Form 1099-K: All the Details a US Expat Needs to Know
The threshold limit for Form 1099-K has been reduced from $20,000 to $600 but this is not applicable for the returns filed in 2023.
The announcement of this delayed implementation has been a cause for confusion.
This article covers all the aspects of the 1099-K plus what to do to it and how.
Read on to also find out about recent amendments and their implications.
What is the Form 1099-K & Its Purpose?
Technological advancement has altered the way we receive payments from customers. Cash is exchanged less often now. It is also common to see retail stores having an online presence. In stores, they have POS terminals where customers swipe their credit or debit card. On their website, they have integrated third-party processors like PayPal to receive payments.
Since the role of tax authorities is to keep track of their taxpayers' earnings from every source so they can collect taxes to run the country, therefore the payment settlement entities (PSE) and credit card companies offering payment processing services are required to send Form 1099-K, the information return, to the taxpayers and the IRS.
Form 1099-K broadly serves two purposes:
1. Voluntary Compliance
The IRS uses this form to check whether or not the income reported here also reflects in the submitted return by the taxpayer. It provides a reason for voluntary compliance with tax regulations.
2. Tax Collection and Assessment Improvement
Think about Form 1099-K as an accountability tool. When you submit your tax return it is compared with Form 1099-K to identify underreported income. If discrepancies are found you will be notified.
If the IRS suspects income is under-reported you may end up receiving a letter for tax audit which may lead to a heavy tax penalty. To avoid this make sure your reported income is aligned with the 1099-K.
Pro Tip! Keep it with your tax record along with your reconciling statement as you may need to substantiate your income in case the tax man arrives at your doorstep.
Who Gets the 1099-K?
If you would accept online payments from your customers then you are likely to receive Form 1099-K unless your earnings remain below the specified limit.
Imagine you are setting up your online business store and decided to have an integrated payment system. You approach your domestic bank and have an agreement with them to facilitate the clearing and settlement of electronic payment transactions. They now have a contractual obligation to make payments to you.
The financial institutions or organizations that are responsible for processing and reconciling payments are called payment settlement entities (PSE). They ensure that the funds are transferred from the payer’s account to the payee’s account.
Let’s say you already have a store in your area that has a point-of-sale machine where customers swipe their credit or debit card to pay for the goods.
At the end of the tax year, you can expect Form 1099-K from your PSE and your credit card companies if you meet the minimum threshold limit which has been amended recently.
Let’s look at what these amendments are and how it is going to impact you.
What Changed with the 1099-K Rules in 2022
Prior to 2022, if you had more than 200 transactions and the value of those transactions exceeds $20,000 then the PSE is required to send you Form 1099-K. In 2022, the minimum threshold was revised.
The specified limit for the value of transactions was reduced to $600 regardless of the number of transactions. Later the IRS put the implementation on hold and instructed that the previous threshold would be applicable to the returns filed for 2022.
The announcement for this delayed implementation came late so there is a possibility that the third-party settlement organization (TPSO) has already prepared your 1099-K so you might receive it. Some payers might send you this form even if you don’t meet the minimum threshold guidelines for 2022 to be on the safe side.
How the 1099-K Rules Changed Again in 2023
Technically, in 2023 the rules didn't change but the delayed implementation of the reporting threshold is going to become effective.
The IRS declared the year 2022 as a transition year to ensure a smooth implementation for the participating payee and TPSO tax compliance. If you are receiving payments from a TPSO for a business transaction you are a participating payee.
For 2023, business transactions that exceed the minimum threshold of $600 in aggregate payments, paid in 2022 are reportable and TPSO is required to send the 1099-K to the participating payee.
The number of transactions will no longer be considered. Additionally, the law is not going to track personal transactions. These include:
- Cash gifts for Birthdays or holidays;
- Sharing the cost of a ride with friends and family;
- Paying a family member.
What Caused the 1099-K Changes for Tax Season 2024
The recent changes are an attempt to cover the tax gap that resulted from people turning into gig workers during Covid 19.
The pandemic has seen a dramatic increase in the gig economy and online business operations. Most businesses are working to have a digital outlet along with traditional ones. Working from home became the new normal.
