represented
approximately  86%  of  our  total  revenues  in  2005  and we believe that this
percentage  will  increase  as  we  anticipate adding new merchant customers and
experiencing  growth in transaction volumes as a result. We believe our merchant
business  provides  us  with  the  best  opportunity for revenue growth and will
continue  to  comprise  the  majority  of  our  business  in  the  future.

                                       5
<PAGE>

Competition

The  payment  processing  industry  is  highly competitive. Many small and large
companies  compete  with us in providing payment processing services and related
services  to  a wide range of merchants. There are a number of large transaction
processors,  including  First  Data  Merchant Services Corporation, Concord EFS,
Inc.,  National  Processing, Inc., and Global Payments, Inc., that serve a broad
market  spectrum  from  large  to small merchants and provide banking, automatic
teller  machine,  and  other payment-related services and systems in addition to
card-based  payment  processing.  There  are  also  a  large  number  of smaller
transaction  processors  that provide various services to small and medium-sized
merchants.  Many of our competitors have substantially greater capital resources
than  us  and  operate  as  subsidiaries of financial or bank holding companies,
which  may  allow them on a consolidated basis to own and conduct depository and
other  banking activities that we do not have the regulatory authority to own or
conduct.  We  believe  that  the  principal  competitive  factors  in our market
include:

o     quality  of  service;
o     reliability  of  service;
o     ability  to  evaluate,  undertake  and  manage  risk;
o     speed  in  implementing  payment  processes;
o     price  and  other  financial  terms;  and
o     multi-channel  payment  capability.

We  believe  that  our specific focus on providing integrated payment processing
solutions  to merchants, in addition to our understanding of the needs and risks
associated with providing payment processing services electronically, gives us a
competitive  advantage  over  other  competitors,  which  have a narrower market
perspective, and over competitors of a similar or smaller size that may lack our
experience  in  the  electronic  payments  industry.  Furthermore, we believe we
present  a competitive distinction through the use of our internal technology to
provide  a  single  integrated  payment  storage or warehouse that consolidates,
processes,  tracks  and  reports  all  payments  regardless of payment source or
channel.

Trademarks

We  own  federally registered trademarks on the marks Payment Data Systems, Inc.
and  Payment  Data  Systems,  Inc.  and design. We have also secured domain name
registrations  for  billx.com,  billxpress.com,  billhelp.com,
paymentdatasystems.com,  paymentdata.org  and  paymentdata.com.  We  rely  on  a
combination  of  copyright,  trademark and trade secret laws, employee and third
party  nondisclosure  agreements,  and  other  intellectual  property protection
methods  to  protect  our  services  and  related  products.

Patent

We  have  filed the final application for patent protection from the U.S. Patent
Office  for  the  technology  that will enable the industry's first bill payment
capability using a debit card. The debit card technology for which we have filed
for patent protection allows a cardholder to use their stored-value debit or ATM
card  to  pay  local,  national, or international bills with the card from their
electronic  balance.  Because  it  does  not  require  linkage  to a traditional
checking  or  savings  account,  this  new debit technology is unique in that it
allows  for  use  by  "unbanked"  consumers.

EMPLOYEES

As  of  December  31,  2005,  we  had  8  employees.  We  are not a party to any
collective  bargaining  agreements.  We  believe  that  our  relations  with our
employees  are  good.

ITEM  2.  DESCRIPTION  OF  PROPERTY.

As  of  December  31,  2005,  our  headquarters  and  operations  were housed in
approximately 4,500 square feet of leased office space in San Antonio, Texas. We
recently  extended  the term of our office lease, which calls for annual rent of
$81,126  through  October  2009.  We  believe  our  existing  facilities will be
adequate  to  meet  our  anticipated  needs  for  the  foreseeable  future.

                                       6
<PAGE>

ITEM  3.  LEGAL  PROCEEDINGS.

Beginning  in December 2000, we pledged as loan guarantees certain funds held as
money market funds and certificates of deposit to collateralize margin loans for
the  following  executive  officers:  (1)  Michael R. Long, then Chairman of the
Board  of  Directors  and  Chief  Executive  Officer;  (2)  Louis  A. Hoch, then
President  and Chief Operating Officer; (3) Marshall N. Millard, then Secretary,
Senior  Vice  President,  and  General  Counsel;  and  (4)  David S. Jones, then
Executive Vice President. Mr. Millard and Mr. Jones are no longer our employees.
The margin loans were obtained in March 1999 from institutional lenders and were
secured by shares of our common stock owned by these officers. The pledged funds
were held in our name in accounts with the lenders that held the margin loans of
the officers. Our purpose in collateralizing the margin loans was to prevent the
sale  of our common stock owned by these officers while we were pursuing efforts
to  raise additional capital through private equity placements. The sale of that
common  stock  could have hindered our ability to raise capital in such a manner
and  compromised  our  continuing  efforts  to  secure additional financing. The
highest  total amount of funds pledged for the margin loans guaranteed by us was
approximately  $2.0 million. The total balance of the margin loans guaranteed by
us  was  approximately  $1.3 million at December 31, 2002. At the time the funds
were  pledged,  we  believed  we would have access to them because (a) our stock
price  was  substantial  and  the  stock pledged by the officers, if liquidated,
would  produce funds in excess of the loans payable, and (b) with respect to one
of  the  institutional lenders (who was also assisting us as a financial advisor
at the time), even if the stock price fell, we had received assurances from that
institutional  lender  that the pledged funds would be made available as needed.
During the fourth quarter of 2002, we requested partial release of the funds for
operating purposes, which request was denied by an institutional lender. At that
time,  our  stock  price  had  fallen  as  well,  and  it became clear that both
institutional  lenders  would  not  release the pledged funds. In light of these
circumstances,  we  recognized  a  loss  on  the guarantees of $1,278,138 in the
fourth  quarter of 2002 and recorded a corresponding payable under related party
guarantees  on our balance sheet at December 31, 2002 because it became probable
at  that  point that we would be unable to recover our pledged funds. During the
quarter  ended  March 31, 2003, the lenders applied the pledged funds to satisfy
the  outstanding  balances  of  the loans. The total balance of the margin loans
guaranteed  by  us was zero at December 31, 2005. We may institute litigation or
arbitration  in collection of the outstanding repayment obligations of Mr. Long,
Mr.  Hoch,  Mr.  Millard,  and  Mr.  Jones,  which  currently  total $1,278,138.
Presently,  we have refrained from initiating action to recover these funds from
Mr. Long, Mr. Hoch, and Mr. Millard because they may have offsetting claims that
total $1,445,500 collectively by virtue of the change of control clause in their
respective  employment  agreements  based  on  our  preliminary  analysis.  We
understand  that  these  individuals may assert such claims based on our sale of
substantially all of our assets to Harbor Payments, Inc. on July 25, 2003. While
Mr.  Long  and  Mr.  Hoch  agreed,  in  connection with such sale, to forego any
affirmative  recovery  of  their  compensation by virtue of a change of control,
they have maintained the right to claim an offset of that amount in the event we
seek  recovery of the loan balances. We have not initiated any formal settlement
negotiations  with  these  individuals  because they have been under an extended
employment contract with us or have not been amenable to such an action. We have
not  pursued the outstanding repayment obligation of Mr. Jones because we do not
consider  a  recovery  attempt  to  be  cost  beneficial.  In order to attempt a
recovery from Mr. Jones, we estimate that we would incur a minimum of $20,000 in
estimated  legal costs with no reasonable assurance of success in recovering his
outstanding  obligation  of approximately $38,000. Because of the limited amount
of  the  obligation,  we  also  anticipate  difficulty in retaining counsel on a
contingency  basis to pursue collection of this obligation. The ultimate outcome
of  this  matter  cannot  presently  be  determined.

On  July  25,  2003,  certain of our stockholders (those stockholders being Mike
Procacci,  Jr.,  Mark and Stefanie McMahon, Anthony and Lois Tedeschi, Donna and
James  Knoll, John E. Hamilton, III, William T. Hagan, Samuel A. Fruscione, Dana
Fruscione-Penzone,  Gia  Fruscione,  Alicia  Fruscione, Joseph Fruscione, Robert
Evans,  John Arangio, Gary and JoAnne Gardner, Lee and Margaret Getson, G. Harry
Bonham,  Jr.,  Gary Brewer, Bob Lastowski, Robert Filipe, Mitchell D. Hovendick,
Dr.  John  Diephold,  Joseph  Maressa, Jr., and Charles Brennan) commenced legal
action  against  us,  Ernst  & Young, LLP, and certain of our current and former
directors  (including  the executive officers named above) in the District Court
of  the  45th Judicial District, Bexar County, Texas. With respect to us and the
current  and former directors named in the suit, the plaintiffs alleged that we,
acting  through  such  directors,  misstated in our 2000 and 2001 Form 10-Ks our
ability to use for operational purposes the funds pledged as security for margin
loans  of  certain of our executive officers, as discussed above. The plaintiffs
alleged  and  sought  resulting  economic  and  exemplary  damages,  rescission,
interest,  attorneys'  fees  and  court  costs.

On  November  9,  2005,  we  entered  into  a  settlement agreement with all the
plaintiffs  named in the suit. Under the terms of the settlement, the plaintiffs
dismissed  the  pending  litigation,  with  prejudice,  and  released all claims
against  us,  our  current  and  former  officers  and directors, and our former
auditors,  Ernst  &  Young,  LLP.  Additionally,  we reset the exercise price of
1,912,400  warrants  to  purchase  our  common stock held by the plaintiffs from
$1.80 per share to a new exercise price of $0.20 per share. We also extended the
expiration date of the warrants from November 27, 2006, to November 27, 2007. We
recorded a non-cash expense of $151,309 in the third quarter of 2005 as a result
of  the  modification of the warrant terms. We are not paying any other economic
consideration  to fund this settlement. On balance, we believe the terms of this
settlement  to  be  fair  and  equitable  to our shareholders and us. We will no
longer  incur significant expenses associated with defense of the litigation and
the uncertainly inherent in any litigation is now resolved at a reasonable cost.

ITEM  4.  SUBMISSION  OF  MATTERS  TO  A  VOTE  OF  SECURITY  HOLDERS.

There  were no matters submitted to a vote of our stockholders during the fourth
quarter  of  fiscal  year  2005.

                                       7
<PAGE>
                                     PART II


ITEM  5.  MARKET  FOR  COMMON  EQUITY  AND  RELATED  STOCKHOLDER  MATTERS.

MARKET  INFORMATION

Our  common  stock  was traded on the National Association of Securities Dealers
Over  the Counter Bulletin Board through March 13, 2000 at which time our common
stock was approved for trading on the NASDAQ Small Cap Market. Subsequently, our
stock  was  approved  for trading on the NASDAQ National Market on July 31, 2000
under  the symbol BLLS. On February 4, 2003, the NASDAQ National Market delisted
our  common stock because we did not meet the requirements for continued listing
on  the  NASDAQ National Market. Our common shares were immediately eligible for
quotation  on  the  Over  the  Counter  Bulletin  Board  effective at opening of
business  on February 4, 2003. Our common stock began trading under a new ticker
symbol,  PYDS,  on  the  Over  the  Counter  Bulletin  Board on August 20, 2003.

The  following table sets forth for the quarterly periods indicated the range of
high  and  low  closing  prices  of our common stock as reported on the Over the
Counter  Bulletin  Board:

<TABLE>
<CAPTION>

<S>             <C>    <C>
                High   Low
                -----  -----
    2005
--------------
First Quarter   $0.34  $0.20
Second Quarter  $0.25  $0.19
Third Quarter   $0.22  $0.15
Fourth Quarter  $0.15  $0.08

    2004
--------------
First Quarter   $0.46  $0.15
Second Quarter  $0.43  $0.21
Third Quarter   $0.26  $0.16
Fourth Quarter  $0.34  $0.21
</TABLE>

HOLDERS

As  of  March  10,  2006,  39,417,088  shares of our common stock are issued and
outstanding.  As  of March 10, 2006, there were approximately 4,473 stockholders
of  record  of  our  common  stock.

DIVIDENDS

We  have never declared or paid cash or stock dividends and have no plans to pay
any such dividends in the foreseeable future, instead, we intend to reinvest our
earnings,  if  any.

SECURITIES  AUTHORIZED  FOR  ISSUANCE  UNDER  EQUITY  COMPENSATION  PLANS

The following table provides information as of December 31, 2005 with respect to
compensation  plans (including individual compensation arrangements) under which
equity  securities  of  the  registrant  are  authorized  for  issuance:

<TABLE>
<CAPTION>

<S>                            <C>                         <C>               <C>
                                                           Weighted-average   Number of securities
                               Number of securities to be   exercise price   remaining available for
                                 issued upon exercise of    of outstanding    future issuance under
                                   outstanding options          options         compensation plan
                               --------------------------  ----------------  -----------------------
Employee Comprehensive Stock
Plan approved by stockholders          4,658,167                $ 0.50               1,353,959

Non-Employee Director
Plan approved by stockholders            858,003                $ 1.20               1,160,000
</TABLE>

UNREGISTERED  SALES  OF  EQUITY  SECURITIES

During the quarter ended December 31, 2005, we sold 160,000 shares of our common
stock  to  Dutchess  Private  Equities  Fund, LP pursuant  to  an equity line of
credit  and  received  total  proceeds,  net  of  issuance  costs,  of  $21,367.

