The number one question received during 2021 Fall Tax School was “how do I handle the changing rules for Form 1099-K for clients?” Below I’ve outlined some background information and suggested steps and guidance.
Enacted by the American Rescue Plan (ARPA) this past March, the issuance requirements for Form 1099-K are being greatly reduced from $20,000 down to $600. (PL 117-2, §9674). (I am not including a link to the instructions since they do not reflect the ARPA changes). This means we could be seeing nearly all our clients potentially receiving these income reports starting a year from now.
Form 1099-K is issued by third-party settlement organizations such as PayPal, Venmo, ebay, etc.
The problem for all of us mousers (recall the definition of M.O.U.S.E. found in the November 15 blog) is what to do when our clients start receiving Form 1099-K.
For those of you who are outside Illinois, the federal law applicability begins next year, 2022, so you won’t be seeing a great number of the 1099-Ks until 2023. However, many states such as Illinois lowered the required filing threshold beginning in 2020 so we here in the Land of Lincoln are already aware of the new requirements.
What should you do with a client who receives a 1099-K?
Follow my thought pattern:
- Don’t ignore your client’s receipt of a 1099-K. Unless you enjoy answering IRS correspondence, these forms need to be addressed.
- Discuss with your client why they received the form. If they (and you) conclude they are in the active conduct of a trade or business, review with them the tried and true nine factors to determine if an activity is engaged in for-profit:
- Is the activity carried out in a businesslike manner and the taxpayer maintains complete and accurate books and records?
- Does the time and effort the taxpayer puts into the activity show they intend to make it profitable?
- Does the taxpayer depend on income from the activity for their livelihood?
- Are any losses due to circumstances beyond the taxpayer’s control or are normal for the startup phase of their type of business?
- Does the taxpayer change methods of operation to improve profitability?
- Does the taxpayer and their advisors have the knowledge needed to carry out the activity as a successful business?
- Was the taxpayer successful in making a profit in similar activities in the past?
- Does the activity make a profit in some years and how much profit does it make?
- Does the taxpayer expect to make a future profit from the appreciation of the assets used in the activity?
This discussion should be conducted with a client each year to determine if their activity is, in fact, engaged in for-profit. The determining factor shouldn’t be because a Schedule C was filed last year.
- So, what do you do if you determine the client is not in the active conduct of a trade or business? Don’t forget the first point I made which is to not ignore the 1099-K. I am fearful that 100% of the time a 1099-K is issued to your client the IRS will be looking for a Schedule C to be completed. Therefore, my mouse-trap-avoidance advice is to include the 1099-K information as gross receipts on a Schedule C, then enter the same amount as other expenses, indicating the activity is not engaged in for-profit and where the 1099-K is being reported on the tax return. An example of the wording on Schedule C might be, “Activity not engaged in for-profit, See Form 1040, Schedule 1, Line 8”.
- The next step is to determine if your taxpayer is conducting a hobby, or perhaps is the unfortunate recipient because they just sold some “stuff” such as many persons do through yard sales or through ebay.
- If the activity is in fact a hobby, I suggest the income be reported on Form 1040, Schedule 1, Line 8, reported as “Hobby Income”. It is important to remember that hobby activity may not report a loss. However, your taxpayer can deduct a reasonably and consistently allocated cost of goods sold. Create a statement for Schedule 1, Line 8, with the first line being the income and the second line being the cost of goods. The result may be net taxable income (not subject to self-employment tax, or zero, but again you may not show a loss).
- If the activity is from the sale of personal property as I described such as yard sales or via ebay, I suggest using Form 8949 (which carries the result to Schedule D) checking Box ‘B’ for short-term transactions, or Box ‘E’ for long-term transactions. The sale proceeds should match to the reported amount on the 1099-K. The basis reported should not exceed the proceeds as we can’t take a loss on the sale of personal property.
- If your conversation results in a conclusion that the property in question was being held for investment, then you might report gain or loss, but be sure to document the reasons for your conclusion.
Stay thirsty for knowledge, fellow “mousers”.
Tom O’Saben, EA.