UNITED STATES
                       SECURITIES AND EXCHANGE COMMISSION
                             WASHINGTON, D.C.  20549

                                   FORM 10-QSB

                [ X ]  QUARTERLY REPORT UNDER SECTION 13 OR 15(d)
                     OF THE SECURITIES EXCHANGE ACT OF 1934

                  For the quarterly period ended March 31, 2006

                                       OR

                [   ] TRANSITION REPORT UNDER SECTION 13 OR 15(d)
                               OF THE EXCHANGE ACT

                   For the transition period from ____ to ____

                        Commission file number 000-30152


                           PAYMENT DATA SYSTEMS, INC.
        (Exact name of small business issuer as specified in its charter)



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


                           12500 SAN PEDRO, SUITE 120
                             SAN ANTONIO, TX  78216
                    (Address of principal executive offices)

                                 (210) 249-4100
                           (Issuer's telephone number)


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 12 months (or for such shorter
period  that the registrant was required to file such reports), and (2) has been
subject  to  such  filing  requirement  for  the  past  90 days.  Yes  X  No ___
                                                                      --

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

As  of  May  1, 2006, 41,702,937 shares of the issuer's common stock, $0.001 par
value,  were  outstanding.

Transitional  Small  Business  Disclosure  Format  (Check  one):  Yes ___  No  X

================================================================================

                                        1
<PAGE>

                           PAYMENT DATA SYSTEMS, INC.

                                      INDEX


PART I - FINANCIAL INFORMATION                                            Page
                                                                          ----

Item 1.     Financial Statements (Unaudited)

            Consolidated Balance Sheets as of March 31, 2006
            and December 31, 2005                                           3

            Consolidated Statements of Operations for the three months
            ended March 31, 2006 and 2005                                   4

            Consolidated Statements of Cash Flows for the three months
            ended March 31, 2006 and 2005                                   5

            Notes to Consolidated Financial Statements                      6

Item 2.     Management's Discussion and Analysis or Plan of Operation       9

Item 3.     Controls and Procedures                                        13

PART II - OTHER INFORMATION

Item 1.     Legal Proceedings                                              14

Item 2.     Unregistered Sales of Equity Securities and Use of Proceeds    14

Item 3.     Defaults Upon Senior Securities                                15

Item 4.     Submission of Matters to a Vote of Security Holders            15

Item 5.     Other Information                                              15

Item 6.     Exhibits and Reports on Form 8-K                               15

                                        2
<PAGE>

                         PART I - FINANCIAL INFORMATION

ITEM 1. FINANCIAL STATEMENTS


<TABLE>
                           PAYMENT DATA SYSTEMS, INC.
                           CONSOLIDATED BALANCE SHEETS
<CAPTION>
<S>                                                           <C>              <C>
                                                              March 31, 2006   December 31,
                                                                (Unaudited)        2005
                                                              --------------  --------------
Assets:
Current assets:
     Cash and cash equivalents                                $     134,216   $     378,098
     Accounts receivable, net                                       156,539          59,558
     Prepaid expenses and other                                     258,802          51,962
                                                              --------------  --------------
Total current assets                                                549,557         489,618

Property and equipment, net                                         164,824         162,600
Other assets                                                         63,693          20,833
                                                              --------------  --------------
Total assets                                                  $     778,074   $     673,051
                                                              ==============  ==============
Liabilities and stockholders' equity (deficit):
Current liabilities:
     Accounts payable                                         $     503,644   $     524,520
     Accrued expenses                                               377,682         776,595
     Deferred revenue                                               123,921          44,038
                                                              --------------  --------------
Total current liabilities                                         1,005,247       1,345,153

Stockholders' equity (deficit):
Common stock, $0.001 par value, 200,000,000 shares
authorized; 40,495,683 and 32,827,056 issued and outstanding         40,496          32,827
Additional paid-in capital                                       50,289,132      49,486,143
Deferred compensation                                              (769,459)       (829,687)
Accumulated deficit                                             (49,787,342)    (49,361,385)
                                                              --------------  --------------
Total stockholders' equity (deficit)                               (227,173)       (672,102)
                                                              --------------  --------------
Total liabilities and stockholders' equity (deficit)          $     778,074   $     673,051
                                                              ==============  ==============
<FN>
See notes to interim consolidated financial statements.
</TABLE>