                                       8
<PAGE>

ITEM  6.  MANAGEMENT'S  DISCUSSION  AND  ANALYSIS  OR  PLAN  OF  OPERATION.

The  following  discussion  and  analysis should be read in conjunction with the
Consolidated  Financial  Statements  and  Notes  thereto,  and  other  financial
information  included  elsewhere  in  this  Form  10-KSB.  This  report contains
forward-looking  statements that involve risks and uncertainties. Actual results
in  future periods may differ materially from those expressed or implied in such
forward-looking  statements  as  a result of a number of factors, including, but
not  limited  to,  the  risks  discussed  under  the  heading "Risk Factors" and
elsewhere  in  this  Form  10-KSB.

OVERVIEW

We  provide  integrated  electronic payment services, including credit and debit
card-based  processing  services  and  transaction  processing via the Automated
Clearinghouse  Network,  and  continue to operate an Internet electronic payment
processing  service  for  consumers  under  the domain name www.billx.com. Since
inception,  we  have  incurred operating losses each quarter, and as of December
31,  2005,  we  have  an  accumulated deficit of $49.4 million. OUR PROSPECTS TO
CONTINUE  AS  A GOING CONCERN MUST BE CONSIDERED IN LIGHT OF THE RISKS, EXPENSES
AND  DIFFICULTIES  FREQUENTLY  ENCOUNTERED BY COMPANIES IN THEIR EARLY STAGES OF
GROWTH,  PARTICULARLY  COMPANIES  IN  NEW  AND  RAPIDLY EVOLVING MARKETS SUCH AS
ELECTRONIC COMMERCE. Such risks include, but are not limited to, an evolving and
unpredictable  business model and our ability to continue as a going concern. To
address these risks, we must, among other things, grow and maintain our customer
base,  implement  a  successful  marketing  strategy,  continue  to maintain and
upgrade  our  technology  and  transaction-processing  systems, provide superior
customer  service,  respond  to  competitive  developments,  attract, retain and
motivate  qualified  personnel,  and respond to unforeseen industry developments
and other factors. We cannot assure you that we will be successful in addressing
such risks, and the failure to do so could have a material adverse effect on our
business,  prospects,  financial  condition  and  results  of  operations.

We  believe  that  our  success  will depend in large part on our ability to (a)
manage our operating expenses, (b) add quality customers to our client base, (c)
meet evolving customer requirements and (d) adapt to technological changes in an
emerging  market.  Accordingly,  we  intend  to  focus  on  customer acquisition
activities  and  outsource  some  of our processing services to third parties to
allow  us  to  maintain  an  efficient  operating  infrastructure and expand our
operations  without  significantly  increasing  our  fixed  operating  expenses.

As  a  result  of  our  limited operating history and the emerging nature of the
markets  in  which we compete, we are unable to precisely forecast our revenues.
Our  current and future expense levels are based largely on our investment plans
and  estimates  of future revenues. Revenue and operating results will depend on
the  volume of payment transactions processed and related services rendered. The
timing of such services and transactions and our ability to fulfill a customer's
demands are difficult to forecast. Although we systematically budget for planned
outlays  and  maintain  tight  controls on our expenditures, we may be unable to
adjust  spending  in  a  timely  manner to compensate for any unexpected revenue
shortfall. Accordingly, any significant shortfall in revenues in relation to our
planned  expenditures  could  have  a  material  adverse effect on our business,
prospects,  financial  condition and results of operations. Further, we may make
certain  pricing,  service, marketing or acquisition decisions that could have a
material  adverse  effect  on  each  or  all  of  these  areas.

CRITICAL  ACCOUNTING  POLICIES

General

Management's  discussion  and analysis of its financial condition and results of
operations  is based upon our consolidated financial statements, which have been
prepared  in  accordance with U.S. generally accepted accounting principles. The
preparation  of  these  financial  statements  requires us to make estimates and
judgments  that  affect the reported amounts of assets, liabilities, revenue and
expenses,  and  related  disclosure  of contingent assets and liabilities. On an
on-going  basis,  we  evaluate  our  estimates,  including  those related to the
reported  amounts  of  revenues  and expenses, bad debt, investments, intangible
assets, income taxes, and contingencies and litigation. We base our estimates on
historical  experience  and  on  various other assumptions that we believe to be
reasonable  under  the  circumstances,  the  results of which form the basis for
making  judgments  about  the carrying values of assets and liabilities that are
not  readily apparent from other sources. Actual results could differ from these
estimates  under  different  assumptions  or  conditions.

Reserve  for  Losses  on  Card  Processing

If,  due  to insolvency or bankruptcy of the merchant, or for another reason, we
are not able to collect amounts from our card processing merchant customers that
have  been  properly  "charged back" by the cardholders, we must bear the credit
risk  for  the  full  amount  of the cardholder transaction. We may require cash
deposits  and  other  types of collateral from certain merchants to minimize any
such  risk. In addition, we utilize a number of systems and procedures to manage
merchant  risk.  Card merchant processing loss reserves are primarily determined
by  performing  a  historical  analysis  of  our  chargeback loss experience and
considering  other factors that could affect that experience in the future. This
reserve  amount  is  subject  to risk that actual losses may be greater than our
estimates.  At  December  31,  2005, the balance of our card merchant processing
loss  reserve  was  $33,552.

                                        9
<PAGE>

Bad  Debts

We  maintain  an  allowance for doubtful accounts for estimated losses resulting
from  the  inability  or  failure of our customers to make required payments. We
charged  bad  debt  expense  of $10,000 and recorded bad debt write-offs of $936
against  our  allowance for doubtful accounts in 2005. We did not charge any bad
debt  expense or bad debt write-offs in 2004. At December 31, 2005 and 2004, the
balance  of  the  allowance  for  doubtful  accounts  was  $12,219  and  $3,155,
respectively.  If  the financial condition of our customers were to deteriorate,
resulting  in  an  impairment  of  their  ability  to make contractual payments,
additional  allowances  may  be  required.

Valuation  of  Long-Lived  and  Intangible  Assets

We  assess the impairment of long-lived and intangible assets at least annually,
and whenever events or changes in circumstances indicate that the carrying value
may  not  be  recoverable.  Factors considered important, which could trigger an
impairment  review, include the following: significant underperformance relative
to  historical or projected future cash flows; significant changes in the manner
of  use  of  the assets or the strategy of the overall business; and significant
negative  industry  trends.  When  we  determine  that  the  carrying  value  of
long-lived  and  intangible assets may not be recoverable, we measure impairment
as  the  excess  of the assets' carrying value over the estimated fair value. No
impairment  losses  were  recorded  in  2005  or  2004.

Income  Taxes

Deferred tax assets and liabilities are recorded based on the difference between
the  tax bases of assets and liabilities and their carrying amount for financial
reporting  purposes,  as measured by the enacted tax rates and laws that will be
in  effect when the differences are expected to reverse. Deferred tax assets are
computed  with  the  presumption  that they will be realizable in future periods
when  pre-taxable  income  is generated. Predicting the ability to realize these
assets  in  future  periods  requires  a great deal of judgment by us. It is our
judgment  that we cannot predict with reasonable certainty that the deferred tax
assets  as  of  December  31,  2005  will  be  fully realized in future periods.
Accordingly,  a valuation allowance has been provided to reduce the net deferred
tax  assets  to  $0.  At December 31, 2005, we have available net operating loss
carryforwards of approximately $37.0 million, which expire beginning in the year
2020.

RESULTS  OF  OPERATIONS

Our  revenues  are  principally  derived  from  providing  integrated electronic
payment  services  to  merchants  and  businesses,  including  credit  and debit
card-based  processing  services  and  transaction  processing via the Automated
Clearinghouse  Network. We also operate an online payment processing service for
consumers under the domain name www.billx.com. Total revenues for 2005 increased
230%  to $1,180,753 from $357,566 for 2004. The increase from the prior year was
primarily  attributable  to  the  increase in revenues generated from card-based
processing services due to increased transaction volume. Revenues also increased
form  the  prior  year  due  to  an  increase in the average number of consumers
subscribing  to  the  billx.com  payment  service. The monthly average number of
consumers using our online payment service increased to 2,419 in 2005 from 2,190
in  2004.  The  number  of  transactions generated by billx.com customers is not
indicative  of revenue growth because the majority of these customers pay a flat
monthly  fee to process up to a certain number of payments each month and do not
exceed the maximum number of payments allowed. We transitioned to processing the
online  payments ourselves during the third quarter of 2005, and are now able to
market  the  service  as  a  private-label application to prospective resellers.

We  expect  our  revenues  to  increase as we anticipate continued growth in the
volume of card transactions and additional merchant customers. Revenue generated
by  our  merchant  customers represented approximately 86% of our total revenues
for  the  year  ended  December  31,  2005,  and we believe this percentage will
increase  as we anticipate adding new merchant customers and experiencing growth
in transaction volumes as a result. We believe our merchant business provides us
with  the  best  opportunity  for  revenue  growth  and revenues from card-based
processing  services  will  continue  to  grow  in  future  periods.

Cost  of  services  includes the cost of personnel dedicated to the creation and
maintenance  of  connections  to third party payment processors and fees paid to
such  third  party providers for electronic payment processing services. Through
our  contractual  relationships  with  our  payment  processors,  we are able to
process  Automated Clearinghouse and debit or credit card transactions on behalf
of  our  customers  and  their consumers. We pay volume-based fees for debit and
credit  transactions  initiated through these processors, and pay fees for other
transactions  such  as  returns,  notices  of  change  to bank accounts and file
transmission.  Cost  of  services was $1,038,346 and $327,474 for 2005 and 2004,
respectively.  The increase from the prior year is due primarily to the increase
in  fees  related  to  processing  the  increased card-based transaction volume.

Selling,  general  and  administrative  expenses increased to $1,696,015 in 2005
from  $1,374,779 for 2004. The increase from the prior year was primarily due to
non-cash  deferred  compensation  expense  of  $140,193  recorded in 2005 and an
increase  of  approximately  $94,000  in  legal  fees.

                                       10
<PAGE>

Depreciation  and  amortization  was  $86,374  and  $95,190  for  2005 and 2004,
respectively.  The  decrease  from  the prior year was due to lower depreciation
expense  related to certain assets that became fully depreciated during 2005. We
purchased  $107,000  of  computer  equipment and software during 2005 and do not
anticipate  making  significant  capital  expenditures  in  2006.

Net  other  income was $444,292 in 2005 compared to net other expense of $74,654
in  2004.  The  change  from 2004 to 2005 is primarily attributable to a gain of
$911,350  on  the  sale  of  our  bills.com  domain name and trademark to Alivio
Holdings,  LLC in December 2005. We retained our existing customer base that had
been  using bills.com for online payment processing services and transitioned it
to  a  new  domain  name,  www.billx.com,  and  continue  to offer such services
directly  to  consumers  as  well  as  through  resellers,  including  Alivio.

Net  loss improved to $1,195,690 in 2005 from $1,514,531 in 2004, as a result of
the  items  discussed  above.

LIQUIDITY  AND  CAPITAL  RESOURCES

At  December 31, 2005, we had $378,098 of cash and cash equivalents, compared to
$153,966  of  cash  and  cash equivalents at December 31, 2004. We have incurred
substantial  losses  since  inception and believe our current available cash and
cash equivalents along with anticipated revenues may be insufficient to meet our
anticipated  cash needs for the foreseeable future. CONSEQUENTLY, OUR ABILITY TO
CONTINUE  AS  A GOING CONCERN MAY BE CONTINGENT ON US RECEIVING ADDITIONAL FUNDS
IN  THE FORM OF EQUITY OR DEBT FINANCING. We are currently aggressively pursuing
strategic  alternatives.

In  February  2004,  we  executed an agreement for an equity line of credit with
Dutchess  Private  Equities  Fund,  LP. Under the terms of the agreement, we may
elect  to receive as much as $10 million from Dutchess in common stock purchases
over  three  years  at our option. We filed a registration statement registering
the  resale  of  the  shares of our common stock to be issued to Dutchess, which
became  effective  on  August 13, 2004. During the years ended December 31, 2005
and  2004,  we  sold  3,179,844  and  1,459,435  shares  of  its  common  stock,
respectively, pursuant to the equity line of credit and received total proceeds,
net  of  issuance  costs,  of  $597,162  and  $321,485,  respectively.

On August 24, 2004, we entered into a promissory note with Dutchess. Pursuant to
terms  of the promissory note, we received $260,000 and promised to pay Dutchess
$284,000  with a maturity date of December 24, 2004. We repaid this note in full
on the maturity date. We also issued 75,000 shares of restricted common stock to
Dutchess  as  an  incentive for the investment and agreed to register the common
stock  issued pursuant to the promissory note on the next registration statement
that  we  file.

On  December  10,  2004,  we entered into another promissory note with Dutchess.
Pursuant  to  terms of the promissory note, we received $260,000 and promised to
pay  Dutchess  $284,000  with  a maturity date of April 10, 2005. We also issued
75,000  shares  of  restricted  common stock to Dutchess as an incentive for the
investment  and  agreed  to  register  the  common  stock issued pursuant to the
promissory  note  on  the  next  registration  statement  that  we  file.

On  May  12, 2005, we entered into another promissory with Dutchess. Pursuant to
terms  of the promissory note, we received $600,000 and promised to pay Dutchess
$720,000  with  a  maturity  date  of  December 22, 2005. We also issued 500,000
shares of restricted common stock to Dutchess as an incentive for the investment
and  agreed  to register the common stock issued pursuant to the promissory note
on  the  next  registration  statement  that  we  file. We used a portion of the
proceeds  from  this note to repay the balance of the note due April 10, 2005 to
Dutchess  in full, including a penalty of $5,116 for late payment. We repaid the
note  due  December  22,  2005  to  Dutchess  in  full  on  the  maturity  date.

