The American Rescue Plan Act of 2021 was one of the most ambitious relief packages ever passed, but the Child Tax Credit and other popular provisions of the law distracted from a substantial change in how self-employed taxpayers will prepare their tax returns in the future. The law created new reporting requirements pertaining to third-party network transactions, reportable payment card transactions, and IRS form 1099-K. If you’re not prepared, you may face headaches once tax filing season rolls around in 2023.
If you haven't previously received 1099-K and you receive payment card and third party payments, now would be a good time to consult with a tax expert, as the 1099-K changes will apply to you. For now, here’s what you need to know about how to file 1099-K this year, as well as for tax year 2022.
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What is Form 1099-K?
From the government’s perspective, the goal of Form 1099-K, Payment Card and Third-Party Network Transactions is to facilitate tax compliance related to income that otherwise might not be included on an individual or business’ income tax return. This includes certain payment transactions and card payments received by independent contractors and small business owners.
What is a Payment Settlement Entity?
Third party network transactions and payment cards are each a type of payment settlement entity. Payment card transactions belonging to credit card companies like MasterCard, while PayPal, Cash App and Venmo are payment settlement entities that process reportable transactions between customers and vendors.
Who Receives a Form 1099-K?
Taxpayers have always been required to report all of their business income, but the American Rescue Plan revised the process by dramatically lowering the threshold for generating a 1099-K. Where third-party processors were formerly required to issue Form 1099-K when reportable payment transactions exceeded $20,000 and 200 individual payments per year, in tax year 2022 (for which tax returns are filed in April of 2023) the minimum threshold for generating the IRS 1099 form drops to $600 in total and any number of individual payments. Payees who receive a 1099-K from third party networks and payment settlement entities must attach them and include their information their income tax return. This makes it nearly impossible to avoid a 1099 from PayPal or other third-party transaction networks.
If you're self-employed, a sole proprietorship, or an independent contractor, you've probably received IRS form 1099-NEC or 1099-MISC forms in the past. These came from individual clients who paid you $600 or more in the previous calendar year, and you included the forms with your tax return and reflected their information on your tax return. But unless you generated transactions totaling over $20,000 and 200 individual transactions per year through a third-party payment network or any payment card transactions, you probably haven't received a Form 1099-K.
New Minimum Reporting Thresholds
The American Cares Act dramatically lowered the minimum reporting threshold for the 1099-K. Now, when annual card and third party payments from the prior calendar year total $600 or more — whether from an individual client or in total — Form 1099-K will be generated and mailed out no later than January 31st.
Each applicable payment settlement entity and third-party network with transactions totaling over $600 will request your taxpayer identification number (TIN) or Social Security Number so they can send Form 1099-K. A copy will also be sent to the IRS. Whatever your business structure, you'll need to include the 1099-K information on the appropriate IRS form you attach to your income tax return.
The Challenge of Reporting Business Income
Though the IRS has always required that all taxable income be reported, the information included on Form 1099-K will substantially complicate that process. That's why it's a good idea to seek tax advice if you've never received them from third-party settlement organizations or payment entities before. The most startling thing is that they reflect the gross amount of transactions rather than income, requiring significant work to correctly calculate your reported income.
Extensive New Calculations Required
When working with platforms like PayPal, Amazon, or Etsy, freelancers and other independent business owners have traditionally recorded income under the threshold of $20,000 and 200 transactions based on information they’ve tracked on their own. They’ve computed payments and deducted their own costs from each third-party network transaction and entered the information on their Schedule C. Form 1099-K will dramatically increase the work involved.
Form 1099-K Reports Gross Receipts
Each Form 1099-K generated by a payor contains a record of the gross amount of payment receipt records or cash transferred to the payee. The gross payments reflected on the form makes no adjustment for fees that the payment settlement entity may deduct or of any refunds or discount amounts that you may have issued to clients. To get a sense of how this will complicate matters, consider the following:
Individual sole proprietors who use the same bank account for both personal and business purposes will find that the gross receipts recorded on Form 1099-K by Venmo or PayPal may include cash payments they’ve received as gifts from family members or other non-business transactions, including items like cash transferred to split restaurant bills among friends.
Businesses that provide cash back service as a convenience for debit cards and stored value card transactions will see the total payment card transaction recorded on the form as gross receipts rather than the actual sales income belonging to the business. A customer that purchases $40 worth of goods and asks for $10 in cash back has always seen the $50 deducted from their bank account, but now vendors will see $50 recorded as revenue on Form 1099-K.
Form 1099-K Requires Meticulous Record-keeping
In the face of this new reality, businesses that process payment card transactions and that receive payments from third party payment networks will need to introduce meticulous recordkeeping practices related to Form 1099-K, and the sooner they do so, the better.
These changes may include keeping track of payment card receipt records, cashback amounts dispensed, fees deducted by third party payment networks such as PayPal and Etsy, and any discounts or refunded amounts provided to clients. The Form 1099-K that you receive will reflect reportable transactions broken down by month as well as for the entire year, which should prove helpful in matching different transactions to your own records.
Adjusting to Your Business's Needs
The specific adjustments you make and records you keep will depend upon the needs of your individual business. If clients compensate you via a third-party payment network for expenses incurred on their behalf, that will need to be reflected on your Schedule C. If you share a credit card reader with another business to process stored value cards, credit cards, and debit card transactions, you'll need identifying data to distinguish each business's card payments.
Avoid Duplication of Payment Transactions
Your individual clients probably file a 1099-NEC or 1099-MISC to reflect payments over $600 made to your business. But if those payments were made via a third-party processor such as PayPal, this will mean that the transaction is reported as income to you twice — once on the 1099-MISC and once on Form 1099-K. Business owners being paid in this way will need to exercise particular care to avoid being doubly taxed.
Takeaways for How to File 1099-K
It's important that you carefully review each Form 1099-K you receive to ensure it correctly reflects your business operations. Smart steps include:
Confirm that the form reflects your business’s tax identification number if you operate as a corporation, an S-corporation, or a partnership and therefore report business income on a Form 1120, 1120S, or 1065 on your entity's tax return.
Separate income recorded and collected from a single credit card terminal for different business entities, and either discontinue use of the same card terminal or find a way to separate your own payments.
Keep meticulous records that correctly describe returns and refunds, cashback activity, fees, and other income and expenses that offset the gross receipts reflected on the Form 1099-Ks you receive.
Separate personal transactions from business transactions, particularly if you regularly receive cash for non-business purposes.
If you receive a 1099-K that you don't think belongs to you, contact the company that sent the form. Their name and telephone number will both be listed.
The new Form 1099-K requirements and the arrival of the forms in the mail early next year are likely to create a good deal of confusion for small business owners and freelancers across the country. By familiarizing yourself with them now, consulting with a tax expert, and beginning to make appropriate changes, you can save yourself headaches in the future.
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