                                        3
<PAGE>

<TABLE>
                           PAYMENT DATA SYSTEMS, INC.
                     CONSOLIDATED STATEMENTS OF OPERATIONS
                                  (UNAUDITED)
<CAPTION>
<S>                                                           <C>             <C>
                                                                Three Months Ended March 31,
                                                              ------------------------------
                                                                   2006            2005
                                                              --------------  --------------
Revenues                                                      $     348,010   $     242,962

Operating expenses:
Cost of services                                                    298,382         224,629
Selling, general and administrative                                 443,830         411,103
Depreciation and amortization                                        21,467          20,393
                                                              --------------  --------------
Total operating expenses                                            763,679         656,125
                                                              --------------  --------------
Operating loss                                                     (415,669)       (413,163)

Other income (expense):
Interest income                                                         189               2
Interest expense                                                    (10,477)        (42,065)
Other income (expense)                                                    -            (754)
                                                              --------------  --------------
Total other income (expense)                                        (10,288)        (42,817)
                                                              --------------  --------------
Loss from operations before income taxes                           (425,957)       (455,980)
Income taxes                                                              -               -
                                                              --------------  --------------
Net loss                                                      $    (425,957)  $    (455,980)
                                                              ==============  ==============

Basic and diluted net loss per common share                   $       (0.01)  $       (0.02)

Weighted average common shares
     outstanding                                                 36,149,686      24,426,962
<FN>
See notes to interim consolidated financial statements.
</TABLE>

                                        4
<PAGE>

<TABLE>
                           PAYMENT DATA SYSTEMS, INC.
                     CONSOLIDATED STATEMENTS OF CASH FLOWS
                                  (UNAUDITED)
<CAPTION>
<S>                                                           <C>             <C>
                                                               Three Months Ended March 31,
                                                              ------------------------------
                                                                    2006           2005
                                                              --------------  --------------
Operating activities:
Net loss                                                      $    (425,957)  $    (455,980)
Adjustments to reconcile net loss to net cash
     used in operating activities:
     Depreciation and amortization                                   21,467          20,393
     Non-cash issuance of common stock                              198,375         322,024
     Deferred compensation                                           60,228               -
     Amortization of debt discount                                        -          17,849
     Changes in current assets and current liabilities:
     Accounts receivable                                            (96,981)        (18,051)
     Prepaid expenses and other                                    (249,700)         20,880
     Deferred revenue                                                79,883            (911)
     Accounts payable and accrued expenses                          (16,649)        (46,102)
                                                              --------------  --------------
Net cash used in operating activities                              (429,334)       (139,898)

Investing activities:
Purchases of property and equipment                                 (23,691)         (6,381)
                                                              --------------  --------------
Net cash used in investing activities                               (23,691)         (6,381)

Financing activities:
Principal payments for notes payable                                      -         (52,135)
Issuance of common stock, net of issuance costs                     209,143         161,213
                                                              --------------  --------------
Net cash provided by financing activities                           209,143         109,078
                                                              --------------  --------------
Change in cash and cash equivalents                                (243,882)        (37,201)

Cash and cash equivalents, beginning of period                      378,098         153,966
                                                              --------------  --------------
Cash and cash equivalents, end of period                      $     134,216   $     116,765
                                                              ==============  ==============
<FN>
See notes to interim consolidated financial statements.
</TABLE>
                                        5
<PAGE>

                           PAYMENT DATA SYSTEMS, INC.

               NOTES TO INTERIM CONSOLIDATED FINANCIAL STATEMENTS
                                   (UNAUDITED)

NOTE  1.  BASIS  OF  PRESENTATION

Payment  Data  Systems,  Inc.  and  subsidiaries  (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 that
its  current  available cash along with anticipated revenues may be insufficient
to meet its anticipated cash needs for the foreseeable future. CONSEQUENTLY, THE
COMPANY'S  ABILITY  TO  CONTINUE  AS A GOING CONCERN IS LIKELY CONTINGENT ON THE
COMPANY  RECEIVING ADDITIONAL FUNDS IN THE FORM OF EQUITY OR DEBT FINANCING. The
Company  is currently aggressively pursuing strategic alternatives (see Note 4).
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  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.  The  accompanying  unaudited  consolidated  financial
statements of the Company 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.