Net  cash  used  in  operating activities was $891,786 and $940,859 for 2005 and
2004,  respectively.  Net  cash  used  in  operating  activities  was  primarily
attributable  to  operating  net losses generated by growth stage activities and
overhead  costs.  We  plan  to  continue  focusing  on  expending  our resources
prudently  given  our  current  state  of  liquidity.

Net  cash  provided  by investing activities was $849,986 for 2005 and primarily
reflected  proceeds  of  $950,000  from the sale of our bills.com domain name in
December  2005 partially offset by $106,910 of capital expenditures for computer
hardware  and  software. Net cash provided by investing activities was $2,095 in
2004 and reflected the return of $6,693 of deposits that had been used to secure
the  lease for our corporate office offset by capital expenditures of $4,598 for
computer equipment. We do not anticipate making significant capital expenditures
during  2006.

Net  cash  provided  by  financing  activities  of  $265,932  for  2005 resulted
primarily from proceeds, net of issuance costs, of $689,932 from the issuance of
common stock offset by $404,000 of net repayments of borrowings under short-term
promissory notes. Net cash provided by financing activities of $564,611 for 2004
resulted  primarily  from  proceeds, net of issuance costs, of $328,611 from the
issuance  of common stock as well as $236,000 of net borrowings under short-term
notes.

The  satisfactory  completion of an additional investment or growth of cash flow
from  operations  is essential as we have no other alternative that will provide
sufficient  cash  flows  to  meet  current  operating  requirements. The sale of
additional  equity  or  convertible  debt  securities would result in additional
dilution  to  our  stockholders,  and  debt financing, if available, may involve
restrictive  covenants which could restrict operations or finances. There can be
no  assurance that financing will be available in amounts or on terms acceptable
to us, if at all. If we cannot raise funds or achieve positive cash flow, we may
not  be  able  to continue to exist, conduct operations, grow market share, take
advantage  of  future  opportunities  or  respond  to  competitive  pressures or
unanticipated  requirements,  any of which would negatively impact our business,
operating  results  and  financial  condition.

                                       11
<PAGE>

OFF-BALANCE  SHEET  ARRANGEMENTS

We  currently have no off-balance sheet arrangements that have or are reasonably
likely  to  have a current or future material effect on our financial condition,
changes  in  financial  condition,  revenues or expenses, results of operations,
liquidity,  capital  expenditures  or  capital  resources.

RISK  FACTORS

There  are  many  factors  that  affect  our  business  and  the  results of its
operations, some of which are beyond our control. The following is a description
of  some  of  the  important  factors  that  may cause the actual results of our
operations  in future periods to differ materially from those currently expected
or  desired.

                          RISKS RELATED TO OUR BUSINESS

Our independent accountants have issued a going concern opinion and if we cannot
obtain  additional  financing,  we  may  have  to  curtail  operations  and  may
ultimately  cease  to  exist.

Our  independent  accountants  have  issued  a  going  concern  opinion.  Due to
continuing  operating  losses,  our  current available cash and cash equivalents
along  with  anticipated  revenues  are  likely  to  be insufficient to meet our
anticipated  cash  needs  for  the  near  future.  Consequently,  our ability to
continue  as  a  going  concern  is likely contingent on us receiving additional
funds  in  the  form  of equity or debt financing. We currently plan to meet our
capital  requirements primarily through the issuance of equity securities or new
borrowing  arrangements.  Accordingly,  we  are  aggressively pursuing strategic
alternatives.  However,  financing  may  not be available in amounts or on terms
acceptable  to  us,  if  at all. If we cannot raise funds on acceptable terms or
achieve  positive  cash  flow,  we  may  be  forced to curtail operations or may
ultimately  cease  to  exist.

We have generated significant losses and expect to generate operating losses for
the  foreseeable  future,  therefore  we  may  not  become  profitable.

We  organized  in  1998  and  began  operations  as  a public company in 1999 by
offering  electronic  billing services to other companies. After the sale of our
primary  business  in July 2003, we have concentrated on building our electronic
payments services operations. We have not been profitable since inception and we
may  never  become  profitable. As of December 31, 2005, our accumulated deficit
was  $49.4  million.

If  our  security  applications  are  not  sufficient to address changing market
conditions  and  customer  concerns,  we  may  not be able to sell our services.

Our  use  of  applications  designed  for premium data security and integrity to
process electronic transactions may not be sufficient to address changing market
conditions  or  the  security  and  privacy  concerns  of existing and potential
customers.  Adverse  publicity  raising  concerns about the safety or privacy of
electronic  transactions,  or  widely  reported  breaches  of  our  or  another
provider's  security, have the potential to undermine consumer confidence in the
technology  and  could  have  a  materially  adverse  effect  on  our  business.

If  we  do  not  adapt  to  rapid  technological  change, our business may fail.

Our  success  depends  on  our ability to develop new and enhanced services, and
related products that meet changing customer needs. The market for our services,
however,  is  characterized  by  rapidly  changing technology, evolving industry
standards,  emerging competition and frequent new and enhanced software, service
and  related  product introductions. In addition, the software market is subject
to  rapid  and  substantial  technological change. To remain successful, we must
respond  to new developments in hardware and semiconductor technology, operating
systems,  programming  technology  and computer capabilities. In many instances,
new  and enhanced services, products and technologies are in the emerging stages
of  development  and  marketing,  and  are  subject to the risks inherent in the
development  and  marketing  of  new software, services and products. We may not
successfully  identify  new service opportunities, and develop and bring new and
enhanced  services and related products to market in a timely manner. Even if we
do  bring such services, products or technologies to market, they may not become
commercially  successful.  Additionally,  services,  products  or  technologies
developed  by others may render our services and related products noncompetitive
or  obsolete.  If  we are unable, for technological or other reasons, to develop
and  introduce  new  services  and  products  in  a timely manner in response to
changing  market  conditions  or  customer  requirements, our business may fail.

                                       12
<PAGE>

We  rely on our relationship with the Automated Clearinghouse Network and if the
Federal  Reserve rules were to change, our business could be adversely affected.

We  have a contractual relationship with a third party provider, which maintains
a  relationship  with  multiple Originating Depository Financial Institutions in
the  Automated  Clearinghouse  Network. The Automated Clearinghouse Network is a
nationwide batch-oriented electronic funds transfer system that provides for the
interbank  clearing  of  electronic  payments  for  participating  financial
institutions. An Originating Depository Financial Institution is a participating
financial  institution  that  must  abide  by  the  provisions  of the Automated
Clearinghouse Operating Rules and Guidelines. Through our relationship with this
third  party  provider, we are able to process payment transactions on behalf of
our  customers  and  their  consumers  by  submitting  payment instructions in a
prescribed Automated Clearinghouse format. We pay volume-based fees to the third
party  provider  for debit and credit transactions processed each month, and pay
fees  for  other  transactions  such  as  returns  and notices of change to bank
accounts.  These  fees  are  part  of our cost structure. If the Federal Reserve
rules were to change to introduce restrictions or modify access to the Automated
Clearinghouse,  our  business  could  be  materially  adversely  affected.

If our third party card processing providers or our bank sponsors fail to comply
with  the  applicable  requirements  of  Visa  and  MasterCard  credit  card
associations,  we  may have to find a new third party processing provider, which
could  increase  our  costs.

Substantially  all  of  the  card-based  transactions we process involve Visa or
MasterCard. If our third party processing provider, TriSource Solutions, LLC, or
our  bank  sponsor,  DuTrac  Community  Credit  Union,  fail  to comply with the
applicable  requirements  of  the  Visa and MasterCard credit card associations,
Visa  or  MasterCard  could  suspend  or terminate their registration. Also, our
contract with these third parties is subject to cancellation upon limited notice
by  either  party.  The  cancellation  of  our  contract,  termination  of their
registration  or  any  changes in the Visa or MasterCard rules that would impair
their  registration  could  require us to stop providing such payment processing
services  if  we  are  unable  to  obtain another provider or sponsor at similar
costs.  Additionally,  changing  our  bank  sponsor  could  adversely affect our
relationship  with our merchants if the new sponsor provides inferior service or
charges  higher  costs.

We  depend  on Michael R. Long and Louis A. Hoch and if these officers ceased to
be  active  in  our  management,  our  business  may  not  be  successful.

Our  success depends to a significant degree upon the continued contributions of
our  key  management,  marketing,  service  and  related product development and
operational personnel, including our Chairman, Chief Executive Officer and Chief
Financial  Officer,  Michael  R.  Long  and  our  President  and Chief Operating
Officer,  Louis A. Hoch. We had employment agreements with Mr. Long and Mr. Hoch
that  expired  in  July  2004  and  prohibited them from competing with us for a
period  of  two  years  upon termination of their employment. We intend to enter
into  similar  new  employment agreements with both of these individuals and are
currently  negotiating  the  terms  of  such agreements. Our business may not be
successful  if,  for any reason, either of these officers ceased to be active in
our  management.

If our software fails, and we need to repair or replace it, or we become subject
to  warranty  claims,  our  costs  could  increase.

Our software products could contain errors or "bugs" that could adversely affect
the  performance  of  services  or damage a user's data. We attempt to limit our
potential  liability  for  warranty  claims  through  technical  audits  and
limitation-of-liability  provisions  in  our customer agreements. However, these
measures  may  not  be effective in limiting our exposure to warranty claims. We
have  not  experienced  a  significant  increase  in software errors or warranty
claims.  Despite  the  existence  of  various security precautions, our computer
infrastructure  may also be vulnerable to viruses or similar disruptive problems
caused  by  our  customers  or  third  parties  gaining access to our processing
system. If our software fails, and we need to replace or repair it, or we become
subject  to  warranty  claims,  our  costs  could  increase.

Our  business strategy includes identifying new businesses to acquire, and if we
cannot  integrate  acquisitions into our company successfully, we may not become
profitable.

Our  success  partially  depends  upon  our  ability  to  identify  and  acquire
undervalued  businesses  within our industry. Although we believe that there are
companies  available  for  potential  acquisition that are undervalued and might
offer  attractive  business  opportunities,  we  may  not  be  able  to make any
acquisitions,  and  if we do make acquisitions, they may not be profitable. As a
result,  our  business  may  not  grow  and  we  may  not  achieve  or  sustain
profitability.

If  we  do  not  manage our growth, we may not achieve or sustain profitability.

We may experience a period of rapid growth that could place a significant strain
on  our  resources.  In order to manage our growth successfully, we will have to
continue to improve our operational, management and financial systems and expand
our  work force. A significant increase in our customer base may necessitate the
hiring of a significant number of additional personnel, qualified candidates for
which,  at  the  time needed, may be in short supply. In addition, the expansion
and  adaptation  of  our computer and administrative infrastructure will require
substantial operational, management and financial resources. Although we believe
that  our  current infrastructure is adequate to meet the needs of our customers
in  the  foreseeable  future,  we  may  not  be  able  to  expand  and adapt our
infrastructure  to  meet  additional demand on a timely basis, at a commercially
reasonable  cost,  or  at  all.  If  our  management  is unable to manage growth
effectively, hire needed personnel, expand and adapt our computer infrastructure
and  improve our operational, management, and financial systems and controls, we
may  not  attain  or  sustain  profitability.

                                       13
<PAGE>

If  we  do  not manage our credit risks related to our merchant accounts, we may
incur  significant  losses.

We  rely  on the Federal Reserve's Automated Clearinghouse system for electronic
fund  transfers  and  the  Visa  and  MasterCard  associations for settlement of
payments by credit or debit card on behalf of our merchant customers. In our use
of  these  established  payment  clearance systems, we generally bear the credit
risks  arising  from  returned  transactions  caused by insufficient funds, stop
payment  orders,  closed  accounts, frozen accounts, unauthorized use, disputes,
customer charge backs theft or fraud. Consequently, we assume the credit risk of
merchant  disputes,  fraud,  insolvency or bankruptcy in the event we attempt to
recover  funds  related  to  such  transactions  from our customers. We have not
experienced  a  significant  increase  in  the  rate of returned transactions or
incurred  any  losses  with respect to such transactions. We utilize a number of
systems  and  procedures  to manage and limit credit risks, but if these actions
are  not  successful  in  managing  such risks, we may incur significant losses.

                          RISKS RELATED TO OUR INDUSTRY

The electronic commerce market is relatively new and if it does not grow, we may
not  be  able  to  sell  sufficient  services  to  make  our  business  viable.

The electronic commerce market is a relatively new and growing service industry.
If  the  electronic  commerce  market  fails  to  grow  or  grows  slower  than
anticipated,  or  if  we,  despite  an  investment of significant resources, are
unable  to adapt to meet changing customer requirements or technological changes
in this emerging market, or if our services and related products do not maintain
a  proportionate  degree  of acceptance in this growing market, our business may
not grow and could even fail. Additionally, the security and privacy concerns of
existing  and  potential  customers  may  inhibit  the  growth of the electronic
commerce  market  in general, and our customer base and revenues, in particular.
Similar  to  the  emergence  of  the  credit  card  and automatic teller machine
industries,  we  and  other organizations serving the electronic commerce market
must  educate  users  that electronic transactions use encryption technology and
other electronic security measures that make electronic transactions more secure
than  paper-based  transactions.

