Income is all included in tax forms so the appropriate state and federal taxes can be paid. When payments for goods or services are processed through a third-party network, they must be declared on the tax forms if they reach a certain minimum threshold. The IRS is changing the threshold under new laws, which means those who use third-party networks need to be aware of what is happening and what they need to do to make sure their taxes are filed appropriately.
The 1099-K Form: What it is and How it Works
The tax reporting rule for the 1099-K form has, in the past, required reporting by digital payment processors if the payments exceed $20,000 in one year and if there were more than 200 transactions within the year. This is a higher threshold, so many freelancers would not have received a 1099-K to file with their taxes. When someone does meet the threshold, they are required to report the income with their taxes to ensure the tax forms are filed appropriately.
Changes to the 1099-K with the American Rescue Plan of 2021
With the American Rescue Plan of 2021 came changes to the threshold for reporting business transactions on third-party networks. The minimum amount that must be reported using the 1099-K is now $600 instead of $20,000. There is also no minimum number of transactions, so even a single business transaction can trigger the form if it meets the minimum $600. This means more freelancers will receive a 1099-K from payment processors like PayPal, Venmo, or Zelle.
Who is Impacted by the Changes?
Those who use peer-to-peer payment processors for business transactions are impacted by the changes as long as they bring in more than $600 in payments per year. This will impact the majority of freelancers and small business owners who use these types of apps to accept payments from customers or clients.
It is important to note that those who use these apps to split bills with friends, send small gifts, and otherwise use the money for personal reasons are not included in those who are impacted by the change. Since they are not buying or selling goods or services, those who use online payment processors for other situations will not need to worry about receiving a 1099-K or using it for their taxes.
Common Misconceptions About the Changes
With the changes to the tax rules, there have been a lot of misconceptions online about how it works, who is impacted, and what it means for those who use the apps but don’t use them for business. Some of the most common questions people have include the following.
Will I Get a 1099-K for Personal Transactions?
No. Personal transactions are not going to lead to a 1099-K being sent to users of P2P money-sharing apps. The tax laws only apply to business-related income and those who use these apps for their business.
Do I Need to Pay Taxes on Personal Transactions?
No. Personal transactions like sending money to a friend to help cover the cost of dinner are not covered by the 1099-K form and will not need to be reported. Taxes are not paid on these types of transactions.
Who Will Send the 1099-K Form?
Third-party payment processors like Venmo, Zelle, and PayPal will be responsible for sending out 1099-K forms to anyone who uses their platforms. Right now, this is only done if the user reaches $20,000 in transactions and has more than 200 transactions on the platform, but for the 2023 tax year, it will include everyone who receives $600 or more in business transactions on the platform.
If I Didn’t Receive a 1099-K, Do I Need to Report the Income?
Even if a 1099-K is not received, it is necessary to report the income. Anyone who receives more than $400 from self-employment income is required to report the income they received, whether or not they used a third-party network for transactions. This has always been the case and is not changing with the new laws.
How Much Do I Need to Make Before I Receive a 1099-K?
Right now, the minimum threshold for receiving a 1099-K is $20,000 and 200 or more transactions within a year. However, this is changing to $600 in business transactions with no minimum number of transactions.
Designating a Transition Period
Though the new law was intended to start with the 2022 reporting period, the IRS announced on December 23, 2022, that the changes would not go into effect until the following year. What this means is that those who make less than the $20,000 threshold that is currently in place may not receive a 1099-K from third-party payment processors this year. However, this is simply a delay as an opportunity to transition more easily into the new rules, and they will go into effect for the 2023 tax year.
When Do the Changes Go Into Effect?
The changes were intended to take place on January 1, 2023, and be applied to the 2022 tax year. The delay is set to push this date back one year, allowing for a transition period to clear up any confusion and make sure everything is implemented properly. Now, those who meet the lowered threshold may not receive a 1099-K during January of 2023 for the 2022 tax year. Instead, it will go into effect on January 1, 2024, and cover the 2023 tax year.
What Happens if Payments Aren’t Reported?
Income received from business transactions must be reported when filing taxes, even if the small business owner doesn’t receive a 1099-K. The minimum threshold for reporting is $400, so anyone who makes more than that through their business during the year will need to report the income on their taxes. There are potentially serious implications if the income is not reported.
Penalties and fines are common if business income isn’t reported or is not fully reported. While the IRS may not worry about $100 that was forgotten accidentally when filing taxes, if the amount is significant and was done intentionally, the penalties can increase. If it is discovered that something was forgotten when the taxes were filed, filing an amendment is possible to correct the taxes before any fines or penalties are assessed.
Depending on the situation, there are more serious penalties that taxpayers may receive. If the income was omitted intentionally as a way to reduce the money paid to the IRS, it is possible the person will have additional financial penalties assessed, and they could end up going to jail for tax fraud. Even if someone isn’t arrested for it, though, it is expensive to deal with the fines and other penalties, as the interest continues to accrue until everything is paid in full.
The IRS announced changes for reporting income through the 1099-K form as a part of the American Rescue Plan of 2021. Though the changes aren’t going into effect as early as expected, they will still go into effect in the future. It is crucial for small business owners and freelancers to understand how the changes can impact their reporting of income and what they need to know when filing taxes in the future.
During this transition period, it’s a good idea to get extra help to fully understand the changes and how they may impact your business. If you receive payments for goods and services through a third-party payment processor like PayPal, Zelle, or Venmo, the time to start thinking about your taxes and how to track your income is now. Contact Abacus Tax & Books today to schedule a consultation and learn more about how they can help.