Article Highlights:
- 1099-K Reporting Threshold
- IRS Is After Unreported Income
- Venmo, e-Bay, Etsy, and Others
- Deductible Expenses
- Self-employment tax
- Self-employment Retirement
- Self-Employed Health Insurance Deduction
- Hobby vs. Business
This article explores the several ways taxpayers can be affected. But first, we need to review the purpose of the 1099-K and what can occur for you to receive one.
The 1099-K was created by the IRS as a means to detect unreported income by businesses. The IRS does that by requiring third-party settlement organizations such as credit card companies, eBay, Venmo, and others to report the transactions they’ve handled for an individual or business on a 1099-K if the gross amount of those transactions exceeds a specified threshold.
Example: Susan, who owns and operates a gift shop, accepts credit cards for purchases made by her customers. Since the credit card transactions are processed through a third-party settlement organization, that third party must issue a 1099-K for the total dollar amount of credit card transactions that Susan had for the year. The 1099-K goes to the IRS and a copy goes to Susan. The IRS can then compare the 1099-K amount to the amount Susan reports as the gross income from her business. The IRS is also aware of, through studies they have conducted, the number of cash sales certain types of businesses might have. With this information, the IRS can efficiently identify taxpayers who are not reporting all their income and ID them for audit.
Although primarily intended for businesses, there are situations where you may find yourself a recipient of a a1099-K.
One such situation is where a taxpayer is downsizing and selling personal property on eBay. If the total amount sold is $600 or more the taxpayer will receive a 1099-K. Although these sales are generally not taxable since used personal items are usually sold for less than their cost, the IRS does not know the circumstances of the sale and if the amount is significant, it needs to be reconciled on the individual’s tax return. A sale of personal property that results in a loss, is not deductible for tax purposes. In prior years, because the threshold for requiring a 1099-K was $20,000, a 1099-K was never issued to most non-business taxpayers, so there was no concern about reconciliation.
Many taxpayers are also involved in the gig economy selling their products through Etsy, eBay, etc., or hiring out their services on TaskRabbit.
Others may be driving for Uber or Lyft or making deliveries through Door Dash, Uber Eats, etc.
Some individuals have been meeting their tax responsibilities from these activities while others have not, thus prompting Congress to reduce the threshold. In either case, it is important that these individuals keep records of their expenses associated with their income-producing activities to reduce any tax liability. Here are some examples:
- Cost of goods sold
- Advertising
- Vehicle travel
- Business cell phone service
- Internet service for online sales
- Office supplies
- Postage & shipping
- Some may qualify for a home office deduction
Self-employment tax – This is like Social Security and Medicare taxes paid by employees and matched by the employer through payroll taxes. Except a self-employed individual pays both the employee’s and the employer’s share, which combined can total 15.3% of net profit.
Self-employment Retirement – Self-employment Income qualifies for IRA contributions and the very popular Simplified Employee Pension Plan (SEP) where a self-employed individual can contribute a tax-deductible amount of 20% of their net earnings to the retirement plan.
Self-Employed Health Insurance Deduction – Most self-employed individuals can deduct as an above-the-line expense 100% of the amount paid during the tax year for medical insurance on behalf of the taxpayer, spouse, dependents, and children under age 27 even if the child is not a dependent. However, this deduction is limited to the net income from the business.
Hobby vs. Business – Whether the activity is truly a business or just a hobby impacts how the income is reported on the tax return, deductibility of expenses (including medical insurance premiums), whether self-employment tax applies, and if contributions to retirement plans can be based on the activity’s income.
As you can see, all of this can become quite complicated and the penalties for not reporting self-employment income can be severe. Please contact this office about what expenses are deductible for your specific type of endeavor and your business filing obligations.
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