Changes  in  regulation  of  electronic  commerce and related financial services
industries  could  increase  our  costs  and  limit  our business opportunities.

We  believe  that  we  are  not  required  to  be  licensed by the Office of the
Comptroller  of  the  Currency,  the  Federal Reserve Board, or other federal or
state  agencies  that  regulate  or monitor banks or other types of providers of
electronic commerce services. It is possible that a federal or state agency will
attempt  to  regulate  providers  of  electronic  commerce services, which could
impede  our  ability  to  do  business  in  the regulator's jurisdiction. We are
subject  to  various  laws  and regulations relating to commercial transactions,
such  as the Uniform Commercial Code, and may be subject to the electronic funds
transfer  rules  embodied  in  Regulation  E, promulgated by the Federal Reserve
Board.  Given  the  expansion  of  the  electronic  commerce market, the Federal
Reserve  Board might revise Regulation E or adopt new rules for electronic funds
transfer  affecting  users  other  than  consumers.  Because  of  growth  in the
electronic  commerce  market,  Congress has held hearings on whether to regulate
providers  of services and transactions in the electronic commerce market. It is
possible  that  Congress  or  individual  states could enact laws regulating the
electronic  commerce  market. If enacted, such laws, rules and regulations could
be  imposed  on  our business and industry and could increase our costs or limit
our  business  opportunities.

If  we  cannot  compete successfully in our industry, we could lose market share
and  our  costs  could  increase.

Portions  of  the  electronic  commerce  market  are  becoming  increasingly
competitive.  We  expect  to  face  growing  competition  in  all  areas  of the
electronic payment processing market. New companies could emerge and compete for
merchants  of all sizes. We expect competition to increase from both established
and  emerging  companies  and  that  such  increased competition could lower our
market  share  and  increase  our  costs.  Moreover,  our  current and potential
competitors, many of whom have greater financial, technical, marketing and other
resources  than  us,  may  respond  more  quickly  than  us  to  new or emerging
technologies or could expand to compete directly against us in any or all of our
target  markets.  Accordingly,  it  is  possible  that  current  or  potential
competitors  could  rapidly  acquire market share. We may not be able to compete
against  current  or  future competitors successfully. Additionally, competitive
pressures  may  increase  our  costs,  which  could  lower our earnings, if any.

                                       14
<PAGE>

                        RISKS RELATED TO OUR COMMON STOCK

Our  stock  price  is  volatile and you may not be able to sell your shares at a
price  higher  than  what  you  paid.

The  market  for our common stock is highly volatile. In 2005, our closing stock
price  fluctuated between $0.08 and $0.34. The trading price of our common stock
could  be  subject  to  wide  fluctuations  in  response to, among other things,
quarterly  variations  in  operating  and  financial  results,  announcements of
technological  innovations  or new products by our competitors or us, changes in
prices  of  our products and services or our competitors' products and services,
changes  in  product  mix,  or  changes in our revenue and revenue growth rates.

Existing  stockholders  may  experience  significant  dilution  from the sale of
securities  pursuant  to our investment agreement with Dutchess Private Equities
Fund.

The  sale  of  shares pursuant to our Investment Agreement with Dutchess Private
Equities  Fund  may have a dilutive impact on our stockholders. As a result, our
net  income  per  share could decrease in future periods and the market price of
our common stock could decline. In addition, the lower our stock price is at the
time  we  exercise  our  put  option,  the  more shares we will have to issue to
Dutchess  Private  Equities  Fund  to  draw  down  on  the full equity line with
Dutchess  Private Equities Fund. If our stock price decreases, then our existing
stockholders  would experience greater dilution. As of December 31, 2005, we had
issued  4,639,279  shares to Dutchess under our Investment Agreement. At a stock
price  of  $0.25 or less, we would have to issue all of the remaining 35,360,721
shares  currently  registered  in  order  to  draw down on the full equity line.

Dutchess  Private  Equities  Fund  will pay less than the then-prevailing market
price  of  our  common stock, which could cause the price of our common stock to
decline.

Our common stock to be issued under our agreement with Dutchess Private Equities
Fund  will  be  purchased  at a 5% discount to the lowest closing best bid price
during  the  five  days  immediately  following  our  notice to Dutchess Private
Equities  Fund  of  our  election  to  exercise  our put right. Dutchess Private
Equities  Fund  has  a  financial incentive to sell our common stock immediately
upon receiving the shares to realize the profit between the discounted price and
the  market price. If Dutchess Private Equities Fund sells our shares, the price
of  our  stock  could  decrease.  If our stock price decreases, Dutchess Private
Equities  Fund  may  have  a  further incentive to sell the shares of our common
stock  that  it  holds.  The  discounted sales under our agreement with Dutchess
Private  Equities  Fund  could  cause  the price of our common stock to decline.

We  must comply with penny stock regulations that could effect the liquidity and
price  of  our  stock.

The  SEC  has  adopted rules that regulate broker-dealer practices in connection
with  transactions  in  "penny  stocks."  Penny  stocks  generally  are  equity
securities  with a price of less than $5.00, other than securities registered on
certain national securities exchanges or quoted on NASDAQ, provided that current
price  and volume information with respect to transactions in such securities is
provided  by  the exchange or system. Prior to a transaction in a penny stock, a
broker-dealer  is  required  to:

-  deliver  a  standardized  risk  disclosure  document  prepared  by  the  SEC;
-  provide  the  customer  with  current  bid and offer quotations for the penny
   stock;
-  explain  the  compensation  of  the  broker-dealer and its salesperson in the
   transaction;
-  provide  monthly  account  statements  showing the market value of each penny
   stock  held  in  the  customer's  account;
-  make  a  special  written  determination  that  the penny stock is a suitable
   investment  for  the  purchaser  and  receive  the  purchaser's  executed
   acknowledgement  of  the  same;  and
-  provide  a  written  agreement  to  the  transaction.

These requirements may have the effect of reducing the level of trading activity
in  the  secondary  market  for our stock. Because our shares are subject to the
penny  stock  rules,  you  may  find  it  more  difficult  to  sell your shares.

We  have  adopted  certain  measures that may make it more difficult for a third
party  to  acquire  control  of  our  company.

Our  Board  of  Directors  is classified into three classes of directors serving
staggered  three-year  terms.  Such  classification  of  the  Board of Directors
expands  the  time required to change the composition of a majority of directors
and  may  tend  to  discourage  a  proxy  contest  or other takeover bid for our
company.  We have also instituted a shareholders rights plan that serves to help
prevent  a  hostile  takeover  of  our  company.

                                       15
<PAGE>

<TABLE>
<CAPTION>



ITEM 7. FINANCIAL STATEMENTS.


INDEX TO CONSOLIDATED FINANCIAL STATEMENTS

<S>                                                                                            <C>
Report of Independent Registered Public Accounting Firm                                        17

Consolidated Balance Sheets as of December 31, 2005 and 2004                                   18

Consolidated Statements of Operations for the years ended
  December 31, 2005 and 2004                                                                   19

Consolidated Statement of Changes in Stockholders' Equity (Deficit) for the years ended
  December 31, 2005 and 2004                                                                   20

Consolidated Statements of Cash Flows for the years ended
  December 31, 2005 and 2004                                                                   21

Notes to Consolidated Financial Statements                                                     22
</TABLE>

                                       16
<PAGE>

             REPORT OF INDEPENDENT REGISTERED PUBLIC ACCOUNTING FIRM


The  Board  of  Directors  and  Stockholders
Payment  Data  Systems,  Inc.  and  Subsidiaries
San  Antonio,  Texas

We  have  audited  the  accompanying consolidated balance sheets of Payment Data
Systems, Inc. and Subsidiaries (collectively referred to as "the Company") as of
December  31,  2005  and  2004,  and  the  related  consolidated  statements  of
operations,  changes  in  stockholders' equity and cash flows for the years then
ended.  These  financial  statements  are  the  responsibility  of the Company's
management.  Our  responsibility  is  to  express  an opinion on these financial
statements  based  on  our  audits.

We  conducted  our audits in accordance with the standards of the Public Company
Accounting Oversight Board (United States). Those standards require that we plan
and perform the audit to obtain reasonable assurance about whether the financial
statements  are free of material misstatement. An audit includes examining, on a
test  basis,  evidence  supporting  the amounts and disclosures in the financial
statements.  An audit also includes assessing the accounting principles used and
significant  estimates  made  by  management,  as well as evaluating the overall
financial  statement  presentation.  We  believe  that  our  audits  provide  a
reasonable  basis  for  our  opinion.

In  our  opinion,  the financial statements referred to above present fairly, in
all  material  respects,  the  consolidated financial position of the Company at
December 31, 2005 and 2004, and the consolidated results of their operations and
cash  flows for the years then ended, in conformity with U.S. generally accepted
accounting  principles.

The  accompanying  financial  statements  of  Payment  Data  Systems,  Inc.  and
Subsidiaries  have  been  prepared  assuming that the Company will continue as a
going  concern.  As  more  fully  described  in Note 1, the Company has incurred
substantial  losses  since inception, which has led to a significant decrease in
its  cash  position  and  a  deficit  in working capital. These conditions raise
substantial  doubt  about  the Company's ability to continue as a going concern.
The  financial  statements of Payment Data Systems, Inc. and Subsidiaries do not
include  any  adjustments  to  reflect  the  possible  future  effects  on  the
recoverability and classification of assets or the amounts and classification of
liabilities  that  may  result  from  the  outcome  of  this  uncertainty.



/s/  Akin,  Doherty,  Klein  &  Feuge,  P.C.
AKIN,  DOHERTY,  KLEIN  &  FEUGE,  P.C.
San  Antonio,  Texas

February  17,  2006,  except  for  Note  15,
  to  which  the  date  is  March  10,  2006

                                       17
<PAGE>

<TABLE>
<CAPTION>

                           PAYMENT DATA SYSTEMS, INC.
                          CONSOLIDATED BALANCE SHEETS

<S>                                                             <C>                          <C>
                                                                 December 31,                 December 31,
                                                                     2005                         2004
                                                                -------------                -------------
Assets:
Cash and cash equivalents                                       $    378,098                 $    153,966
Accounts receivable, net                                              59,558                       57,788
Prepaid expenses and other                                            51,962                       47,833
                                                                -------------                -------------
Total current assets                                                 489,618                      259,587


Property and equipment, net                                          162,600                      132,064
Other assets                                                          20,833                       23,589
                                                                -------------                -------------
Total assets                                                    $    673,051                 $    415,240
                                                                =============                =============


Liabilities and stockholders' equity (deficit):
Current liabilities:
  Accounts payable                                              $    524,520                 $    482,788
  Accrued expenses                                                   776,595                      364,953
  Deferred revenue                                                    44,038                       27,562
  Short-term borrowings                                                    -                      264,165
                                                                -------------                -------------
Total current liabilities                                          1,345,153                    1,139,468

Stockholders' equity (deficit):
Common stock, $.001 par value, 200,000,000 shares authorized;
  32,827,056 and 23,569,180 issued and outstanding                    32,827                       23,569
Additional paid-in capital                                        49,486,143                   47,417,898
Deferred compensation                                               (829,687)                           -
Accumulated deficit                                              (49,361,385)                 (48,165,695)
                                                                -------------                -------------
Total stockholders' equity (deficit)                                (672,102)                    (724,228)
                                                                -------------                -------------
Total liabilities and stockholders' equity (deficit)            $    673,051                 $    415,240
                                                                =============                =============
<FN>

See  notes  to  consolidated  financial  statements.
</TABLE>

                                       18
<PAGE>

<TABLE>
<CAPTION>
                           PAYMENT DATA SYSTEMS, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS

<S>                                             <C>             <C>
                                                  Year ended      Year ended
                                                 December 31,    December 31,
                                                     2005            2004
                                                --------------  --------------
Revenues                                        $   1,180,753   $     357,566

Operating expenses:
  Cost of services                                  1,038,346         327,474
  Selling, general and administrative               1,696,015       1,374,779
  Depreciation and amortization                        86,374          95,190
                                                --------------  --------------
Total operating expenses                            2,820,735       1,797,443
                                                --------------  --------------
Operating loss                                     (1,639,982)     (1,439,877)

Other income (expense):
  Interest income                                         950             712
  Interest expense                                   (171,330)        (46,111)
  Other income (expense)                              614,672         (29,255)
                                                --------------  --------------
Total other income (expense)                          444,292         (74,654)
                                                --------------  --------------

Loss from operations before income taxes           (1,195,690)     (1,514,531)
Income taxes                                                -               -
                                                --------------  --------------
Net loss                                        $  (1,195,690)  $  (1,514,531)
                                                ==============  ==============

Net loss per common share - basic and diluted   $       (0.04)  $       (0.07)
Weighted average common shares
 outstanding - basic and diluted                   29,254,629      21,813,979
<FN>

See  notes  to  consolidated  financial  statements.
</TABLE>

                                       19
<PAGE>

<TABLE>
<CAPTION>

                           PAYMENT DATA SYSTEMS, INC.
      CONSOLIDATED STATEMENT OF CHANGES IN STOCKHOLDERS' EQUITY (DEFICIT)

