An Important IRS Change Affecting Online Sellers

Late in 2021, the IRS announced a change to third-party payment apps like Venmo and PayPal. Financial advice websites were suddenly filled with people asking, "does Paypal report taxes?" and "does this mean there are Venmo taxes now?" What changed is the threshold at which third-party payment apps like Venmo and Paypal have to report the earnings of the people using their apps.

Until January 1 of 2022, third-party transaction apps did not need to report their clients' online selling transactions unless a client made more than $20,000 as a 1099 filer in that tax year, or the client had more than 200 transactions. Now that threshold is reduced to $600.

Does Paypal report to IRS on friends and family?

The change to the IRS threshold has caused a lot of confusion, but the IRS has never required users to pay Paypal or Venmo taxes on payments between family or friends, no matter how big the payments might have been. The new tax laws won't change Venmo taxes or taxes for any third-party payment apps.

So you can still send cash to your nephew graduating from high school, and your best friend can still reimburse you for half of the restaurant check without Venmo needing to report it to the IRS. The new rule is only meant to track taxable income but not money transfers between friends and family.

Why did the IRS change the requirements?

This was one of several changes to the tax code made as part of the American Rescue Plan, which was signed into law in part to address challenges presented by the Covid-19 pandemic.

In a perfect world, this new threshold should not affect online sellers much at all, because it's not a new tax for Venmo and Paypal. It's a change in reporting requirements.

Online sellers have always been required to report their income on their 1099 form at the end of every tax year – whether they were receiving 1099-K forms or not. Until this year, that income wasn't easily verified by the IRS. Third-party reporting on a 1099-K form wasn't required unless a person's income from online sales or services was above $20K.

Because the threshold is significantly lower now, your sales over $600 for those paintings you sell on Etsy will trigger payment apps to report that income to the IRS.

In the IRS' FAQs, the reasoning is that “Third party information reporting has been shown to increase voluntary tax compliance and improve collections and assessments within the IRS.” If you know the IRS is aware of how much you earned, the thinking is that you'll be more likely to pay tax on those earnings.

Does this affect payments using Zelle?

Zelle and its users won't see any change in how they use the app. On its website, Zelle says the new 1099-K law "does not apply to the Zelle Network.”

How do third-party apps know whether payments I receive are business income?

The apps have ways for users to indicate whether a payment is personal or for business by tagging individual payments, and Cash App, for example, has business accounts that make it easy.

If you do use Venmo or Paypal for doing business, you might have also received a notice from them asking you to correctly report your income and confirm your tax information with the app, so that it knows whether to send you a 1099-K when the tax year is over.

Is there an alternative to third-party apps?

Payment apps have revolutionized the way we use money, both when we give it to friends and family, and when we do business. Similarly, the internet has changed the way we buy and sell things, and cash apps make those transactions easier by transferring money without the fees associated with credit card companies.

People might find a way to get around the IRS' new rules, but there are some good reasons to report the income you receive through third-party payment apps.

  1. If you don't report your income, you're breaking the law, and it could land you in big trouble with the IRS. Is it a huge agency with more to do than it can handle? Yes, but the consequences for those who get caught are serious.
  2. Whether or not you qualify for loans depends mostly on your income. The more you make, the more you might be able to borrow, and the better the home or car you might be able to buy.
  3. You can't take advantage of certain tax credits if the IRS doesn't think you qualify. The Earned Income Tax Credit, for example, can be more than enough incentive to report all of your income.

If you're working hard to get by, paying taxes can feel like it shouldn't apply to you, but the choices you make now about income reporting could have long-term effects on your future finances.

FlyFin CPA Team

FlyFin CPA Team

With a combined 150 years of experience, FlyFin's CPA tax team includes tax CPAs, IRS Enrolled Agents and other tax professionals, offering users the most comprehensive tax advice and preparation.

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