What Should You Do if You Receive a 1099-K Form?

Typically, one can expect to receive a 1099 tax form if they’ve freelanced or done gig work such as rideshare and food delivery. In 2023 however, people who don’t normally receive 1099s might feel like they’re in the tax man’s crosshairs when they get surprised by one.

With a new law that impacts digital payment processor users, personal and business transactions could get tangled together and cause a migraine during the upcoming tax season. If you unexpectedly received a 1099 form, here’s what you can do to make your 2023 tax preparation easier.

Understanding the 1099 Series: Digital Payments and the 1099-K

Getting a surprise tax form can be scary, and the best way to conquer that fear is to learn how they work.

1099 forms are part of a series where each form has an appendage to denote meaning, such as 1099-R for retirement and pension income. 1099-INT, 1099-DIV, and 1099-B are for investment income.

Freelancers and small business owners most commonly receive 1099-MISC and 1099-NEC. 1099-NEC is issued when you are paid $600 or more for services rendered, but the threshold for 1099-MISC is only $10 (typically issued for advertising and royalty payments).

1099-K is a newer form in this series issued to users of digital payment processors such as PayPal, Venmo, and Cash App and massive online marketplaces like Etsy and Amazon. Initially, it was created to help close the “tax gap,” which the Treasury estimates siphons $600 billion yearly from the government. It was issued to business account owners with at least 200 transactions or $20,000 in revenue on a specific platform or marketplace.

Subsequently, the Treasury urged the Biden administration to increase the IRS budget and mandate financial institutions and fintech companies to use data they already possess. The passage of the American Rescue Plan in 2021 included a provision to reduce the 1099-K threshold to just $600, regardless of the number of transactions starting with the 2022 tax year.

Personal Transactions Might Accidentally Get Reported to the IRS

While the Treasury claimed the intent of the 1099-K was to close the tax gap widened by wealthier taxpayers, advocacy groups have disagreed and urged Congress to revert to the old 1099-K threshold. Among the most notable opponents to this change is the American Institute of Certified Public Accountants, which found that the $600 reporting threshold dates back to living costs circa 1954 and believes a $5,000 threshold is a reasonable compromise.

The IRS created a FAQ page for individual taxpayers worried about receiving Form 1099-K under the new rules. The Service has also emphasized that gifts, reimbursements for expenses, and other personal transfers will not be taxed.

But now, a single $600 transaction can trigger your account to require a 1099-K. It’s easy to make more than $600 having a digital yard sale on eBay, even though it’s just your personal belongings. Is it fair to lump that in with people who purposely sell goods online full-time?

Fair or not, this is currently the law and our reality. This 1099-K threshold is also a reporting mandate; the underlying tax laws concerning what is and isn’t taxable have not changed. Whether you have a formal small business or freelance on the side, you need to report your income and expenses if you’ve netted at least $400 for the year.

Online payment processors can make mistakes. You or they may have incorrectly classified your account or payment type. Small business owners and freelancers who use multiple accounts for business and personal activity often reimburse themselves or draw their earnings. How will the system know which transaction is taxable?

Conversely, if you’re in the business of selling goods but make a personal PayPal account to avoid the 1099-K, you still need to report this income on your tax return regardless.

What You Can Do if You Unexpectedly Received a 1099-K Form

The most important thing you can do to prepare is to isolate each transaction from each platform or marketplace for the 2022 tax year. Freelancers and small business owners usually have a financial recordkeeping system to search and confirm transactions easily and won’t be hit as hard by this new legislation.

However, it’s possible to accidentally double-report income if a client sent you a 1099-NEC, and the amount is already included in the total reported on Form 1099-K. Keep all 1099 forms where you can easily find them and reconcile them if necessary.

Taxpayers who don’t typically have these recordkeeping systems will need to rely on the records they do have. If you sold goods online, search your digital and physical receipts for how much you paid for that item. Sales tax and shipping costs add to the item’s cost (referred to as basis), and you can deduct your selling fees and shipping costs.

If you don’t have records of how much you paid for the items you sold, you, unfortunately, have to work with the numbers that you do have and not further reduce the number reported on Form 1099-K.

If you have nontaxable personal transactions mixed with taxable transactions, differentiate personal gifts and transfers from potentially taxable items. You may need to note on your tax return in the “other income” section that you’re reporting the income, although you won’t be taxed.

Additionally, you can request an extension if you are unsure how to report your 1099-K income and need more time. You have until Tax Day, which is April 18, 2023, to file for an extension that gives you until October 18 to resolve this issue and file your tax return.

Update: The IRS has announced this policy will be deferred until January 1, 2024 upon pressure from tax professionals and advocacy groups. The current reporting threshold of $20,000 or 200 transactions remains in effect.

This article was produced and syndicated by Wealth of Geeks.