You May Need To Prepare for 1099-K Reporting

Article Highlights:

• 1099-K Reporting Threshold
• IRS Is After Unreported Income
• Venmo, e-Bay, Etsy, and Others
• Deductible Expenses
• Self-employment tax
• Self-employment Retirement
• Self-Employed Health Insurance Deduction 
• Hobby vs. Business

The IRS Tax law, since 2011, has required third-party settlement organizations such as Venmo, PayPal, CashApp, and Ebay to report transactions over $20,000 in payments per year from over 200 transactions.    

The American Rescue Plan of 2021 abruptly changed the reporting threshold to $600 per year regardless of the number of transactions. This change was supposed to have taken place beginning for 2022 transactions.

However, some pressure from the tax preparation community and businesses have caused the IRS to delay for one year the implementation of the $600 threshold, so it will be applicable to transactions that occur beginning in 2023 instead of those in 2022.

This delay will give folks more time to prepare for the change in 2023. Even with the reporting relief provided by the IRS, some 1099-Ks may be issued by the payment processers when transactions reach the $600 threshold if their computer programs have already been set to use the lower threshold.  

So, you might ask, what does that have to do with me? This change can impact taxpayers in several ways, some unexpected, so you may find yourself in for a surprise that can be unpleasant in some situations.

This article explores the several ways taxpayers can be adversely affected.  But first we need to review the purpose of the 1099-K and what can transpire for you if you receive one.

The 1099-K was created by the IRS as a means to detect unreported income by businesses. The IRS does that by requiring third-party settlement organizations such as credit card companies, eBay, Venmo and others to report on IRS Form 1099-K the transactions they’ve handled for an individual or business if the gross amount of those transactions exceeds a specified threshold.

Example: Susan, who owns and operates a gift shop, accepts credit cards for purchases made by her customers. Since the credit card transactions are processed through a third-party settlement organization, that third party must issue a 1099-K for the total dollar amount of credit card transactions that Susan had for the year. The 1099-K goes to the IRS and a copy goes to Susan. The IRS can then compare the 1099-K amount to the amount Susan reports as the gross income from her business. The IRS is also aware of, through studies they have conducted, the amount of cash sales certain types of businesses might have. With this information, the IRS can efficiently identify taxpayers who are not reporting all their income and ID them for audit.

Although primarily intended for businesses, there are situations where you may find yourself a recipient of a 1099-K. 

One such situation is if you sold personal property on eBay or a similar web platform.  If the total amount received is $600 or more (now starting with 2023 transactions), you will receive a 1099-K. Although these sales are generally not taxable since used personal items are usually sold for less than their cost, the IRS does not know the circumstances of the sale and if the amount is significant, it needs to be reconciled on your individual tax return. A sale of personal property that results in a loss is not deductible for tax purposes. In years when the threshold for requiring a 1099-K is $20,000, a 1099-K is never issued to most non-business taxpayers, so there is no concern about reconciliation.

Many taxpayers are also involved in the gig economy selling their products through Etsy, eBay, etc., or hiring out their services on TaskRabbit.

Others may be driving for Uber or Lyft or making deliveries through Door Dash, Uber Eats, etc. 

Some individuals have been meeting their tax responsibilities from these activities while others have not, thus prompting Congress to reduce the threshold. In either case, it is important that these individuals keep records of their expenses associated with their income-producing activities to reduce any tax liability. Here are some expense examples:

• Cost of goods sold
• Advertising
• Vehicle travel
• Business cell phone service
• Internet service for on-line sales
• Office supplies
• Postage & shipping
• Some may qualify for a home office deduction

Since these activities are generally treated as self-employment income, here are other issues to be aware of:

Self-employment tax – Which is like Social Security and Medicare taxes paid by employees and matched by the employer through payroll taxes. Except a self-employed individual pays both the employee’s and the employer’s share, which combined can total 15.3% of net profit. 

Self-employment Retirement – Self-employment Income qualifies for IRA contributions and the very popular Simplified Employee Pension Plan (SEP) where a self-employed individual can contribute a tax-deductible amount of 20% of their net earnings to the retirement plan.  

Self-Employed Health Insurance Deduction – Most self-employed individuals can deduct as an above-the-line expense 100% of the amount paid during the tax year for medical insurance on behalf of themself, spouse, dependents, and children under age 27 even if the child is not a dependent. However, this deduction is limited to the net income from the business.

Hobby vs. Business – Whether the activity is truly a business or just a hobby impacts how the income is reported on the tax return, deductibility of expenses (including medical insurance premiums), whether self-employment tax applies, and if contributions to retirement plans can be based on the activity’s income.

As you can see, all of this can become quite complicated and the penalties for not reporting self-employment income can be severe. Please contact this office about what expenses are deductible for your specific type of endeavor and your business filing obligations.

What ever you do, don’t ignore a 1099-K; it must be reconciled on your tax return.

Please contact this office if you have any questions.