The accompanying unaudited consolidated financial statements of the Company have
been  prepared  without  audit,  pursuant  to  the  rules and regulations of the
Securities and Exchange Commission. Certain information and footnote disclosures
normally  included  in  financial  statements  prepared  in accordance with U.S.
generally accepted accounting principles have been condensed or omitted pursuant
to  such  rules  and regulations. In the opinion of management, the accompanying
consolidated  financial statements reflect all adjustments of a normal recurring
nature  considered necessary to present fairly the Company's financial position,
results  of operations and cash flows for such periods. The accompanying interim
consolidated  financial  statements  should  be  read  in  conjunction  with the
consolidated  financial  statements  and  the  notes  thereto  included  in  the
Company's  Annual  Report  on  Form 10-KSB for the year ended December 31, 2005.
Results  of  operations  for  interim  periods are not necessarily indicative of
results  that  may  be expected for any other interim periods or the full fiscal
year.

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.

NOTE  2.  STOCK-BASED  COMPENSATION

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. Statement No. 123R
eliminates the ability to account for stock-based compensation using APB No. 25,
"Accounting for Stock Issued to Employees," and requires that these transactions
be  recognized  as compensation cost in the income statement based on their fair
values  on  the  date  of grant. The transition provisions require the "modified
prospective  method"  be applied to all new or modified awards and the remaining
expense  for  unvested  options.  The  Company  adopted Statement No. 123R as of
January  1,  2006,  but  the  impact  to  the  current period was immaterial, as
substantially  all  outstanding options completed their vesting during 2005. The
Company  previously applied the intrinsic value method under the recognition and
measurement  provisions  of  APB  No.  25 in accounting for its stock option and
stock  purchase plans. Accordingly, no stock-based employee compensation expense
has  been recognized in prior periods 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 No. 123R, "Accounting
for Stock-Based Compensation," to stock-based employee compensation in the prior
period.

                                        6
<PAGE>

                                      Three Months Ended March 31, 2005
                                      ---------------------------------

Net loss, as reported                          $  (455,980)

Less: Total stock-based employee
compensation expense determined
under fair value based method for
all awards, net of related tax effects              (1,315)
                                               ------------

Pro forma net loss                             $  (457,295)
                                               ============

Net loss per common share
- basic and diluted, as reported               $     (0.02)

Net loss per common share
- basic and diluted, pro forma                 $     (0.02)

NOTE  3.  RELATED  PARTY  TRANSACTIONS

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  March  31, 2006. 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 a 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. On July 25, 2004,
the  Company's  employment agreements with Michael Long, Chief Executive Officer
and  Chief  Financial  Officer,  and  Louis  Hoch, President and Chief Operating
Officer,  expired.  The  Company intends to enter into new employment agreements
with  both  of  these individuals and is currently negotiating the terms of such
agreements.  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.

                                        7
<PAGE>

NOTE  4.  EQUITY  LINE  OF  CREDIT

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.  During  the  quarter  ended March 31, 2006, the Company sold 1,533,760
shares  of  its  common stock pursuant to the equity line of credit and received
total  proceeds,  net  of  issuance  costs,  of  $198,665.

NOTE  5.  ISSUANCE  OF  CAPITAL  STOCK

During the quarter ended March 31, 2006, the Company issued a total of 4,439,024
shares  of common stock granted to employees on December 29, 2005 as a long-term
incentive  for  which  it 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  also  issued  a  total  of  270,000  shares granted to independent
contractors  on December 29, 2005 as a long-term incentive for which it recorded
$22,140  of  deferred  compensation.  The  common  stock is restricted and vests
one-third  annually  on  the  anniversary  date  of  the  grant.

