If you received more than $600 in payments through Paypal, Venmo, Zelle or other online payment platforms, then you need to read about the major changes coming to form 1099-K that could impact your tax liability.
Did you read the American Rescue Plan Act of 2021? The bill was a total of 628 pages, so Senate clerks may be among the only people who read it in its entirety. Chances are you missed some of the details. Lucky for you, we have read it and want to share some insight with you on how these changes impact your taxes.
Do I have to pay taxes on a 1099-K?
You may have seen social media users claiming anyone with more than $600 in annual transactions from cash apps will now face a new tax. This is simply not true.
The tax law applying to such transactions hasn’t changed, it just has become more visible.
What changed with the 1099-K?
The American Rescue Plan Act of 2021 modifies the IRS reporting requirement effective beginning on Jan. 1, 2022. President Joe Biden signed the law with the threshold amendment in March.
You used to be able to avoid giving 1099s to contractors and vendors when you use PayPal or a similar service as your payment platform. This pushed the reporting requirements to PayPal. Current federal law requires that PayPal file Form 1099-K with the IRS and send it to you when:
- Your gross earnings are more than $20,000, and
- You have more than 200 transactions.
Example: You work as a consultant. Your clients pay you $30,000 via PayPal. PayPal does not give you a 1099-K because this fails the more than 200 transactions in a calendar year test.
According to lawmakers, this created a situation where those people who use PayPal have an easy ability to cheat (i.e., not report the income on their tax returns).
Starting January 1, 2022, the American Rescue Plan Act kills the two-step “more than $20,000 and more than 200 transactions” threshold for third-party settlement organization (TPSO) filing of 1099-K and replaces it with the single “$600 or more” reporting threshold. This will only apply to payments for goods and services, not personal payments.
Why is the 1099-K threshold lowered?
The last decade has seen a surge in the number of gig workers aka freelancers or contractors, indicating broad economic and demographic shifts and raising concerns around long-term financial security for a growing share of the workforce, according to some experts. New research indicates that businesses are turning to gig workers with greater regularity. In total, there are 6 million more gig workers today than a decade ago. Half, or 3 million, of that growth reflects the shift of the labor force toward this type of work and away from more traditional employment.
According to this study conducted by the IRS Tax Gap, about 80% of the gig economy workers who earn less than $20,000 in a year from a company don’t receive a 1099-K. This means thousands of gig workers are misreporting their incomes, which is resulting in misreported and/or underreported income.
The Joint Committee on Taxation estimates that this change in the 1099 rules will gain more than $8 billion in new taxes over the next 10 years. According to Rice University’s Baker Institute for Public Policy, the change should raise $8.8 billion in tax revenue over the next ten years. Remember, while these changes increase contractors’ reporting requirements, their tax liability stays the same. This means that there is over $8 billion dollars in taxes that are currently being underreported.
Is there a benefit to the lowered 1099-K Threshold?
Independent contractors (ICs) experience many of the same risks as workers in a standard employment relationship, but face them without many of the rights, benefits, and social insurance protections enjoyed by traditional employees. It is also important to note that until the CARES Act forced the separation of nonemployee compensation reporting from the 1099-MISC, some employees were losing unemployment benefits like health insurance in the middle of a global pandemic.
With these changes, contractors or gig workers will have to report income more accurately, driving the collection of billions in tax revenue. This will give the federal government a better understanding of the size of the gig economy. Receiving 1099-Ks will also make it easier for independent contractors and the self-employed to file for unemployment insurance.
How will the lowered 1099-K threshold impact Social Security?
On a related note, independent contractors contribute to Social Security and Medicare through the self-employment tax. Since independent contractors have no employer, they pay both the employer and the employee shares of the Social Security and Medicare contributions. These individuals are more likely to under report their income which means that they may end up with lower overall earnings which generally results in lower Social Security benefits.
What does this 1099-K change mean for you?
Do you receive payments through PayPal, Cash App, Venmo, eBay or Zelle? If so, you will likely receive a 1099-K form if you receive more than $600 from any source. Remember, this doesn’t mean you owe any additional taxes if you have been claiming this as income on your tax return. Current tax law requires anyone to pay taxes on income over $600, regardless of where it comes from. This means that keeping accurate records of your income and expenses is even more valuable now than ever before. Just because you didn’t receive a 1099 previously doesn’t mean you were not required to claim the income on your taxes. No one wants to pay more taxes than they are required. Let us help keep your books in order and pay the least amount of tax that you are legally allowed.
What are potential problems with the new 1099-K change?
If someone is receiving money from a friend or family member as a gift or as a reimbursement, this money will still be included on the 1099-K, but should not be classified as income for tax purposes. Some platforms allow you to categorize these transactions as personal or business transactions, or allow the sender to designate what type of transaction it is, but there will likely be issues in this aspect of the new 1099-K reporting. We recommend keeping clear and accurate records so if there are any issues come tax time, you know how much money was actually income. This will be equally as beneficial if you ever receive an IRS letter or audit and need to prove income or the lack thereof.
Will there be more audits with the new tax law changes?
The IRS only audits a tiny fraction of taxpayers, so it is not very likely that the IRS will perform an audit of every single person who received a 1099-K. However, it is proposed that the IRS will receive $80 billion in funding over the 2022-2031 period earmarked to capture additional tax revenue. This is primarily done through audits and sending out IRS letters. So even though IRS letters may have been few and far between in years past, we will likely see an increase in IRS follow up via letters and audits in order to capture the avoided tax dollars. If you haven’t used a tax professional in the past, this may be the year to start! Call to schedule a meeting with one of our professional advisors at 281-440-6279.