Individuals and small businesses that work as contractors should take notice of recent changes to Form 1099-K, which will sizably increase reporting on self-employment income to the IRS, beginning in 2022.
The threshold for reporting electronic payment transactions is decreasing from $20,000 to $600.
Historically, these contractors received a 1099-MISC from a business if the business paid them $600 or more in a calendar year. This would include payments by cash, check, or ACH. (Note: the 1099-NEC recently replaced the 1099-MISC for the purpose of reporting self-employment income.)
However, certain electronic payment processors (Paypal, Zelle, etc.) were also required to report payment transactions totaling $20,000 or more on 1099-K. As a result, to avoid confusion from income being reported twice, payments made using one of the electronic payment processors are not reported on 1099-MISC or 1099-NEC.
This created a strange scenario where if a contractor was paid, for example, $4,000 by check, the income would get reported to the IRS. However, if the same contractor was paid $4,000 via PayPal, the income was not reported, because it was under the $20,000 reporting threshold.
Beginning in tax year 2022, the $4,000 paid via PayPal will be reported to the IRS on 1099-K.
The compliance takeaway: individuals, freelancers, and small businesses need to make sure they are incorporating 1099-K into their annual tax review and preparation. If business revenue reported on your tax return is less than the amount reported on 1099-K, this will raise a red flag and potentially lead to additional IRS scrutiny.