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New IRS 1099 Rule for PayPal and Venmo Targets Very Small Businesses and Will Cause Misreporting and Errors

The IRS recently announced that payment apps such as PayPal, Venmo and CashApp will be required to issue 1099s to small businesses and self-employed persons. The problem is these taxpayers don't have accounting departments and professionals to rely on.

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The IRS recently announced that payment apps such as PayPal, Venmo, and CashApp will be required to issue 1099s to small businesses and self-employed persons. Here's what you need to know.

New rule is targeted at very small businesses and individuals with a side hustle

Starting in tax year 2022, payment apps will be required to report to the IRS total payments received by a business account in excess of $600 annually. This new requirement is clearly targeted at the smallest of small businesses and at individuals with a side hustle, as the prior rule only required a payment app to report when an account received more than $20,000 and had 200 or more transactions within the year. These micro-businesses that collect less than $20,000 a year previously did not fall under the 1099 rule, but will now be treated like every other business, large or small.

Related: Venmo Built Crypto Trading Into Its Payments App

A small business, including an individual with a side hustle, must report its income received regardless of whether a 1099-K was issued from a payment app. This is something that companies large and small have dealt with for years from payment apps and credit-card processors. However, these very small businesses that are now subject to the new rule do not have their own internal tax departments or a CPA who prepares their taxes to help them wade through numerous income issues and questions that arise when receiving a 1099-K.

Small businesses worry about two 1099s being reported for the same income

Ignatius L. Jackson, a Phoenix CPA, worries that the income will be counted twice if payment apps "send a 1099-K to a small business for payments received and the business that makes the payment will also send a 1099-NEC, basically double counting the income." Consider a graphic designer who does part-time freelance work and who is paid $3,000 by a single customer for their work via PayPal. The freelancer will get a 1099-K from PayPal for the $3,000 and will also get a 1099-NEC from the business customer they did work for in the amount of $3,000. Because two 1099s are reported, it appears that the freelance graphic designer made $6,000. The IRS is actually instructing businesses to issue a 1099-NEC to contractors they pay even though they know the contractor will also be receiving a 1099-K from their payment app. The IRS is requiring two 1099s in this instance, and it's going to cause confusion and overreporting of income for self-employed persons and very small businesses.

While proper accounting procedures and bookkeeping can help avoid the double counting of income, self-employed persons with a side hustle, freelancers and the smallest of small-business owners simply don't have the resources or technical expertise to catch these accounting details and will be left doing their taxes with multiple 1099s reporting the same income. Mr. Jackson says, "I foresee it will be a disaster when these 1099-Ks start being sent and will likely result in taxpayers having to pay someone to help them with their tax returns, when they could normally do them on their own."

Concerns over personal payments being misreported

PayPal and Venmo have two different account types: personal and business. Presumably, they will only be reporting 1099-Ks on business accounts and business owners can establish a separate business account and can have their customers pay that account. Despite the two-account option, it's going to be very common for business owners to receive personal payments in their business accounts, and those amounts will get included on their 1099-K to the IRS.

The examples are endless and happen in some of the most common self-employed situations. Consider a hairstylist whose who goes out for drinks with a friend who is also a client, and that friend ends up splitting costs for drinks and pays her hairstylist friends business account. Or consider the childcare provider who is paid $7,000 a year for their services but also incurs and is reimbursed another $2,000 over the year for gas or food that is bought to care for the children. If the childcare provider is paid via Venmo for the entire $9,000 for the year, their 1099-K will reflect $9,000 in gross income, and not $7,000 that is the taxable part of the payments. These self-employed persons and taxpayers can certainly deduct the travel and food costs as expenses to income, but it will create a significant record-keeping burden on them to verify the amounts reported on their 1099s to ensure that they aren't reporting more income than they received.

Related: Visa, PayPal to Allow Customers to Pay With Cryptocurrency

Tips for following the new Venmo/Paypal rules

Small businesses who will begin receiving 1099s under the new rules should keep in mind the following three key tips to avoid overreporting of income on their taxes.

  1. Separate your business and personal account payment apps. Small-business owners and self-employed persons should use a separate business account for their business activities. They should only use that payment account for business income and expenses, and it should be tied to their separate business-checking account. They need to be careful not to receive personal reimbursements and funds into their business- payment account, as those amounts received will end up on their 1099-K that's reported to the IRS.
  2. Track expenses and reimbursement amounts. Keep good records of your business expenses and amounts you are paid that are reimbursements of costs you covered for your customer. These amounts are used to reduce the gross income reported to the IRS via a 1099-K, but you've got to keep good records and need to track these items in order to deduct them.
  3. Don't double count income on 1099s. There will be numerous instances where a self-employed person who provides services to a business customer will receive a 1099-K from the payment app and they will also receive a 1099-NEC from the same customer for the same payment. Self-employed persons and small businesses using payment apps need to ensure that they do not count these amounts twice on their tax return and need to track their business income carefully so that they don't get taxed twice on the same income. Don't just rely on the 1099s themselves to track your income. They can result in overpayment of taxes as the payment app has to report the payment, and so does a business customer who is paying the small business or freelancer.

These new rules will certainly create new headaches, but as with anything else, stay up to date and do your due diligence and they don't have to cause undue pain.

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