Individuals are selling their services internationally to direct clients through social media and online platforms. All of these sales go unreported and create tax gaps which are estimated to be around billions of dollars.
To minimize these losses in tax revenue and to catch up with the ever-changing world, the American Rescue Plan 2021 amended the existing tax laws and regulations related to 1099-K.
The amendments and delayed implementation have caused confusion among the taxpayers and TPSO. The IRS is committed to releasing additional information in the coming months to bring more clarity around the issue so keep an eye on it.
Do I Have to Pay Taxes on 1099-K?
Whether or not you owe taxes on the income reported on the 1099-K will depend on the nature of your income. For the tax year 2022, you will receive this form if the number of your business transactions is more than 200 and their gross value is $20,000. The applicable threshold for the tax year 2023 has been reduced to $600.
NOTE! As a self-employed person, you are responsible to pay self-employed taxes. The total SE tax rate is 15.3%. Out of which social security tax is 12.4% and the remaining 2.9% is medicare taxes.
How Much Tax do I Pay on a 1099-K?
Let’s say you are preparing your tax return for the year 2022, the value of your online business transactions totaled up to $25,000 and you had 225 transactions. Since this exceeds the minimum threshold applicable for the current year you will receive the Form 1099-K.
You need to factor in all the deductible business expenses you are eligible for to arrive at your taxable income. You can apply the income tax rate on your taxable income depending on the tax bracket you fall in to calculate how much you owe. Your tax liability can be further reduced if you qualify for tax credits.
Remember - a tax specialist can help you if you are unsure about which tax deductions you can claim and which tax credits you qualify for.
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1099-K vs. 1099-NEC vs. 1099-Misc - What’s the Difference?
Often Form 1099-K gets confused with 1099-NEC and/or 1099-Misc.
You now know that credit card companies and third-party payment processors send you 1099-K if your business transactions exceed the reporting thresholds.
To understand Form 1099-NEC vs. 1099-Misc you need to get familiar with a brief background.
In the early 80s, Form 1099-NEC was introduced to simply report non-employment compensation. This mainly reported the money earned by self-employed people. In 1983, 1099-Misc replaced 1099-NEC and it reported payments that can be broadly classified into the two following categories:
- Non-employment compensation that is paid to self-employed people;
- Other payments.
The IRS has two different deadlines to report these payments. This dual filing deadline created confusion among many payers. To address this confusion Form 1099-NEC was reintroduced with updates in 2020.
Businesses use 1099-NEC to report non-employment compensation if it exceeds $600. These are the payments made to independent contractors. Suppose you are a freelancer, who sells content writing services to a business. Your earnings for the tax year are $2,000. They are required to send you Form 1099-NEC since they paid you more than $600.
Personal payments are not reportable on 1099-NEC. If let’s say a friend asked you to edit a book he wrote and paid you $1,000 for it. They won’t be required to send you a 1099-NEC. However, you will have to report this income in your tax return.
Form 1099-Misc is used to report royalties if they are at least $10 and the following payments if they are more than $600:
- Prize and awards;
- Medical and health care payments;
- Payments to attorney;
- Fish boat proceeds;
- Other miscellaneous payments.
Do I Have to Report 1099-K Income on My Tax Return?
Yes. Since the 1099-K reports your income from online sources it needs to be reported by you.
Hobby income is reported on Schedule 1 of Form 1040 whereas business income is reported on Schedule C. However you need to make sure your income is not reported twice.
Also read - Hobby Income: Five Things You Need to Know
Suppose you are a graphic designer and worked as a freelancer for a company during the tax year and earned $45,300. The amount was paid to you online. This income will be reflected in two forms.
The company you worked for will send you Form 1099-NEC and the PSE will send you 1099-K. If you are not paying attention chances are you will end up over-reporting your income.
NOTE! Additionally, make sure you avoid using your business card for personal expenses as much as possible. You will end up paying more taxes if you don’t exclude personal transactions. (but this is not always practical, especially for self-employed individuals)
How to File a 1099-K Form?
