Rumors of a new tax rule have spread over all major platforms this past week regarding additional taxation on third-party transactional apps. Social media users say peer-to-peer (P2P) platforms such as Zelle, PayPal, Venmo, and CashApp will face new tax reporting requirements when annual transactions exceed $600. But how accurate is this claim?

  Although there is some truth to the claim, it is not as daunting as it seems. The American Rescue Plan Act of 2021 proposes to lower IRS reporting requirements from $20,000 in aggregate payments to $600 effective January 1, 2022. The aim is to collect unreported income, which the IRS estimates to be nearly $166 billion every year. Before the bill, if a seller using a P2P app receives over $20,000 in over 200 aggregate payments over a year, platforms such as Venmo, CashApp, and Zelle, will send you a 1099k form. The new proposal’s threshold is decreased to $600 in aggregate payments, with no minimum transaction number. Note that states like Maryland, Virginia, and Vermont already have a $600 threshold enacted for P2P apps. 

   If you are a business owner, it’s likely that you already receive a 1099k each tax year from the IRS. The sale of goods or services is considered income, and in the eyes of the IRS, should be reported. However, it’s important to differentiate the difference between taxable income and other forms of payments. Payments made through P2P apps for living expenses such as rent or paying a friend to cover the dinner bill are not taxable income. Your family sending you rent money is also not considered taxable income. Paying your friend back for dinner is considered a reimbursement, while the latter is considered support from your family members. For payments to be considered inflows of income, they have to result from a sale of goods or services in exchange for compensation. Reimbursements for things such as rent is not considered income and therefore are not taxable.

   Let’s clarify what is considered taxable income with an example. Joe is a college student with a corporate job. On the weekends, Joe details cars for extra cash. All of his car detailing transactions occur on Venmo, totaling $2,300 a month in gross receipts. Even though he is working part-time as a W2 employee and is a freelancer on the side, he struggles to pay off his school and living expenses. So to help, his father sends him money through Venmo to help cover his bases. Once his grandparents heard of this, they also decided to contribute. Monthly, Joe’s father sends Joe $1,200 for his rent, and his grandparents send $1000 to cover books and other college expenses through Venmo. On top of that, Joe’s roommate sends his half of the rent also through Venmo. Collectively, Joe’s account is deposited $4,500 monthly through the platform.

   Since Joe meets the $600 threshold for the tax year, he is sent a 1099k form. Within the form, Joe must classify all of his transactions. Otherwise, he is subject to paying the taxes at the full amount. Out of the $4,500 he receives monthly, only his car detailing business proceeds are income and taxable after allowable expenses. The money he receives from his father and his grandparents is exempt from taxation, as it is a gift and not income. His roommate’s contribution to the rent is also not income. Instead of paying the taxes for the total $4,500 of earnings, Joe is only obligated to pay taxes on the income earned from providing car detailing services. 

In the event of an audit, the IRS can claim that the entire $4,500 per month is taxable income.   

     Of course, we now know that this claim is incorrect. Suppose Joe classified all of his transactions from Venmo correctly. In that case, he is only subject to paying taxes on the $2,300 per month earned, less his deductible expenses. Personal loans, gifts, and debt reimbursements have never been taxable, and even with this new proposal, that will not change. What will change, however, is the volume of people who receive a 1099k form. With the threshold dropping from $20,000 to only $600, most people who regularly use third-party transactional apps will receive one. 

    The new proposal, if enacted, will likely affect most people using transactional apps such as Venmo, Zelle, CashApp, and PayPal. Although these platforms are already required to report their activity to the IRS, lowering the threshold requirement from $20,000 to $600 will complicate many people’s taxes. Those who file their own taxes are at risk of either over-reporting or under-reporting their taxes, likely with a heavier emphasis on the latter. Given the additional complexities of this upcoming tax season, it is important to seek the advice of a tax professional when preparing your taxes. For those who have a shared account for personal and business transactions, it’s important to separate the accounts to simplify the classification process during tax season. Such as opening a separate bank account for all business activity, including deposits. 

   A couple of months ago, we published an article entailing the repercussions of a $900 million increase in the IRS budget. The goal of the increased budget is to increase the auditing capacity of the IRS to ensure that the wealthy are paying their fair share of taxes. Make no mistake; however, the increase in audits will not just be directed towards the rich. The unfortunate reality is that everyone will have a greater chance of being audited. On top of the budget increase, this proposal to tax transactional apps will leave even more room for IRS audits. 

   If you are a user of third-party transactional apps, you will likely receive a 1099k form to classify your transactions, given that this proposal is enacted. With the exponential increase in potential audits, consulting your local tax advisor regarding your tax filings this tax season is more important than ever. With the help of a tax professional, you can put yourself in a better position in the event of an audit. Here at Mendoza & Company, we work in favor of you and not the government. Given the uncertainty and increased power of the IRS this tax season, it is pertinent to file your tax returns correctly and with certainty.