<S>                                                <C>           <C>          <C>           <C>           <C>          <C>
                                                                                                                            Total
                                                         Common Stock          Additional                              Stockholders'
                                                  --------------------------   Paid - In      Deferred     Accumulated      Equity
                                                     Shares        Amount       Capital     Compensation     Deficit      (Deficit)
                                                  ------------  ------------  ------------  ------------  ------------  ------------
Balance at December 31, 2003                       20,987,956   $    20,988   $46,842,908   $         -  $(46,651,164)  $   212,732

Issuance of common stock-equity line of credit      1,459,435         1,459       320,026             -             -       321,485
Issuance of common stock-other                      1,070,789         1,071       218,215             -             -       219,286
Exercise of stock options                              51,000            51         7,074             -             -         7,125
Issuance of common stock warrants                           -             -        29,675             -             -        29,675
Net loss for the year                                       -             -             -             -    (1,514,531)   (1,514,531)
                                                  ------------  ------------  ------------  ------------  ------------  ------------
Balance at December 31, 2004                       23,569,180        23,569    47,417,898             -   (48,165,695)     (724,228)

Issuance of common stock-equity line of credit      3,179,844         3,181       625,476             -             -       628,657
Issuance of common stock-other                      5,813,032         5,812     1,230,450             -             -     1,236,262
Exercise of stock options                              15,000            15         1,260             -             -         1,275
Exercise of stock warrants                            250,000           250        59,750             -             -        60,000
Modification of common stock warrants                       -             -       151,309             -             -       151,309
Deferred compensation                                       -             -             -      (829,687)            -      (829,687)
Net loss for the year                                       -             -             -             -    (1,195,690)   (1,195,690)
                                                  ------------  ------------  ------------  ------------  ------------  ------------
Balance at December 31, 2005                       32,827,056   $    32,827   $49,486,143   $  (829,687) $(49,361,385)  $  (672,102)
                                                  ============  ============  ============  ============  ============  ============
<FN>

See  notes  to  consolidated  financial  statements.
</TABLE>

                                       20
<PAGE>

<TABLE>
<CAPTION>
                           PAYMENT DATA SYSTEMS, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
<S>                                                 <C>           <C>
                                                        2005           2004
                                                    ------------  ------------
Operating activities:
Net loss                                            $(1,195,690)  $(1,514,531)
Adjustments to reconcile net loss
  to net cash used in operating activities:
Bad debts                                                10,000             -
Depreciation                                             86,374        87,690
Amortization                                                  -         7,500
Gain on disposition of assets                          (911,350)            -
Deferred compensation                                   147,843             -
Non-cash issuance of common stock                       484,548       215,710
Non-cash issuance of common stock warrants              151,309        29,675
Amortization of debt discount                           139,835        28,165
Changes in current assets and current liabilities:
  Accounts receivable                                   (11,770)      (14,095)
  Prepaid expenses and other                            168,731        65,817
  Accounts payable and accrued expenses                  21,908       125,648
  Deferred revenue                                       16,476        27,562
                                                    ------------  ------------
Net cash used in operating activities                  (891,786)     (940,859)

Investing activities:
Purchases of property and equipment                    (106,910)       (4,598)
Proceeds from sale of assets                            950,000             -
Long-term deposits, net                                   6,896         6,693
                                                    ------------  ------------
Net cash provided by investing activities               849,986         2,095

Financing activities:
Proceeds from notes payable                             600,000       520,000
Principal payments for notes payable                 (1,004,000)     (284,000)
Financing costs, net                                    (20,000)            -
Issuance of common stock, net of issuance costs         689,932       328,611
                                                    ------------  ------------
Net cash provided by financing activities               265,932       564,611
                                                    ------------  ------------

Change in cash and cash equivalents                     224,132      (374,153)
Cash and cash equivalents, beginning of year            153,966       528,119
                                                    ------------  ------------
Cash and cash equivalents, end of year              $   378,098   $   153,966
                                                    ============  ============

Supplemental information:
  Cash paid for interest                            $   144,000   $    24,000
  Cash paid for federal income taxes                          -             -

<FN>

See  notes  to  consolidated  financial  statements.
</TABLE>

                                       21
<PAGE>

                          PAYMENT  DATA  SYSTEMS,  INC.
                   NOTES TO CONSOLIDATED FINANCIAL STATEMENTS
                           DECEMBER 31, 2005 AND 2004


NOTE  1.  DESCRIPTION OF BUSINESS AND SUMMARY OF SIGNIFICANT ACCOUNTING POLICIES

Going  Concern

The  Company has incurred substantial losses since inception, which has led to a
significant  decrease in its cash position and a deficit in working capital. The
Company  believes its current available cash along with anticipated revenues may
be  insufficient  to meet its anticipated cash needs for the foreseeable future.
Accordingly,  the  Company  is  currently  aggressively  pursuing  strategic
alternatives,  including  investment in the Company via an equity line of credit
(See  Note  2).  The  satisfactory completion of an additional investment in the
Company  or  growth of cash flow from operations is essential as the Company has
no  other  alternative  that  will  provide  sufficient  funds  to  meet current
operating  requirements.  The  sale  of  additional  equity  or convertible debt
securities  would  result  in additional dilution to the Company's stockholders,
and  debt financing, if available, may involve restrictive covenants which could
restrict  operations  or finances. There can be no assurance that financing will
be available in amounts or on terms acceptable to the Company, if at all. If the
Company  cannot raise funds, on acceptable terms, or achieve positive cash flow,
it  may not be able to continue to exist, conduct operations, grow market share,
take  advantage  of  future opportunities or respond to competitive pressures or
unanticipated  requirements,  any of which would negatively impact its business,
operating  results  and  financial  condition.

Description  of  Business

Payment  Data  Systems,  Inc.  and its subsidiaries (collectively referred to as
"the Company"), provide integrated electronic payment services, including credit
and  debit  card-based  processing  services  and transaction processing via the
automated  clearinghouse  ("ACH") network to billers and retailers. In addition,
the  Company  operates  an  Internet  electronic  payment processing service for
consumers  under  the  domain  name  www.billx.com.

Principles  of  Consolidation  and  Basis  of  Presentation

The  accompanying  consolidated financial statements include the accounts of the
Company and its wholly-owned subsidiaries. All significant intercompany accounts
and  transactions  have  been  eliminated  in  consolidation.

The  accompanying  financial statements have been presented assuming the Company
will  continue  as  a  going  concern.

Reclassifications

Certain prior year amounts have been reclassified to conform to the current year
presentation.

Use  of  Estimates

The  preparation  of  financial  statements  in  conformity  with U.S. generally
accepted  accounting  principles  requires  management  to  make  estimates  and
assumptions  that  affect  the  reported  amounts  of assets and liabilities and
disclosure  of  contingent  assets  and liabilities at the date of the financial
statements  and  the  reported  amounts  of  revenues  and  expenses  during the
reporting  period.  Actual  results  could  differ  from  those  estimates.

Cash  and  Cash  Equivalents

The  Company  considers all highly liquid investments purchased with an original
maturity  of  three  months  or  less  to  be  cash  equivalents.

Accounts  Receivable

Accounts  receivable  are  reported at outstanding principal net of an allowance
for  doubtful  accounts  of  $12,219  and  $3,155 at December 31, 2005 and 2004,
respectively.  The allowance for doubtful accounts is generally determined based
on  an  account-by-account  review.  Accounts  are  charged  off when collection
efforts  have  failed  and  the  account  is  deemed  uncollectible. The Company
normally  does  not  charge  interest  on  accounts  receivable.

                                       22
<PAGE>

Concentration  of  Credit  Risk

Financial instruments that potentially expose the Company to credit risk consist
of  cash  and cash equivalents, investments and accounts receivable. The Company
is  exposed  to credit risk on its cash, cash equivalents and investments in the
event  of  default  by  the  financial  institutions  or  the  issuers  of these
investments to the extent of the amounts recorded on the balance sheet in excess
of  amounts  that are insured by the FDIC. Trade receivables potentially subject
the  Company  to  concentrations  of  credit  risk.  The Company's customer base
operates  in  a  variety of industries and is geographically dispersed, however,
the relatively small number of customers increases the risk. The Company closely
monitors  extensions  of  credit and credit losses have been provided for in the
consolidated  financial  statements  and  have  been  within  management's
expectations.  The Company recorded bad debt expense of $10,000 and recorded bad
debt  write-offs  of $936 to its allowance for doubtful accounts in 2005. No bad
debt  expense  or  bad debt write-offs were recorded in 2004. For the year ended
December 31, 2005, 51% of total revenues were from sales to three customers. For
the  year  ended  December  31, 2004, 13% of total revenues were from sales to a
single  customer.

Fair  Value  of  Financial  Instruments

Cash  and  cash  equivalents,  accounts  receivable,  accounts  payable, accrued
liabilities  and  short-term  borrowings  are  reflected  in  the  accompanying
consolidated financial statements at cost, which approximates fair value because
of  the  short-term  maturity  of  these  instruments.

Property  and  Equipment

Property  and  equipment  are  stated at cost. Depreciation and amortization are
computed  on  a  straight-line  method  over  the  estimated useful lives of the
related  assets,  ranging  from three to seven years. Leasehold improvements are
amortized  over  the  lesser  of  the  estimated useful lives or remaining lease
period.  Expenditures  for  maintenance  and  repairs  are charged to expense as
incurred.

Impairment  of  Long-Lived  Assets

The  Company  periodically  reviews,  on  at least an annual basis, the carrying
value  of  its  long-lived  assets,  including  property,  plant  and equipment,
whenever events or changes in circumstances indicate that the carrying value may
not  be  recoverable. To the extent fair value of a long-lived asset, determined
based  upon  the  estimated  future cash inflows attributable to the asset, less
estimated future cash outflows, are less than the carrying amount, an impairment
loss  is  recognized.

Revenue  Recognition

Revenue  consists  primarily of fees generated through the electronic processing
of  payment  transactions and related services, and are recognized as revenue in
the  period  the  transactions  are  processed  or when the related services are
performed.  Merchants  may be charged for these processing services at a bundled
rate based on a percentage of the dollar amount of each transaction and, in some
instances,  additional  fees  are charged for each transaction. Certain merchant
customers  are  charged  a  flat  fee  per transaction, while others may also be
charged  miscellaneous  fees, including fees for chargebacks or returns, monthly
minimums,  and  other  miscellaneous  services. Revenues derived from electronic
processing  of  credit  and  debit  card  transactions  that  are authorized and
captured  through  third  party  networks  are reported gross of amounts paid to
sponsor  banks  as  well  as  interchange  and  assessments  paid to credit card
associations  (MasterCard and Visa). Revenue also includes any up-front fees for
the  work  involved  in implementing the basic functionality required to provide
electronic  payment  processing  services  to  a  customer.  Revenue  from  such
implementation fees is recognized over the term of the related service contract.

Reserve  for  Losses  on  Merchant  Accounts

Disputes  between a cardholder and a merchant periodically arise as a result of,
among  other  things,  cardholder  dissatisfaction  with  merchandise quality or
merchant services. Such disputes may not be resolved in the merchant's favor. In
these  cases, the transaction is "charged back" to the merchant and the purchase
price  is  refunded  to  the customer through the merchant's acquiring bank, and
charged  to the merchant. If the merchant has inadequate funds, the Company must
bear  the  credit  risk  for  the  full  amount  of the transaction. The Company
evaluates  its  risk  for such transactions and estimates its potential loss for
chargebacks based primarily on historical experience and other relevant factors.

Advertising  Costs

The  cost of advertising is expensed as incurred. The Company incurred $4,291 in
advertising  costs  in  2005  and  did  not incur any advertising costs in 2004.

                                       23
<PAGE>

Income  Taxes

Deferred  tax  assets  and liabilities are recorded based on differences between
financial  reporting  and  tax  bases of assets and liabilities and are measured
using the enacted tax rates and laws that will be in effect when the differences
are  expected  to  reverse.

Stock-Based  Compensation

The  Company  applies  the  intrinsic  value  method  under  the recognition and
measurement  provisions  of  APB  No.  25,  "Accounting  for  Stock  Issued  to
Employees",  in  accounting  for  its  stock  option  and  stock purchase plans.
Accordingly,  no  stock-based  employee compensation expense has been recognized
for  options  granted  with  an  exercise price equal to the market value of the
underlying  common stock on the date of grant or in connection with the employee
stock  purchase  plan.  The following table illustrates the effect on net income
and  earnings  per  share  if the Company had applied the fair value recognition
provisions  of  Statement of Financial Accounting Standards No. 123, "Accounting
for Stock-Based Compensation" ("FAS 123"), to stock-based employee compensation.

<TABLE>
<CAPTION>
<S>                                                 <C>           <C>
                                                        2005          2004
                                                    ------------  ------------

Net loss, as reported                               $(1,195,690)  $(1,514,531)

Less: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effects                  (89,332)     (141,751)
                                                    ------------  ------------

Pro forma net loss                                  $(1,285,022)  $(1,656,282)
                                                    ============  ============

Net loss per common share:
Basic and diluted, as reported                      $     (0.04)  $     (0.07)

Basic and diluted, pro forma                        $     (0.04)  $     (0.08)
</TABLE>

Net  Loss  Per  Share

Basic and diluted losses per common share are calculated by dividing net loss by
the  weighted  average  number  of  common shares outstanding during the period.
Common  stock  equivalents,  which consist of stock options and warrants and the
convertible  debt,  were  excluded  from the computation of the weighted average
number of common shares outstanding for purposes of calculating diluted loss per
common  share  because  their  effect  was antidilutive. See Notes 10 and 11 for
disclosure  of  securities that could potentially dilute basic EPS in the future
that  were not included in the computation of diluted EPS because to do so would
have  been  antidilutive  for  the  periods  presented.