During  the  quarter ended March 31, 2006, the Company issued a total of 690,548
shares  of common stock under the terms of its Comprehensive Employee Stock Plan
to  independent  contractors  providing  consulting  services to the Company for
which  it  recorded  $90,375  of  related  expense.

During  the  quarter  ended March 31, 2006, the Company issued 735,295 shares of
restricted common stock to Carmen Electra under the terms of a license agreement
with  her and recorded $125,000 of prepaid expense, which will be amortized over
the  term  of  the  license  agreement.

NOTE  6.  SUBSEQUENT  EVENTS

Subsequent  to  March  31, 2006 and through the date of this report, the Company
sold  1,097,902 shares of its common stock pursuant to the equity line of credit
(see  Note  4)  and received total proceeds, net of issuance costs, of $128,856.

Subsequent  to  March  31, 2006 and through the date of this report, the Company
issued  a  total  of  279,312  shares  of  common  stock  under the terms of its
Comprehensive  Employee  Stock  Plan  to  independent  contractors  providing
consulting  services  to  the  Company  for which it recorded $36,500 of related
expense.

                                        8
<PAGE>

ITEM 2.     MANAGEMENT'S DISCUSSION AND ANALYSIS OR PLAN OF OPERATION

FORWARD-LOOKING  STATEMENTS  DISCLAIMER

Except for the historical information contained herein, the matters discussed in
this  Form  10-QSB include certain forward-looking statements that involve risks
and  uncertainties,  which  are  intended  to  be covered by safe harbors. Those
statements  include,  but  are  not limited to, all statements regarding our and
management's  intent, belief and expectations, such as statements concerning our
future  and  our  operating  and growth strategy. We generally use words such as
"believe," "may," "could," "will," "intend," "expect," "anticipate," "plan," and
similar expressions to identify forward-looking statements. You should not place
undue  reliance  on  these  forward-looking statements. Our actual results could
differ  materially  from those anticipated in the forward-looking statements for
many  reasons  including our ability to implement our business plan, our ability
to  raise additional funds and manage our substantial debts, consumer acceptance
of  our  products,  our  ability  to  broaden  our customer base, our ability to
maintain  a  satisfactory  relationship  with  our  suppliers  and  other  risks
described  in  our  reports  filed  with the Securities and Exchange Commission.
Although we believe the expectations reflected in the forward-looking statements
are  reasonable,  they  relate  only  to  events  as  of  the  date on which the
statements  are made, and our future results, levels of activity, performance or
achievements  may  not meet these expectations. Investors are cautioned that all
forward-looking  statements  involve  risks and uncertainties including, without
limitation,  the  factors  set  forth  under the Risk Factors section of Item 6,
Management's  Discussion  and  Analysis  of  Financial  Condition and Results of
Operations,  of the Annual Report on Form 10-KSB for the year ended December 31,
2005  and  other  factors  detailed  from  time  to time in our filings with the
Securities  and  Exchange  Commission. In light of the significant uncertainties
inherent  in  the  forward-looking  statements included herein, the inclusion of
such  information  should not be regarded as a representation by us or any other
person  that  our  objectives  and  plans  will be achieved. All forward-looking
statements made in this Form 10-QSB are based on information presently available
to  our  management.  We  do  not  intend  to  update any of the forward-looking
statements after the date of this document to conform these statements to actual
results  or  to  changes  in  our  expectations,  except  as  required  by  law.

This  discussion  and  analysis should be read in conjunction with the unaudited
interim consolidated financial statements and the notes thereto included in this
report,  and  our  Annual  Report on Form 10-KSB for the year ended December 31,
2005.

OVERVIEW

We  provide  integrated  electronic payment processing 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  through  which consumers can pay anyone. Since inception, we have
incurred  operating  losses  each  quarter, and as of March 31, 2006, we have an
accumulated  deficit  of  $49.8  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 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.

                                        9
<PAGE>

CRITICAL ACCOUNTING POLICIES

General

Management's  Discussion  and  Analysis  or  Plan of Operation 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 are believed 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. We consider the following accounting policies to be
critical  because  the nature of the estimates or assumptions is material due to
the  levels  of  subjectivity  and  judgment  necessary  to  account  for highly
uncertain matters or the susceptibility of such matters to change or because the
impact  of  the  estimates  and  assumptions on financial condition or operating
performance  is  material.

