4 Things Small Business Owners and Freelancers Should Know When Filing a 1099-K
Tax Day is just around the corner. And while filing taxes can seem overwhelming and confusing for some, things can get even more complicated for freelancers and small business owners who must file 1099-K forms. Indeed, the regulations around the forms have not only changed numerous times, but have also been delayed, causing potential uncertainty as to its requirements.
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“For small business owners and freelancers navigating the 1099-K filing, understanding the nuances of this process is paramount,” said Bryan Gerson, co-founder and president of Clarify Capital. “Initially, determine if you qualify. Moreover, keep meticulous records for income verification and expense deductions, and familiarize yourself with allowable business-related deductions.”
What Is a 1099-K Form?
Form 1099-K is designed to provide tax reporting on payments from a third party (such as payment apps and online marketplaces) for business transactions, explained Mark Luscombe, principal analyst for Wolters Kluwer‘s Tax and Accounting Division North America.
This applies to third-party payment processors such as PayPal, Stripe and Venmo. “IRS studies over the years have determined that third-party reporting improves tax compliance,” added Luscombe.
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What Is the Threshold?
This is one of the requirements that has caused a lot of confusion.
For several years, the requirement was to report on form 1099-K transactions totaling more than $20,000 or 200 in number for the year.
Congress changed this requirement to require reporting of transactions totaling more than $600 effective starting in 2022, said Luscombe. However, as it has been estimated that this could result in more than 30 million 1099-Ks being filed, to assist third-party processors to gear up for this increased reporting, the Internal Revenue Service (IRS) postponed the additional filing requirement, first for 2022 and then again for 2023.
“Currently for the 2023 tax year, 1099-Ks will still only be required for transactions totaling more than $20,000 […] or 200 in number. For the 2024 tax year, the threshold will fall to $5,000, and thereafter the threshold will fall to $600,” he explained.
The IRS itself acknowledged that it was reverting to the old rule and delaying new requirements “to reduce taxpayer confusion.”
“Given the complexity of the new provision, the large number of individual taxpayers affected and the need for stakeholders to have certainty with enough lead time, the IRS is planning for a threshold of $5,000 for tax year 2024 as part of a phase-in to implement the $600 reporting threshold enacted under the American Rescue Plan (ARP),” the IRS said in a November 2023 statement.
So How Will This Affect Taxpayers?
Once the changes in reporting thresholds go into effect, small business owners who receive payments through platforms such as Paypal, Venmo or Stripe will need to adjust their tax reporting accordingly.
“The lower threshold will mean more small business owners will receive 1099-K forms, prompting small business owners to be more diligent in tracking their transactions to ensure accurate reporting,” said Ben Richmond, U.S. country manager and chartered accountant, Xero.
Yet, Richmond noted that while it doesn’t mean more taxes will be owed, it does prompt a more careful review of income and expenses.
Peter C. Earle, senior economist, American Institute for Economic Research, also noted that the new dollar requirement is a “nearly 97% drop in the reporting threshold and will significantly broaden the number of U.S. taxpayers needing to file — in particular, freelancers, independent contractors, gig workers and for-profit hobbyists.
“The kid who mows your lawn during the summer, the retiree who sells crafts on Etsy, casual eBay book dealers and countless others are likely to trigger that filing requirement from now on,” he added.
Additional Factors To Be Mindful Of
Another important factor to keep in mind, experts said, is that taxpayers need to stay up-to-date with state-specific rules in addition to federal requirements, as these differ on a state-by-state level.
“Some states, including Maryland and Massachusetts, have already adopted the $600 threshold for 2023, so freelancers should be aware of their state’s reporting requirements,” said Matthew Stratman, president, United Tax AI.
Vermont, Virginia and the District of Columbia have a $600 threshold for requiring 1099-K in effect for 2023, according to TurboTax. North Carolina and Montana also have a $600 threshold, although state tax officials have said these states may offer relief, it added.
Finally, increased 1099-K reporting by third-party payment processors could confuse small business taxpayers, according to Luscombe.
“Because third-party payment processors may not know if a particular transaction is a business or personal transaction, taxpayers may receive 1099-Ks for personal transactions that are not taxable, resulting in a need to explain that fact when filing the tax return,” he explained.
In turn, small businesses may also receive more than one 1099 for the same transaction — a 1099-K from the third-party payment processor and perhaps a 1099-NEC from an independent contractor with whom the small business had a business transaction or a 1099-MISC from other transactions, he said.
“Small businesses will therefore have to track the 1099s carefully to avoid overpaying tax because two 1099s might relate to the same transaction,” he added.
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