Recent  Accounting  Pronouncements

In  December  2004,  the  FASB issued Statement No. 123R, "Share-Based Payment,"
which  requires  all  companies to measure compensation cost for all share-based
payments  (including  employee  stock options) at fair value. We will adopt this
statement  as of January 1, 2006, and do not expect it to have a material impact
on  the  Company's  results  of  operations  or  financial  position.

NOTE  2.  ISSUANCE  OF  COMMON  STOCK

In  January  2005,  the  Company's  Chief  Executive Officer and Chief Financial
Officer;  President  and  Chief  Operating Officer, and all other employees owed
unpaid wages elected to receive common stock from the Company in lieu of a total
of  $179,000  in  accumulated  unpaid  salary.  The Company's Board of Directors
granted  a  total  of  859,743 shares of common stock in exchange for the unpaid
salaries.  All  shares  were  issued  under  the terms of the Company's Employee
Comprehensive  Stock  Plan.

On March 28, 2005, the Company's Board of Directors granted a total of 2,956,950
shares  of  common  stock  to  employees  as  a long-term incentive and recorded
$591,390  of  deferred  compensation.  The  common stock is restricted and vests
equally  over  three  years  on the anniversary date of the grant. The Company's
Board  of Directors also granted a total of 50,000 shares of unrestricted common
stock  under  the  terms  of  the Company's Employee Comprehensive Stock Plan to
certain  employees  and  recorded  $10,000  of  compensation  expense.

                                       24
<PAGE>

On  December  29,  2005,  the  Company's  Board  of Directors granted a total of
4,439,024  shares  of  common  stock  to  employees as a long-term incentive and
recorded  $364,000  of deferred compensation. The common stock is restricted and
vests  in ten years on the anniversary date of the grant. The Company's Board of
Directors also granted a total of 270,000 shares to independent contractors as a
long-term  incentive  and  recorded $22,140 of deferred compensation. The common
stock  is  restricted and vests equally over three years on the anniversary date
of  the  grant.

In February 2004, the Company executed an agreement for an equity line of credit
with  Dutchess  Private  Equities  Fund, LP ("Dutchess"). Under the terms of the
agreement, the Company may elect to receive as much as $10 million from Dutchess
in  common  stock  purchases  over  the  next  three  years at the option of the
Company. On August 11, 2004, the Company filed an amended registration statement
on  Form SB-2 with the Securities and Exchange Commission to register the resale
of the shares to be issued under the equity line of credit with Dutchess Private
Equities  Fund, LP. The Securities and Exchange Commission declared this amended
registration  statement  to  be  effective  on August 13, 2004. During the years
ended  December  31,  2005  and  2004,  the Company sold 3,179,844 and 1,459,435
shares  of its common stock, respectively, pursuant to the equity line of credit
and  received  total  proceeds, net of issuance costs, of $597,162 and $321,485,
respectively.

During the years ended December 31, 2005 and 2004, the Company issued a total of
1,146,339  and  943,564 shares of common stock, respectively, under the terms of
its  Comprehensive  Employee  Stock  Plan  to  independent contractors providing
consulting services to the Company and recorded $209,948 and $202,960 of related
expense,  respectively.  During  the  year  ended December 31, 2005, the Company
issued  300,000  shares  of common stock to an independent contractor performing
services  for  the  Company. Such shares were issued pursuant to registration on
Form  S-8  of  the  Securities and Exchange Act of 1933, as amended. The Company
recorded  $64,500  of  expense related to the issuance of this stock in 2005. In
February  2004,  the Company also issued 55,000 shares of common stock under the
terms of its Comprehensive Employee Stock Plan to a former employee for services
provided  while  employed  by  the  Company  in  2003.

In  April  2005,  the Company issued 250,000 shares of common stock and received
cash proceeds of $60,000 related to the exercise of stock warrants granted under
the terms of a warrant agreement with Kubra Data Transfer, Ltd. During the years
ended December 31, 2005 and 2004, the Company issued 15,000 and 51,000 shares of
common  stock,  respectively,  and  received cash proceeds of $1,275 and $7,125,
respectively,  related  to the exercise of stock options granted under the terms
of  its  Comprehensive  Employee  Stock  Plan.

During  the  year  ended  December 31, 2004, the Company issued 72,225 shares of
common  stock  to  certain  independent  contractors performing services for the
Company.  Such shares were issued pursuant to Section 506 of Regulation D of the
Securities and Exchange Act of 1933, as amended. The Company recorded $11,375 of
expense  related  to  the issuance of this stock in 2005 and 2004, respectively.
The  average  closing  price  was used to value the stock given as consideration
because the related independent contractor agreements called for the contractors
to  earn a certain number of shares of common stock for each month (prorated for
any  partial  month)  spent  working  on behalf of the Company with no specified
term. In effect, the contractors earned the same fixed number of shares for each
day  that  they  worked for the Company so the performance commitment was met by
the  contractors  on  a  daily  basis  and valued as such in accordance with the
measurement  date  guidance  provided  by  EITF  96-18.

NOTE  3.  PROPERTY  AND  EQUIPMENT

The  following  is  a  summary  of  property  and  equipment  at  December  31:

<TABLE>
<CAPTION>



<S>                                              <C>         <C>
                                                    2005        2004
                                                 ----------  ----------

Furniture and fixtures                           $ 175,856   $ 175,856
Equipment                                          453,953     428,420
Software                                           265,780     175,819
Leasehold improvements                               9,850       8,434
                                                 ----------  ----------
                                                   905,439     788,529
Less: accumulated depreciation and amortization   (742,839)   (656,465)
                                                 ----------  ----------
Total property and equipment, net                $ 162,600   $ 132,064
                                                 ==========  ==========
</TABLE>

                                       25
<PAGE>

NOTE  4.  SALE  OF  INTANGIBLE  ASSETS

In  December  2005,  the  Company  sold  its  bills.com  domain name and related
trademark  to  Alivio  Holdings,  LLC  for  cash  consideration  of $950,000 and
realized  a gain of $911,350 on the sale. The Company plans to continue offering
online  payment  processing  services  directly  to consumers under a new domain
name,  www.billx.com,  as  well  as  through  resellers,  including  Alivio. The
Company's existing customer base using bills.com for online payment services was
retained  and  transitioned  to  the  new  billx.com  domain  name.

NOTE  5.  ACCRUED  EXPENSES

Accrued  expenses  consist  of  the  following  balances:

<TABLE>
<CAPTION>



<S>                        <C>            <C>
                           December 31,   December 31,
                                2005           2004
                           -------------  -------------
Accrued salaries           $     600,548  $     289,709
Accrued taxes                     26,773         12,266
Accrued professional fees         39,140         32,875
Other accrued expenses           110,134         30,103
                           -------------  -------------
Total                      $     776,595  $     364,953
                           =============  =============
</TABLE>

NOTE  6.  OPERATING  LEASES

The  Company has a lease expiring in October 2009 for approximately 4,500 square
feet that serves as the Company's headquarters. Additionally, the Company leases
office  equipment  under  non-cancelable  operating leases. Rental expense under
operating  leases for the years ended December 31, 2005 and 2004 was $86,000 and
$85,000,  respectively.  Future  minimum lease payments required under operating
leases  are  as  follows.

<TABLE>
<CAPTION>



<S>                           <C>
Year ending December 31,
2006                          $ 81,126
2007                            81,126
2008                            81,126
2009                            67,605
                              --------

Total minimum lease payments  $310,983
                              ========
</TABLE>

NOTE  7.  DEBT

On  August  24,  2004,  the Company entered into a zero-discount promissory note
with Dutchess Private Equities Fund, II, LP. Pursuant to terms of the promissory
note, the Company received $260,000 and promised to pay Dutchess $284,000 with a
maturity  date  of  December  24,  2004,  which  represents  an effective annual
interest rate of 28%. The Company repaid this note in full on the maturity date.
The  Company also issued 75,000 shares of restricted common stock to Dutchess as
an  incentive  for the investment and agreed to register the common stock issued
pursuant  to the promissory note on the next registration statement filed by the
Company.

On  December 10, 2004, the Company entered into another zero-discount promissory
note  with  Dutchess  Private  Equities  Fund,  II, LP. Pursuant to terms of the
promissory  note,  the  Company  received  $260,000 and promised to pay Dutchess
$284,000  with  a maturity date of April 10, 2005, which represents an effective
annual interest rate of 28%. The Company also issued 75,000 shares of restricted
common  stock  to  Dutchess  as  an  incentive  for the investment and agreed to
register  the  common  stock  issued pursuant to the promissory note on the next
registration  statement  filed  by  the  Company.  The  balance of this note was
$264,165  at  December 31, 2004, and the Company repaid this note in full in May
2005.

On  May  12, 2005, the Company entered into a zero-discount promissory note with
Dutchess.  Pursuant  to  terms  of  the  promissory  note,  the Company received
$600,000  and promised to pay Dutchess $720,000 with a maturity date of December
22, 2005, which represents an effective annual interest rate of 33%. The Company
also  issued  500,000  shares  of  restricted  common  stock  to  Dutchess as an
incentive  for  the  investment  and  agreed to register the common stock issued
pursuant  to the promissory note on the next registration statement filed by the
Company.  The  Company  repaid  this  note  in  full  on  the  maturity  date.

                                       26
<PAGE>

NOTE  8.  RELATED  PARTY  TRANSACTIONS  AND  GUARANTEES

Beginning in December 2000, the Company pledged as loan guarantees certain funds
held  as  money market funds and certificates of deposit to collateralize margin
loans  for the following executive officers of the Company: (1) Michael R. Long,
then  Chairman  of the Board of Directors and Chief Executive Officer; (2) Louis
A.  Hoch,  then  President and Chief Operating Officer; (3) Marshall N. Millard,
then  Secretary,  Senior  Vice  President, and General Counsel; and (4) David S.
Jones,  then  Executive  Vice President. Mr. Millard and Mr. Jones are no longer
employees  of  the  Company.  The  margin loans were obtained in March 1999 from
institutional  lenders  and were secured by shares of the Company's common stock
owned  by  these  officers. The pledged funds were held in the Company's name in
accounts  with  the  lenders  that  held  the  margin loans of the officers. The
Company's purpose in collateralizing the margin loans was to prevent the sale of
its  common stock owned by these officers while it was pursuing efforts to raise
additional  capital  through  private equity placements. The sale of that common
stock  could  have  hindered  the  Company's  ability to raise capital in such a
manner  and  compromised  its continuing efforts to secure additional financing.
The highest total amount of funds pledged for the margin loans guaranteed by the
Company  was  approximately  $2.0 million. The total balance of the margin loans
guaranteed  by  the Company was approximately $1.3 million at December 31, 2002.
At  the time the funds were pledged, the Company believed they would have access
to  them  because (a) their stock price was substantial and the stock pledged by
the officers, if liquidated, would produce funds in excess of the loans payable,
and (b) with respect to one of the institutional lenders (who was also assisting
the  Company  as a financial advisor at the time), even if the stock price fell,
they  had  received  assurances  from that institutional lender that the pledged
funds  would be made available as needed. During the fourth quarter of 2002, the
Company  requested  partial  release  of the funds for operating purposes, which
request  was  denied by an institutional lender. At that time, their stock price
had  fallen  as  well, and it became clear that both institutional lenders would
not  release  the  pledged  funds.  In light of these circumstances, the Company
recognized  a loss on the guarantees of $1,278,138 in the fourth quarter of 2002
and  recorded  a  corresponding  payable under related party guarantees on their
balance sheet at December 31, 2002 because it became probable at that point that
they  would  be  unable to recover their pledged funds. During the quarter ended
March 31, 2003, the lenders applied the pledged funds to satisfy the outstanding
balances  of  the loans. The total balance of the margin loans guaranteed by the
Company  was  zero at December 31, 2005. The Company may institute litigation or
arbitration  in collection of the outstanding repayment obligations of Mr. Long,
Mr.  Hoch,  Mr.  Millard,  and  Mr.  Jones,  which  currently  total $1,278,138.
Presently,  the  Company  has  refrained from initiating action to recover these
funds  from Mr. Long, Mr. Hoch, and Mr. Millard because they may have offsetting
claims  that  total  $1,445,500  collectively by virtue of the change of control
clause  in  their  respective  employment  agreements  based  on our preliminary
analysis.  The Company understands that these individuals may assert such claims
based  on  the  Company's  sale  of  substantially  all  of its assets to Harbor
Payments,  Inc.  on  July  25,  2003.  While  Mr.  Long  and Mr. Hoch agreed, in
connection  with  such  sale,  to  forego  any  affirmative  recovery  of  their
compensation by virtue of a change of control, they have maintained the right to
claim  an  offset  of that amount in the event the Company seeks recovery of the
loan  balances. The Company has not initiated any formal settlement negotiations
with  these  individuals  because  they  have  been under an extended employment
contract  with  us  or have not been amenable to such an action. The Company has
not  pursued  the  outstanding  repayment  obligation  of  Mr. Jones because the
Company  does not consider a recovery attempt to be cost beneficial. In order to
attempt  a  recovery from Mr. Jones, the Company estimates that it would incur a
minimum  of  $20,000  in  estimated  legal costs with no reasonable assurance of
success  in  recovering  his  outstanding  obligation  of approximately $38,000.
Because  of  the  limited amount of the obligation, the Company also anticipates
difficulty  in  retaining counsel on a contingency basis to pursue collection of
this  obligation.  The  ultimate  outcome  of  this  matter  cannot presently be
determined.

