A common question popping up right now relates to dealing with 1099 forms. Do you need to only acquire a 1099-K form provided by PayPal or a similar third-party payment processor, or should your client also send your business a 1099-MISC/NEC form?! Since 2020, tax laws and regulations have changed almost every year and this issue is getting really confusing for freelancers who have clients pay through, say, PayPal and then get BOTH forms (one from PayPal and one from their client) by the time they file their taxes.
Dual forms like this, if not handled properly, can show the IRS you are making double your income and then the IRS assumes you should be charged accordingly for your tax liability. For example, if you make $20,000 a year freelancing and all of your clients pay via PayPal, but then they all send you 1099-NEC forms AND PayPal sends you a 1099K form, it appears you are making $40,000 a year. The IRS is going to see the larger amount and tax you on it OR alternatively, audit you because it appears you are underreporting your income.
This is confusing, so let's dive deeper into the differences between the forms.
1099-MISC And 1099-NEC Forms
A 1099-MISC form is probably the form you are used to seeing as a small business owner. Starting in the year 2020, the 1099-MISC form was replaced by the 1099-NEC form for non-employee compensation for self-employed individuals (the 1099-MISC form is still around, it's just used to report miscellaneous income such as rent or payments to an attorney). Under the IRS regulation, any business that pays your business $600 or more for your services should give you a 1099-NEC by the end of January each year! Otherwise, you may be in trouble for underreporting income. If you have a CPA, they help you oversee filing and receiving 1099-NEC forms. They will also check for errors, check for dual 1099 forms, check for S Corps that don’t require 1099s and make sure you are reporting the correct amount of income. HOWEVER, due to the higher use of third-party processors for payments, like PayPal, Venmo, Square, Stripe, Etsy, eBay, and Amazon, the IRS developed a new form to help monitor revenue via electronic payments… and then the laws recently changed surrounding these forms... which is where a big headache has come about for freelancers.
(If you need more information on 1099-MISC/NEC forms, here is the IRS official link!)
As mentioned above, the IRS created a new form—the 1099-K—in 2011 to better record digital purchases that businesses were not reporting. The requirements are different from 1099-NECs as you can earn more money under a 1099-K before reporting it. It used to be that if you earned $20,000 dollars or more via the third-party online platform AND showed more than 200 purchases, the platform would issue you a 1099-K which is how your business would report income to the IRS (this was honestly a crazy, de minimis rule that also was “conjunctive” in legal terms, meaning you had to have both in order to receive a 1099-K form… so many businesses who didn’t meet that threshold simply weren’t reporting income). Luckily for you, these forms are created and sent out by PayPal/Etsy/eBay/Amazon so you do not have to do it yourself.
HOWEVER, once the economy moved rapidly to online purchasing, the government noticed that people were still not reporting income correctly. Fast forward, President Biden signed the American Rescue Plan Act of 2021 (ARPA) into law on March 11th, 2021, which lowered the threshold for 1099-Ks to be issued from $20,000 to $600. Yup, $600 flat! Thus, if the gross payment volume from sales of goods or services in a single calendar year is $600 or more, then the Payment Settlement Entity (PSE) is required to send you a Form 1099-K. Oh, and, “PSEs” under this law also include any third-party payment processor such as Stripe, Square, etc. Although this law was supposed to be implemented by the end of 2022, the IRS announced on December 23, 2022, that due to many concerns regarding this lowered threshold (aka pushback from large third-party payment companies, and IRS agents), the IRS is delaying the implementation of this regulation. The IRS made it very clear that this was only a delay to clear confusion regarding this new regulation but that this change will still be implemented in the future with more details to come. The bottom line is that you likely won’t have to worry about this new regulation until potentially the 2024 tax season. However, some states have implemented their own rules regarding this. Here is a good resource for you to check your own state's regulations regarding this. Be sure to also check with your CPA on whether your state has its own rules regarding third-party payment companies as they will have the most updated information. If you need more information on 1099-K forms, here is the IRS official link!
But Here Is The Problem…
Due to clients and businesses not understanding when to issue a 1099-NEC versus when to only use the 1099-K from the PSE, it's causing large discrepancies in reported income. Some clients understand that everything will be under the 1099-K form, while others believe a 1099-NEC also needs to be issued, regardless of digital or cash payments. So, if your client pays via PayPal you may receive a 1099-K, and then if they give you a 1099-NEC it equally shows the monetary amount… which is double reporting income on your taxes. Now you either have two forms to monitor or none at all, and a misstep in either route can land you in trouble with the IRS. What do you do?! Small business owners cannot afford to pay double taxes or be audited for unaccounted income (we ain't got time for that!). Do not worry, The Legal Paige is here to help!
You can avoid 1099-NEC or 1099-K confusion from clients altogether by changing your payment policy. If you want everything to be recorded via PayPal/Stripe/Square, only accept payments through that platform (aka credit cards, debit cards, or money transfers). If you want to avoid being issued a 1099-K, implement check or cash-only payments. If you are fine with both, you need to clearly state to your clients who pay through PSEs to NOT give you a 1099-NEC form. You can do this by sending them an email at the end of the year informing them and telling them to work with their CPA to not double issue you a form. You can also add in a clause to your contract regarding this issue so your clients know your business policy on this matter.
TLP recommends adding a Working Relationship Clause (aka an Independent Contractor Clause) to your client contracts!
Read about the UPDATE to 1099K Forms HERE.
THIS BLOG POST IS NOT A SUBSTITUTE FOR LEGAL ADVICE. EVERY SITUATION IS DIFFERENT & IS FACT-SPECIFIC. A proper legal analysis is necessary based on your location and contract. Consult an attorney in your home state for advice regarding your contract or specific legal situation.