You don't have to file Form 1099-K: the payment settlement entities will file it with the IRS if your online payments exceed the minimum threshold limits. They will also send you a copy which will include information about the total amount of income you received through electronic payments.
The TPSO needs to fill out 3 copies:
- Copy 1 is filed with your state tax department;
- Copy B is sent to you for your record;
- Copy 2 is filed with your state income tax return when required.
This form will have the following information:
- The last four digits of your TIN number;
- Your unique account number;
- The aggregate gross amount of payment PSE made to you during the calendar year;
- Merchant category code;
- Number of transactions excluding refunds;
- Backup withholding tax. If you didn't provide your TIN to the payer or you provided an incorrect TIN, the payer is required to deduct backup withholding tax;
- Monthly gross payments made to you during the calendar year;
- State and local income tax withheld.
Pro Tip! Make sure to reconcile the income reported in the 1099-K with your accounting records and keep this form with your tax documents.
Form 1099-K preview
What to Do if My 1099-K is Wrong?
While reconciling your income with your accounting records you may spot discrepancies. One of the following reasons may have caused this.
1. TIN Mismatch
This happens when:
- PSE issues a 1099-K in your name but with your SSN instead of a tax identification number (TIN). You can request PSE to resend the corrected form.
- You forgot to update PSE when:
- You acquired a new business and keep using the terminal associated with the old TIN and business information;
- You upgraded your business from sole proprietor to partnership and carried on using the same processor.
Pro Tip! Ensure to update your PSE of any relevant changes about the acquisition and upgrading of your business.
2. Over or Understatement of Income
This happens when you:
- Share your credit card terminal with another business. Inform your PSE of which payments are related to your business.
- Offer customers to get cashback when they swipe their cards. The cashback will be reported on your 1099-K even though these are not part of your earnings.
Pro Tip! To offset your overstated income you can either report it under “other expenses” on your Schedule C or request your PSE to send you the corrected 1099-K.
3. Incorrect Classification of Income
This happens when you:
- Mix Personal and Business Transactions. If you are a freelancer it is not uncommon to use your personal account for a business transaction. If you don’t specify that the transactions are related to business and not personal the PSE will incorrectly classify them as personal.
Pro Tip! In this case, you can report your income in Schedule C and use a business account next time.
- Have multiple sources of income. Let’s say your tenants pay monthly rent by swiping their credit cards on your business terminal.
Pro Tip! Make sure you correctly classify it as rental income and report it on the relevant form while submitting your tax return.
What if I Need Help with My 1099-K?
Contact your payer if you spot any errors in your Form 1099-K. You may find discrepancies while reconciling it with your accounting record. This means you need to have a proper accounting record for your business transactions.
A streamlined accounting process helps your business transactions to be correctly classified and accurately recorded. Think of the 1099-K Form as a document with which you can verify your business transactions
Our expat tax pros will help you understand why discrepancies occur and how you can prevent them. They can help you develop a preventive strategy to avoid any potential mistakes while preparing your taxes so that you do not overpay.
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SEE THE PROCESS
1. Can I ignore 1099-K?
No. It is crucial that you review Form 1099-K carefully to reconcile it with your records so that you can spot discrepancies and resolve them.
You may receive a form showing a business loss and think since it is not taxable you should disregard it. This is never a good idea. As the new reporting threshold is implemented the IRS will likely scrutinize these forms more often.
2. What happens if I don't report 1099-K?
The payer files the 1099-K with the IRS and sends you a copy. When you submit your return and omit your business income reported in the 1099-K you will receive a notice to explain the reason for the unreported income.
The IRS imposes a penalty and interest retrospectively for unpaid taxes, commencing from the date they believe you owe the additional tax.
3. Why did I receive a 1099-K from PayPal?
You received Form 1099-K from Paypal because your business income has surpassed the reporting threshold set by the IRS. For the year 2022, this limit was over 200 transactions with an aggregate value exceeding $20,000. However, for the year 2023, this limit is reduced to $600.
Under the tax regulation, all payment processing services including Paypal, are mandated to file this form with the IRS and provide a copy to their customers if the designated threshold is met.