NOTE  9.  INCOME  TAXES

Deferred  income  taxes  reflect  the  net  tax  effect of temporary differences
between  the  carrying amounts of assets and liabilities for financial reporting
purposes and the amounts used for income tax purposes. Significant components of
the  Company's  deferred  tax  assets  and  liabilities as of December 31 are as
follows:

<TABLE>
<CAPTION>

<S>                                 <C>            <C>
                                         2005           2004
                                    -------------  -------------
Deferred Tax Assets:
----------------------------------
Warrant expense                     $  3,228,527   $  3,177,082
Loss on related party guarantees         434,567        434,567
Net operating loss carryforwards      12,586,135     12,266,021
Other items                               94,720         77,419
                                    -------------  -------------
                                      16,343,949     15,955,089
Valuation allowance                  (16,319,367)   (15,914,425)
                                    -------------  -------------
Total Deferred Tax Asset                  24,582         40,664


Deferred Tax Liabilities:
----------------------------------
Depreciation and other items              24,582         40,664
                                    -------------  -------------
Net Deferred Tax Asset (Liability)  $          -   $          -
                                    =============  =============
</TABLE>

                                       27
<PAGE>

For  the  period  from  inception (July 30, 1998) through December 31, 2005, the
Company  has  net operating loss carryforwards for tax purposes of approximately
$37.0  million  that  begin  to  expire  in  the year 2020. In October 1999, the
Company  issued  common  stock  pursuant  to  a private placement offering. As a
result,  an  ownership  change  occurred  under  Section  382  that  limits  the
utilization  of  pre-change net operating loss carryforwards. Approximately $3.5
million  of  the  total  net  operating  loss  is  subject  to  the  Section 382
limitations.

The  reconciliation  of  income  tax  computed at the U.S. federal statutory tax
rates  to  income  tax  expense  is  as  follows:

<TABLE>
<CAPTION>
<S>                                     <C>         <C>
                                           2005        2004
                                        ----------  ----------
Tax (benefit) at statutory rate -- 34%  $(406,535)  $(514,941)

Change in valuation allowance             404,942     514,356
Permanent and other differences             1,593         585
                                        ----------  ----------
Income tax expense                      $       -   $       -
                                        ==========  ==========
</TABLE>

NOTE  10.  EMPLOYMENT  BENEFIT  PLANS

Stock  Option  Plans

The Board of Directors and stockholders approved the 1999 Employee Comprehensive
Stock  Plan  ("Employee  Plan")  to  provide  qualified  incentive stock options
("ISOs")  and  non-qualified stock options ("NQSOs") as well as restricted stock
grants  to  key  employees.  Under  the terms of the Employee Plan, the exercise
price  of  ISOs  must  be  equal to 100% of the fair market value on the date of
grant  (or  110%  of  fair  market  value in the case of an ISO granted to a 10%
stockholder/grantee).  There  is no price requirement for NQSOs, other than that
the  option price must exceed the par value of the common stock. The Company has
reserved  10,000,000  shares  of  its  common stock for issuance pursuant to the
Employee  Plan. On December 29, 2003, the Employee Plan was amended and restated
by  the  Board of Directors to add provisions 1) allowing for stock awards to be
made to consultants as provided in Rule 405 promulgated under the Securities Act
of  1933,  as amended from time to time, and other applicable law, 2) increasing
the  amount of shares of common stock of the Company exercisable per fiscal year
from  stock  options,  whether  ISOs  or  NQSOs, from 350,000 to 500,000, and 3)
removing  minimum  holding periods on "Restricted Stock" as such term is defined
in  the  Employee  Plan.

The  1999 Non-Employee Director Plan ("Director Plan") was approved by the Board
of  Directors  and  stockholders  in 1999. Under the Director Plan, non-employee
directors  may  be granted options to purchase shares of common stock at 100% of
fair  market  value  on  the  date  of grant. The Company has reserved 1,500,000
shares  of  its  common  stock  for  issuance  pursuant  to  the  Director Plan.

Option  activity  under  the  Employee  Plan  and  Director  Plan is as follows:

<TABLE>
<CAPTION>

<S>                             <C>                <C>
                                                    Weighted Average
                                Number of Shares     Exercise Price
                                -----------------  -----------------
Outstanding, December 31, 2003         4,551,770   $           0.78
   Granted                                30,000               0.20
   Canceled                             (296,000)              0.86
   Exercised                             (51,000)              0.14
                                -----------------
Outstanding, December 31, 2004         4,234,770               0.78
   Granted                             1,575,000               0.08
   Canceled                             (278,600)              0.32
   Exercised                             (15,000)              0.09
                                -----------------
Outstanding, December 31, 2005         5,516,170   $           0.61
                                =================
</TABLE>

There  was  an  aggregate  of  2,513,959  and  5,866,441 options to purchase the
Company's  common  stock  available  for  future  grants  under the Employee and
Director  Plans  at  December 31, 2005 and 2004, respectively. Exercisable stock
options amounted to 5,496,170 at a weighted average price of $0.61 and 4,079,770
at  a  weighted  average  price  of  $0.81  at  December  31,  2005  and  2004,
respectively.

                                       28
<PAGE>

Summarized  information  about stock options outstanding at December 31, 2005 is
as  follows:

<TABLE>
<CAPTION>

<S>                        <C>                  <C>                         <C>               <C>                <C>
                                                               Options Outstanding                   Options Exercisable
                                                --------------------------------------------  ------------------------------------
                                                    Weighted Average        Weighted Average                     Weighted Average
Range of Exercise Prices   Options Outstanding  Remaining Contractual Life    Exercise Price  Number of Options   Exercise Price
------------------------   -------------------  --------------------------  ----------------  -----------------  -----------------
$0.08 - $0.14                       3,230,000             8.9 years         $          0.11          3,230,000   $           0.11
$0.18 - $0.26                         874,500             7.1 years         $          0.18            854,500   $           0.18
$0.86 - $0.88                         662,668             5.8 years         $          0.86            662,668   $           0.86
$1.88 - $2.07                         334,001             5.0 years         $          2.06            334,001   $           2.06
$2.81 - $11.25                        415,001             3.2 years         $          3.85            415,001   $           3.85
------------------------   -------------------                                                -----------------
                                    5,516,170             7.6 years         $          0.61          5,496,170   $           0.61
                           ===================                                                =================
</TABLE>

The  weighted average fair value of stock options at date of grant was $0.06 and
$0.13  per  option  for  options  granted  during  fiscal  years  2005 and 2004,
respectively.  The  fair  value  of  each option granted was estimated using the
Black-Scholes  option-pricing  model,  utilizing  the  following  assumptions:

<TABLE>
<CAPTION>

<S>                      <C>    <C>
                         2005   2004
                         -----  -----

Dividend yield           None   None
Expected volatility       135%   143%
Risk-free interest rate  4.38%  2.50%
Expected life            2.00   2.00
</TABLE>

Employee  Stock  Purchase  Plan

The Company established the 1999 Employee Stock Purchase Plan ("ESPP") under the
requirements  of  Section 423 of the Internal Revenue Code (the "Code") to allow
eligible  employees to purchase the Company's common stock at regular intervals.
Participating  employees  may  purchase  common  stock through voluntary payroll
deductions  at the end of each participation period at a purchase price equal to
85%  of  the lower of the fair market value of the common stock at the beginning
or  the  end  of  the  participation  period.  Common  stock reserved for future
employee  purchases  under  the  plan  aggregated 755,828 shares at December 31,
2005.  There  were  no  shares  issued  under  the  ESPP  in  2005  or  2004.

401(k)  Plan

The  Company  has  a  defined  contribution plan (the "401(k) Plan") pursuant to
Section  401(k)  of  the  Code. All eligible full and part-time employees of the
Company  who  meet  certain age requirements may participate in the 401(k) Plan.
Participants  may  contribute  between 1% and 15% of their pre-tax compensation,
but  not  in  excess  of  the  maximum allowable under the Code. The 401(k) Plan
allows  for discretionary and matching contributions by the Company. The Company
made  no  contributions  during  2005  or  2004.

NOTE  11.  STOCK  WARRANTS

On  September 30, 2004, the Company signed a performance-based warrant agreement
with  Kubra  Data Transfer, Ltd., a provider of enterprise information solutions
servicing  Electronic  Bill  Presentment and Payment customers, as consideration
for  entering  into  a  customer  referral  agreement  with  the  Company  for a
three-year  term.  Under  the  terms of the referral agreement, the Company will
become  Kubra's  preferred provider of credit and debit card payment processing.
The  incentive warrant agreement provides for both an initial vested warrant for
250,000  shares  of  restricted common stock at $0.24 per share (see Note 2) and
contingent warrants to be earned based on the achievement of annual or quarterly
goals  for  delivery  of  gross  revenue  to the Company through the referral or
transfer  of  profitable  payment  processing customers. The contingent warrants
will  also  be  for  restricted  common  stock and will be priced at 120% of the
market  price  for  the  common  stock  when  earned.

At  December  31, 2005, the outstanding vested warrants to purchase common stock
were  as  follows:

<TABLE>
<CAPTION>



<S>                     <C>              <C>
Shares of Common Stock  Exercise Price   Expiration Date
----------------------  ---------------  ---------------
            2,179,121   $         11.38       06/02/2010
               87,600              1.80       11/27/2006
            1,912,400              0.20       11/27/2007
          ------------
           4,179,121
          ============
</TABLE>

                                       29
<PAGE>

NOTE  12.  SHAREHOLDER  RIGHTS  PLAN

On  April  22, 2005, the Company's Board of Directors declared a dividend of one
right  for  each  outstanding  share  of common stock. The rights were issued to
shareholders  of  record  on  April  29, 2005 and will expire on April 29, 2009.
Until  the  rights  become exercisable, the rights will trade automatically with
the common stock and separate rights certificates will not be issued. The rights
will  be  exercisable  only  if  a  person  or group acquires 15% or more of the
Company's  common  stock,  whether  through  open market or private purchases or
consummation  of  a  tender  or  exchange  offer,  or  announces  an  offer  the
consummation of which would result in such person or group owning 15% or more of
the Company's common stock. When the rights first become exercisable, each right
will entitle the holder to purchase one share of common stock for $0.23, subject
to  adjustment.  If  the  Company  is  involved  in  a  merger or other business
combination  after  a  person  or  group  has acquired 15% or more of its common
stock,  each  right  will  entitle  its  holder  to  purchase,  at  the  right's
then-current exercise price, a number of the acquiring company's shares having a
market  value  of  twice  the exercise price of each right. If a person or group
acquires  15% or more of the Company's common stock, each right will entitle its
holder to purchase a number of additional shares of common stock having a market
value  of  twice  the  exercise  price  of  each  right.

NOTE  13.  COMMON  STOCK  LISTING

The  Company's common stock began trading on the Over the Counter Bulletin Board
("OTCBB") operated by the National Association of Securities Dealers ("NASD") on
December  3,  1998.  The  NASD adopted eligibility rules in 1999, which required
clearance  of  comments  by  the  SEC  on all SEC filings. The Company filed its
initial  filing  on  Form 10 with the SEC on June 10, 1999 but, as of October 7,
1999, the SEC had not cleared its comment period. In accordance with the OTCBB's
phase-in  schedule  for  the new eligibility rules, the listing on the OTCBB was
terminated.  The  Company's  common  stock  was quoted in the National Quotation
Board's  Electronic Pink Sheets until December 7, 1999, when the SEC cleared the
comment  period and the stock was relisted and traded on the OTCBB through March
13,  2000  at  which time the stock was approved for trading on the NASDAQ Small
Cap  Market.  Subsequently  the  stock  was  approved  for trading on the NASDAQ
National  Market  ("NNM") on July 31, 2000, under the symbol "BLLS." On February
4, 2003, the NNM delisted the Company's common stock because the Company did not
meet  the  requirements  for  continued listing on the NNM. The Company's common
shares were immediately eligible for quotation on the OTCBB effective at opening
of  business  on  February  4,  2003.  On July 29, 2003, the Company amended its
Articles  of  Incorporation to change its name to Payment Data Systems, Inc. and
began  trading  on  the  OTCBB  under  a  new  symbol, PYDS, on August 20, 2003.

NOTE  14.  LEGAL  PROCEEDINGS

On  July  25,  2003,  certain of our stockholders (those stockholders being Mike
Procacci,  Jr.,  Mark and Stefanie McMahon, Anthony and Lois Tedeschi, Donna and
James  Knoll, John E. Hamilton, III, William T. Hagan, Samuel A. Fruscione, Dana
Fruscione-Penzone,  Gia  Fruscione,  Alicia  Fruscione, Joseph Fruscione, Robert
Evans,  John Arangio, Gary and JoAnne Gardner, Lee and Margaret Getson, G. Harry
Bonham,  Jr.,  Gary Brewer, Bob Lastowski, Robert Filipe, Mitchell D. Hovendick,
Dr.  John  Diephold,  Joseph  Maressa, Jr., and Charles Brennan) commenced legal
action  against  us,  Ernst  & Young, LLP, and certain of our current and former
directors  (including  the executive officers named above) in the District Court
of  the  45th Judicial District, Bexar County, Texas. With respect to us and the
current  and former directors named in the suit, the plaintiffs alleged that we,
acting  through  such  directors,  misstated in our 2000 and 2001 Form 10-Ks our
ability to use for operational purposes the funds pledged as security for margin
loans  of  certain  of our executive officers, as discussed above in Note 8. The
plaintiffs  alleged  and  sought  resulting  economic  and  exemplary  damages,
rescission,  interest,  attorneys'  fees  and  costs  of  court.