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, such
as  the  types  of  card  transactions  processed  and  nature  of  the merchant
relationship  with  their consumers. This reserve amount is subject to risk that
actual  losses  may  be  greater than our estimates. At March 31, 2006, our card
merchant  processing  loss  reserve  was  $42,799.  We  have  not  incurred  any
chargeback  losses  to  date.  Our  estimate  for chargeback losses is likely to
increase  in  the  future  as  our  volume  of card-based transactions processed
increases.

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
determine  the  allowance  for  doubtful accounts based on an account-by-account
review,  taking  into  consideration  such factors as the age of the outstanding
balance,  historical  pattern  of  collections  and  financial  condition of the
customer.  Past  losses  incurred  by  us  due to bad debts have been within our
expectations.  We  charged  bad  debt  expense  of $10,000 and recorded bad debt
write-offs of $936 against our allowance for doubtful accounts in 2005. At March
31, 2006, the balance of the allowance for doubtful accounts was $27,219. 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. Our estimate for bad debt losses is likely to increase in the
future  as  our  volume  of  transactions  processed  increases.

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 management determines that the carrying value of
long-lived  and intangible assets may not be recoverable, impairment is measured
as  the  excess  of the assets' carrying value over the estimated fair value. No
impairment  losses  were  recorded in 2005 or during the quarter ended March 31,
2006.

                                       10
<PAGE>

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 management. It is
our  judgment that we cannot predict with reasonable certainty that the deferred
tax assets as of March 31, 2006 will be 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 had available net operating loss carryforwards of
approximately  $36.1  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  and  sell  this service as a
private-label application to resellers. Revenues for the quarter ended March 31,
2006  increased  43%  to  $348,010 from $242,962 for the quarter ended March 31,
2005. The increase from the prior year quarter was primarily attributable to the
increase  in  revenues  generated  from  card-based  processing  services due to
increased  transaction volume. 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. Revenues
generated  by  our  billx.com  payment  service  for  the  first quarter of 2006
decreased from the prior year quarter due to a decrease in the average number of
consumers  subscribing to our online payment service. The monthly average number
of  such consumers decreased to 1,623 in the first quarter of 2006 from 2,967 in
the  first  quarter  of  2005.

We  expect  our  total 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 92% of our total
revenues  in  the  quarter  ended  March  31,  2006,  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 that our
merchant  business  provides us with the best opportunity for revenue growth and
that  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 $298,382 and $224,629 for the quarters ended
March  31, 2006 and 2005, respectively. The increase from the prior year quarter
was  due  primarily  to the increase in fees related to processing the increased
card-based  transaction  volume.

Selling,  general  and  administrative  expenses  increased  to $443,830 for the
quarter  ended  March 31, 2006, from $411,103 for the first quarter of 2005. The
increase  from  the  prior  year  quarter  was  principally  due  to  non-cash
amortization  of  deferred compensation of $55,086 related to employee incentive
stock  grants.  We  expect  our  selling, general and administrative expenses to
increase  in  subsequent  quarters  as  we  incur marketing costs related to the
issuance  of  our  new  Carmen  Electra  debit  cards.

Depreciation  and  amortization increased to $21,467 for the quarter ended March
31,  2006,  as  compared to $20,393 for the first quarter of 2005. This increase
was primarily due to depreciation related to asset additions enabling our online
payment  processing capabilities that were put into production during the latter
half of 2005. We capitalized $23,691 of computer hardware and software purchased
during the quarter ended March 31, 2006 and anticipate making additional capital
expenditures  of  approximately $100,000 over the remaining nine months of 2006.

                                       11
<PAGE>

Net  other  expense  decreased  to $10,288 for the quarter ended March 31, 2006,
from  $42,817  for  the  first quarter of 2005. The decrease from the prior year
quarter  was  attributable  to  $34,048 of interest expense and financing costs
incurred  in  the  quarter  ended  March 31, 2005 related to our note payable to
Dutchess.

