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It's time to start thinking about tax season, especially if you have a complicated return or earn income through a side hustle. And if your freelance gig paid you via Venmo, CashApp or PayPal this year, you'll get a tax form reporting those earnings.
Starting this year, third-party payment platforms are required to deliver a 1099-K to all users who made more than $600 in freelance or business income in 2022, according to a tax reporting rule from the IRS. That's a dramatic change in income threshold. Previously, digital payment platforms were only required to send a 1099-K if you had over 200 business transactions totaling more than $20,000 in earned income for the year.
Today, the average side hustle pulls in $12,589 annually, and many Americans get started with a business idea through these freelance gigs and odd jobs. Even if you never form an official business, the IRS still classifies you as a business for reporting purposes.
This means freelancers and side hustlers will need to be extra vigilant about compliance, according to Wendy Walker, a member of the Internal Revenue Service Advisory Council and solutions principal with Sovos, an enterprise tax compliance consultancy. The IRS received nearly $80 billion from the Inflation Reduction Act, mainly for tax enforcement -- that is, identifying and collecting unpaid taxes and "closing the tax gap," said Walker.
Keep in mind that the digital payment platforms are reporting transactions to the IRS in their own filings, so a red flag will go up if the income is unreported on your end. "Unless your neighbors are handing you cash for cutting their lawn, the IRS is going to know, because the activity is reported on official reports from Venmo and CashApp themselves," said Krystal Pino, certified public accountant and founder of Nomad Tax, a tax consultancy for digital nomads. If any business activity is happening, the tax agency is aware of it.
Here's what to know about the 1099-K, how to report your Venmo, CashApp or PayPal earnings and how to avoid tax mistakes, getting audited or hefty penalties.
Read more: Best Tax Software for Self-Employed
What to know about the 1099-K form
The 1099-K is one of many types of 1099 tax forms that are used to report nonemployment income. It's a specific reporting document for anyone who uses a peer-to-peer, or P2P, payment platform -- such as PayPal, Venmo or CashApp -- to receive payments for goods or services, and is sent by the platforms themselves, according to Kathy Pickering, chief tax officer at H&R Block.
Some other types of 1099 forms you might be familiar with are:
- 1099-INT: Documents interest income, such as interest earned from a high-yield savings account.
- 1099-NEC: Documents earned income you made as an independent contractor via cash, check or direct deposit.
- 1099-MISC: Documents miscellaneous income, such as rent from a rental property or prize money.
- 1099-R: Documents income that came from an IRA distribution or a pension.
A 1099-K form can be a bit tricky for anyone who has never reported nonemployee income before, according to Walker. Because the 1099-K reports only gross amounts and not net transactions, you might see discrepancies between what the 1099-K says you made and your actual take-home income. The earnings reported on the form do not factor in business expenses, such as payment processing fees or equipment, which you may be able to itemize as deductions to lower your overall tax burden.
"You shouldn't technically take the amount on the K and put it on your tax return, despite the fact that 90% of taxpayers do that," said Walker.
For example, if you're paid by a vendor that charges a processing fee, you could receive a smaller payment than the total you billed for, say $500. If the platform charges a 2.70% processing fee, you would only receive $486.50. Your 1099-K could reflect the full $500, which you would report, but you should be able to deduct platform processing expenses.
Get organized to simplify your self-employment tax return
In recent years, online platforms like Venmo, CashApp and Paypal have emerged as an easy way to exchange money for services, facilitating the point-of-sale process for side hustlers and business owners alike. (Note: Venmo is owned by Paypal, and CashApp is owned by Block Inc., the company formerly known as Square.)
The platforms have added features to help users distinguish between business and personal transactions. You'll want to familiarize yourself with these tools if you plan to use an app for both business and personal payments throughout the year. According to a PayPal spokesperson, both PayPal and Venmo payments between two consumer accounts default as a Friends and Family transaction, ensuring they are not taxable or reportable to the IRS.
It's also a good idea to log your transactions in some way -- whether that's a Google sheet, free accounting software or through QuickBooks, which lets you integrate PayPal and Venmo -- so you have your own records, according to Pino. "The sooner you can get organized, the more helpful for yourself it's going to be when it comes tax time," she said.
The same goes for tracking business expenses that you'll need to deduct, according to Jessica Shults, a New York-based hair stylist of over 20 years and owner of Twisted Scissors Salon. Prior to opening a brick-and-mortar location, Shults used Venmo as her payment processor and maintains her account for out-of-salon bookings, such as weddings. Rather than trying to compile everything later, Shults keeps a record of everything she purchases that is related to her business transactions.
How to report taxes on earnings from Venmo, Paypal and CashApp
To recap, you'll receive a 1099-K from Venmo, PayPal, CashApp or other payment processing apps if you conducted more than $600 in business activity in 2022. All 1099s are required by law to be distributed to recipients no later than Jan. 31.
Your freelance, side hustle or independent contractor income is subject to self-employment taxes, which means you'll likely have a higher tax bill. You'll be classified as a sole proprietorship, the simplest business formation, and you'll report your business earnings by attaching a Schedule C form, which documents both your income and expenses from all your business-related activities for the year. Your 1099-K earnings should be reported on the Schedule C, which then gets added to your personal tax return before you file.
How to avoid penalties when reporting 1099-K earnings
Remember that the platform is reporting your activity to the IRS, so if your business earnings are significantly different from what the platform reported, you're more likely to get audited. You could also end up paying penalties if your information is reported incorrectly or if you underpay your taxes.
If you haven't been separating or categorizing your third-party transactions as you go along, you might find some personal transfers as part of your 1099-K. If you spot personal payments on your 1099-K, like money sent by a friend to cover their portion of the dinner bill, the IRS recommends reaching out to the payment processor to report the issue and request a corrected 1099-K. You can find the processor's contact information in the top upper left-hand field of your 1099-K. If you do not receive a correct 1099-K in time, you can attach an explanation of the error along with your tax return.
Second, anyone with a side hustle or self-employment income should pay estimated quarterly taxes as they earn income throughout the year. If you did not make estimated tax payments in 2022 (or if you underpaid), you could get hit with an IRS penalty. Making payments in 2023 can help you avoid this penalty in the future. (Note: they're due on April 18, June 15 and Sept. 15 in 2023 and Jan. 15, 2024.)
To ensure your self-employment taxes and payments are squeaky clean, it may be time to start working with a tax professional, particularly if you plan to maintain a side hustle or small business in future years. An accountant or other tax professional can help you stay tax-compliant, while making sure you take advantage of any relevant deductions and credits to lower your tax bill. By taking proactive steps now, you'll be in a better position for tax season.
Correction, 9:56 a.m. PT: A previous version of this article incorrectly stated how much the IRS received from the Inflation Reduction Act. The correct figure is $80 billion.