On  November  9,  2005, the Company entered into a settlement agreement with all
the  plaintiffs  named  in  the  suit.  Under  the  terms of the settlement, the
plaintiffs  dismissed  the  pending litigation, with prejudice, and released all
claims  against  the Company, its current and former officers and directors, and
our  former  auditors,  Ernst  & Young, LLP. Additionally, the Company reset the
exercise  price  of  1,912,400 warrants to purchase our common stock held by the
plaintiffs  from $1.80 per share to a new exercise price of $0.20 per share. The
Company also extended the expiration date of the warrants from November 27, 2006
to November 27, 2007. The Company recorded a non-cash expense of $151,309 in the
quarter  ended September 30, 2005 as a result of the modification of the warrant
terms.  The  Company is not paying any other economic consideration to fund this
settlement.

NOTE  15.  SUBSEQUENT  EVENTS

Subsequent  to  December  31,  2005 and through March 10, 2006, the Company sold
1,298,460 shares of unregistered common stock to Dutchess Private Equities Fund,
LP  pursuant  to  the  equity  line  of credit  (see  Note 2) and received total
proceeds,  net  of  issuance  costs,  of  $171,735.

Subsequent to December 31, 2005 and through March 10, 2006, the Company issued a
total  of  582,548  shares  of  common  stock  under  the  terms of its Employee
Comprehensive  Stock  Plan  to  independent  contractors  providing  consulting
services  to  the  Company  for  which  it  recorded $76,875 of related expense.

                                       30
<PAGE>


ITEM  8.  CHANGES  IN  AND  DISAGREEMENTS  WITH  ACCOUNTANTS  ON  ACCOUNTING AND
          FINANCIAL  DISCLOSURE.

None.

ITEM  8A.  CONTROLS  AND  PROCEDURES.

As  of  the  end  of the period covered by this Annual Report on Form 10-KSB, an
evaluation was performed under the supervision and with the participation of our
management, including the individual serving as both our Chief Executive Officer
and Chief Financial Officer, of the effectiveness of the design and operation of
our disclosure controls and procedures (as defined in Rules 13a-14 and 15d-14 of
the  Securities  Exchange  Act  of  1934).  Based  on that evaluation, our Chief
Executive  Officer  and  Chief  Financial  Officer concluded that our disclosure
controls and procedures are effective to ensure that information we are required
to  disclose in reports that we file or submit under the Securities Exchange Act
of  1934  (i)  is  recorded,  processed, summarized and reported within the time
periods  specified  in  Securities  and Exchange Commission rules and forms, and
(ii)  is  accumulated  and  communicated  to our management, including our Chief
Executive  Officer  and Chief Financial Officer, as appropriate, to allow timely
decisions  regarding required disclosure. Our disclosure controls and procedures
are  designed  to  provide  reasonable  assurance  that  such  information  is
accumulated  and  communicated  to  our  management. Our disclosure controls and
procedures  include components of our internal control over financial reporting.
Management's  assessment  of  the  effectiveness  of  our  internal control over
financial  reporting  is expressed at the level of reasonable assurance that the
control  system,  no  matter  how  well  designed and operated, can provide only
reasonable,  but  not  absolute,  assurance that the control system's objectives
will  be  met.

There  was  no  change  in  our  internal  controls,  which  are included within
disclosure  controls  and  procedures, during our most recently completed fiscal
quarter  that  has  materially  affected,  or is reasonably likely to materially
affect,  our  internal  controls.

ITEM  8B.  OTHER  INFORMATION.

None.

                                       31
<PAGE>

                                    PART III

We  omitted certain information required by Part III from this Report because we
will  file  our  definitive  Proxy  Statement  for  our  2006  Annual Meeting of
Stockholders  pursuant  to  Regulation 14A of the Securities and Exchange Act of
1934  not  later  than 120 days after the end of the fiscal year covered by this
Report.  Certain  information  included  in  the Proxy Statement is incorporated
herein  by  reference.

ITEM  9.  DIRECTORS  ,  EXECUTIVE  OFFICERS,  PROMOTERS  AND  CONTROL  PERSONS;
          COMPLIANCE WITH  SECTION  16(A)  OF  THE  EXCHANGE  ACT.

There  is  incorporated  in  this  Item  9,  by  reference,  that portion of our
definitive  Proxy  Statement  for the 2006 Annual Meeting of Stockholders, which
appears  therein  under  the captions "Election of Director," "Committees of the
Board  of  Directors  and  Meetings"  and  "Section  16(a)  Beneficial Ownership
Reporting  Compliance."

We  have  adopted  a  Code  of  Ethics  that  applies to our principal executive
officer,  principal  financial  officer,  principal  accounting  officer  or
controller,  and  persons  performing  similar  functions. Our Code of Ethics is
filed  as  Exhibit  14.1  to  our  Annual Report on Form 10-K for the year ended
December  31,  2003.  We will provide a copy of our code of ethics to any person
without  charge,  upon  request.  Requests  should be addressed to: Payment Data
Systems,  Inc., Attn: Investor Relations Department, 12500 San Pedro, Suite 120,
San  Antonio,  Texas  78216.

ITEM  10.  EXECUTIVE  COMPENSATION.

There  is  incorporated  in  this  Item  10,  by  reference, that portion of our
definitive  Proxy  Statement  for the 2006 Annual Meeting of Stockholders, which
appears  under  the  caption  "Executive  Compensation."

ITEM  11.  SECURITY  OWNERSHIP  OF  CERTAIN BENEFICIAL OWNERS AND MANAGEMENT AND
           RELATED STOCKHOLDER  MATTERS.

There  is  incorporated  in  this  Item  11,  by  reference, that portion of our
definitive  Proxy  Statement  for the 2006 Annual Meeting of Stockholders, which
appears  under  the caption "Security Ownership of Certain Beneficial Owners and
Management."

ITEM  12.  CERTAIN  RELATIONSHIPS  AND  RELATED  TRANSACTIONS.

There  are  no  reportable  relationships  or  transactions.

ITEM  13.  EXHIBITS.

The  exhibits  listed below are filed as part of or incorporated by reference in
this  Report.

Exhibit     Description
-------     -----------

3.1  Amended  and  Restated  Articles  of  Incorporation.

3.2  Amended  and  Restated  By-laws.

4.1  Amended  and  Restated  1999 Employee Comprehensive Stock Plan (included as
     exhibit 10.1 to the Form 8-K filed January 3, 2006, and incorporated herein
     by  reference).

4.2  Amended  and  Restated 1999 Non-Employee Director Plan (included as exhibit
     10.2  to  the  Form  8-K  filed January 3, 2006, and incorporated herein by
     reference).

4.3  Employee Stock Purchase Plan (included as exhibit 4.3 to the Form S-8 filed
     February  23,  2000,  and  incorporated  herein  by  reference).

4.4  Registration  Rights  Agreement  between  the  Company and Dutchess Private
     Equities Fund, LP, dated June 6, 2004 (included as exhibit 10.9 to the Form
     SB-2  filed  June  18,  2004,  and  incorporated  herein  by  reference).

4.5  Rights  Agreement  between  the Company and American Stock Transfer & Trust
     Company,  dated  May 2, 2005 (included as exhibit 4.1 to the Form 8-A filed
     May  5,  2005,  and  incorporated  herein  by  reference).

10.1 Asset Purchase  Agreement between the Company and Saro, Inc., dated May 19,
     2003  (included as Appendix A to the Definitive Proxy Statement on Form DEF
     14A  filed  June  19,  2003,  and  incorporated  herein  by  reference).

                                       32
<PAGE>

10.2 First Amendment  to  Asset Purchase Agreement between the Company and Saro,
     Inc.,  dated July 25, 2003 (included as exhibit 10.2 to the Form 10-Q filed
     November  14,  2003,  and  incorporated  herein  by  reference).

10.3 Lease Agreement  between the Company and Frost National Bank, Trustee for a
     Designated  Trust,  dated  August 22, 2003 (included as exhibit 10.3 to the
     Form  10-Q  filed November 14, 2003, and incorporated herein by reference).

10.4 Employment Agreement Form between the Company and Executive Officers, dated
     May  31,  2001  (included  as  exhibit 10.4 to the Form 10-K filed April 1,
     2002,  and  incorporated  herein  by  reference).

10.5 Investment  Agreement  between  the  Company  and Dutchess Private Equities
     Fund,  LP,  dated  June  4, 2004 (included as exhibit 10.8 to the Form SB-2
     filed  June  18,  2004,  and  incorporated  herein  by  reference).

10.6 Placement  Agent  Agreement  between  the  Company,  Charleston  Capital
     Corporation,  and  Dutchess  Private  Equities Fund, LP, dated June 4, 2004
     (included  as  exhibit  10.10  to  the  Form  SB-2 filed June 18, 2004, and
     incorporated  herein  by  reference).

10.7 Affiliate  Office  Agreement  between  the Company and Network 1 Financial,
     Inc.  (included as exhibit 10.11 to the Form SB-2 filed April 28, 2004, and
     incorporated  herein  by  reference).

10.8 Promissory Note between the Company and Dutchess Private Equities Fund, II,
     LP,  dated  August 24, 2004 (included as exhibit 10.1 to the Form 8-K filed
     September  2,  2004,  and  incorporated  herein  by  reference).

10.9 Warrant Agreement between the Company and Kubra Data Transfer LTD, dated as
     of  September  30,  2004  (included  as  exhibit 10.1 to the Form 8-K filed
     October  6,  2004,  and  incorporated  herein  by  reference).

10.10 Promissory  Note  between  the Company and Dutchess Private Equities Fund,
     II,  LP,  dated December 10, 2004 (included as exhibit 10.1 to the Form 8-K
     filed  December  16,  2004,  and  incorporated  herein  by  reference).

10.11 Promissory  Note  between  the Company and Dutchess Private Equities Fund,
     II,  LP,  dated  May 12, 2005 (included as exhibit 10.11 to the Form 10-QSB
     filed  May  16,  2005,  and  incorporated  herein  by  reference).

10.12 Corporate  Consulting  Agreement  between  the Company and Theodore Smith,
     dated  April  26, 2005 (included as exhibit 10.1 to the Form S-8 filed June
     3,  2005,  and  incorporated  herein  by  reference).

10.13 Trademark  and  Domain  Name  Purchase  Agreement  between the Company and
     Alivio  Holdings, LLC, dated November 14, 2005 (included as exhibit 10.1 to
     the  Form  8-K  filed  November  17,  2005,  and  incorporated  herein  by
     reference).

14.1 Code of  Ethics  (included as exhibit 14.1 to the Form 10-K filed March 30,
     2004,  and  incorporated  herein  by  reference).

16.1 Letter  from  Ernst and Young LLP to the Securities and Exchange Commission
     dated  February  10,  2004  (included as exhibit 16.1 to the Form 8-K filed
     February  11,  2004,  and  incorporated  herein  by  reference).

21.1 Subsidiaries  of  the  Company  (included  as exhibit 21.1 to the Form 10-K
     filed  April  1,  2002,  and  incorporated  herein  by  reference).

23.1 Consent  of  Akin  Doherty  Klein  & Feuge, P.C., Independent Auditors.

31.1 Certification  of  the  Chief  Executive  Officer/Chief  Financial  Officer
     pursuant  to  Section  302  of  the  Sarbanes-Oxley  Act  of  2002.

32.1 Certification  of  Officers  pursuant to 18 U.S.C. Section 1350, as adopted
     pursuant  to  Section  906  of  the  Sarbanes-Oxley  Act  of  2002.

ITEM  14.  PRINCIPAL  ACCOUNTANT  FEES  AND  SERVICES.

There  is  incorporated  in  this  Item  14,  by  reference, that portion of our
definitive  Proxy  Statement  for the 2006 Annual Meeting of Stockholders, which
appears  under  the  caption  "Fees  Paid  to  the  Independent  Accountant."

                                       33
<PAGE>

                                   SIGNATURES

In  accordance  with  Section  13  or  15(d) of the Exchange Act, the registrant
caused this report to be signed on its behalf by the undersigned, thereunto duly
authorized.

     PAYMENT  DATA  SYSTEMS,  INC.

     By:  /s/  Michael  R.  Long
          ----------------------
     Michael  R.  Long
     Chairman  of  the  Board,  Chief  Executive  Officer,  and
     Chief  Financial  Officer

Date:  March  31,  2006

In  accordance  with  the Exchange Act, this report has been signed below by the
following persons on behalf of the registrant and in the capacities indicated on
March  31,  2006.


                                    By:  /s/  Michael  R.  Long
                                         ----------------------
                                    Michael  R.  Long
                                    Chairman  of  the  Board,  Chief  Executive
                                    Officer,  and  Chief Financial Officer
                                   (principal executive officer  and   principal
                                    financial and accounting officer)


                                    By:  /s/  Louis  A.  Hoch
                                         --------------------
                                    Louis  A.  Hoch
                                    President,  Chief  Operating  Officer,  and
                                    Director


                                    By:  /s/  Peter  G.  Kirby
                                         ---------------------
                                    Peter  G.  Kirby
                                    Director

                                       34
<PAGE>