What You as a Business Owner Need to Know About the IRS Form 1099-K
Did you receive the IRS Form 1099-K from the payment settlement entities and have no idea how it should be reported? This article contains detailed guidelines to help you understand it.
What is a 1099-K?
According to the IRS:
“Form 1099-K, Payment Card, and Third Party Network Transactions is an IRS information return used to report certain payment transactions to improve voluntary tax compliance.”
Imagine you are a small business owner, who runs a retail business and accepts online payments. You have an agreement with a payment settlement entity either domestic or foreign as a mechanism to receive payments from your customer. You will be a participating payee.
A payment settlement entity can either be a bank or another organization that has the contractual obligation to make payments to you.
The mechanism used can either be a payment card or a third-party.
Payment card:
Suppose your customers swipe their credit or debit card to make a payment. At the end of the tax year, your credit card company (Master Card, etc) will issue the IRS Form 1099-K to you.
Third-party processor:
You may be using an integrated third-party processor like PayPal, eBay, etc. to receive payments from your customer. If there are more than 200 transactions and their value is more than $20000, they will issue you the IRS form 1099-K. These are the minimum reporting thresholds that are valid until 2021.
For the year 2022, the reporting thresholds have been revised. IRS Form 1099-K will be issued if the total value of the transactions exceeds $600, regardless of the number of transactions. This dramatic decrease in the threshold requirement will affect small business owners.
It is important not to confuse IRS Form 1099-K with Form 1099-Misc. Form 1099-K is issued by the credit card companies and third-party processors whereas Form 1099-Misc. is issued to the independent contractor by any business for which they have provided services worth more than $600.
How is it used in tax for retail business?
Broadly 1099-K Form is used for two purposes:
Accountability Tool For Online Business Taxation:
IRS uses form 1099-K as an accountability tool while taxing retail businesses. It facilitates the IRS in determining whether or not the taxpayer has reported their income correctly.
This form is issued to small business owners either with their Social Security number or Taxpayer Identification number.
So when your return is matched against this form and there is a discrepancy, the system automatically generates a notice and sends it to you requiring an explanation for it.
This form helps the IRS to highlight under-reported sales. So if you are a small business that receives form 1099-K from their payment partners you need to factor in all the payments received from the customers via credit card companies and third-party settlement organizations.
If the IRS finds out any discrepancies between the information statement and your reported income or suspects under-reported income you have to face a tax audit. If the audit concludes that you have paid less tax than you owed, the IRS will impose penalties on you.
So if you want to avoid penalties and tax audits then you should ensure that your records are accurate and your income is reported correctly on your tax returns.
Voluntary Compliance:
As this form acts as an accountability tool, it encourages small business owners to voluntarily comply with the requirements of the tax authority.
How do small businesses use 1099-K to report their online business tax?
If you are a self-employed independent contractor, you are required to report your income stated in the Form1099-K on schedule C which is a part of your Form 1040.
You may need to go through your records of receipts for payment cards and Merchant statements to verify that the Form 1099-K is reflecting your income correctly.
There may be situations where you are not able to reconcile your records with the gross payment amount shown on the 1099-K form. Your income may be doubled. The reason can be one of the following listed below.
Error in the Form:
Imagine you file a return for partnership income (Form 1065) or you operate as an LLC and elect to be taxed as C-corporation (Form 1020) or S- Corporation (Form 1020S). You received the 1099-K forms in your name with your social security number.
You should contact the Payment settlement entity to correct the error and have them re-issue the form with your taxpayer identification number. Ask them to save your TIN for the future.
Acquired new business:
You purchased a business during the tax year. You forgot to update the business name and tax identification number associated with the terminal. When you receive your Form 1099-K you see those transactions included in the gross payments that took place before you bought it.
You should contact the payment settlement entity to revise the form and request them to update the information for the future.
Share your credit card terminal:
You have agreed to share your credit card terminal with another business or person so the total gross amount on Form 1099-K will be the sum of the transactions from both businesses.
You need to keep proper records so you can track your business income correctly instead of relying on the 1099-K Form to track your online business earnings.
Doing this will ensure that when the tax authority asks you to explain the discrepancy you should be in a position to provide them with explanations along with the documentary evidence.
Discount or cash-back offers to your customers:
Suppose you offer your customers cashback when they swipe their debit cards for acquiring products. Generally, the cashback is not reported on your income tax return.
However, they will become part of the gross amount received via payment card on the 1099-K Forms. Hence the mismatch. So proper records will help you explain to the IRS the reason for it.
Transformation of business structure:
Imagine you were operating as a sole proprietorship. During the year you decided to turn it into a partnership with your business associate. You carry on using the same payment processor.
The amount of the payments will not match with what is reported in your tax return related to the new entity unless you timely notify your tax identification number and any other relevant changes to the payment settlement entities.
Multiple sources of income:
Suppose you run an online retail business and have one credit card terminal. You also own a property that you have rented out. Every month your tenant swipes his credit card on the same terminal you use for business.
The 1099-K form issued to you will include your rental and business income. However, when you file your return you report your gross receipts from the retail business on schedule C and rental income on Schedule E.
Reporting requirements related to the IRS Form 1099-K can become complex while filing your tax returns. A bit of advice from a tax professional will help you file your return accurately and reduce your tax liability.