Net  loss  decreased  to  $425,957  for  the  quarter  ended March 31, 2006 from
$455,980  for  the  prior  year  quarter. Net loss decreased from the prior year
quarter  primarily  as  a result of the increase in gross margin and decrease in
interest  expense  as  discussed.

LIQUIDITY  AND  CAPITAL  RESOURCES

At  March  31,  2006,  we had $134,216 of cash and cash equivalents, compared to
$378,098  of  cash  and  cash equivalents at December 31, 2005. We have incurred
substantial losses since inception and have a deficit in net working capital. We
believe  that  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  June  2004,  we  executed  an  agreement  for  an equity line of credit with
Dutchess  Private  Equities  Fund,  LP. Under the terms of the agreement, at our
option  we  may  elect to receive as much as $10 million from Dutchess in common
stock  purchases  over three years. Through March 31, 2006, we have sold a total
of  6,173,039  shares  of our common stock pursuant to the equity line of credit
and  received  total  proceeds,  net  of  issuance  costs,  of  $1,117,312.

The satisfactory completion of an additional investment, adequate sales of stock
under  our  equity  line  of  credit,  or growth of cash flow from operations is
essential  or  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, on acceptable terms, 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.

Net  cash used in operating activities was $429,334 and $139,898 for the quarter
ended  March  31,  2006  and  2005,  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 focus on expending our
resources  prudently  given  our  current  state  of  liquidity.

Net  cash  used  in  investing activities was $23,691 and $6,381 for the quarter
ended  March 31, 2006 and 2005, respectively, and reflected capital expenditures
for computer hardware and software. We anticipate making capital expenditures of
approximately  $100,000  during  the  remaining  nine  months  of  2006.

Net  cash  provided  by  financing  activities of $209,143 for the quarter ended
March  31,  2006  represented the net proceeds from the issuance of common stock
under  our  equity  line of credit. Net cash provided by financing activities of
$109,078  for  the quarter ended March 31, 2005 resulted from receiving $161,213
in  net  proceeds  from the issuance of common stock, primarily under our equity
line  of  credit,  and  making  payments  of  $52,135  under  our  note payable.

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.

                                       12
<PAGE>

ITEM  3.     CONTROLS  AND  PROCEDURES

As  of the end of the period covered by this Quarterly Report on Form 10-QSB, 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.

                                       13
<PAGE>

                           PART II - OTHER INFORMATION

ITEM 1.  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 March 31, 2006. 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 a 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.

ITEM 2.  UNREGISTERED SALES OF EQUITY SECURITIES AND USE OF PROCEEDS

During  the quarter ended March 31, 2006, we sold 1,533,760 shares of our common
stock  to  Dutchess  Private  Equities  Fund,  LLP pursuant to an equity line of
credit  and  received  total  proceeds,  net  of  issuance  costs,  of $198,665.

During  the quarter ended March 31, 2006, we issued 735,295 shares of restricted
common  stock  to Carmen Electra under the terms of a license agreement with her
and  recorded $125,000 of prepaid expense, which will be amortized over the term
of  the  license  agreement.

                                       14
<PAGE>

ITEM 3. DEFAULTS UPON SENIOR SECURITIES

Not  Applicable.

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

Not  Applicable.

ITEM  5.  OTHER  INFORMATION

Not  Applicable.

ITEM  6.  EXHIBITS  AND  REPORTS  ON  FORM  8-K

(a)     Exhibits:

Exhibit
Number     Description
------     -----------

3.1     Amended  and Restated Articles of Incorporation (included as exhibit 3.1
to  the Form 10-KSB filed March 31, 2006, and incorporated herein by reference).

3.2     Amended and Restated By-laws (included as exhibit 3.2 to the Form 10-KSB
filed  March  31,  2006,  and  incorporated  herein  by  reference).

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).

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 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).

                                       15
<PAGE>

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).

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.

(b)     Reports  on  Form  8-K:

On January 3, 2006, the Company filed a report on Form 8-K to disclose that the
Company amended the terms of its 1999 Employee Comprehensive Stock Plan and 1999
Non-Employee Director Plan.

                                       16
<PAGE>

                                    SIGNATURE

In  accordance  with the requirements 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.


Date: May 12, 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)