Today we welcome first-time guest blogger Nicole Appleberry. Professor Appleberry directs the Tax Clinic at the University of Michigan Law School, and she is also of Counsel with Ferguson, Widmayer & Clark PC. In this post she explains how the Forms 1099-K reporting requirements impact low-income taxpayers, and she brings us up to date on new IRS FAQ. Christine
It is a truth universally acknowledged (by tax professionals), that a taxpayer in possession of any income, from whatever source derived, may be in want of a tax advisor. The money is gross income under IRC 61, and tax may be due if it survives the narrowing of this broad river through a series of exclusions and deductions to the narrower stream of taxable income, and then pools above the levels where income and self-employment tax kick in. Along the way, another truth is self-evident: it is a good idea to keep meticulous records, as one generally has the burden of proof to show why all that income isn’t taxable. This could be because it’s excluded (like gifts and inheritances) or reduced by deductions (such as eligible business expenses that have been documented to the extent required).
The lay taxpayer public, who have generally not fully explored the “Internal Revenue Code and its festooned vines of regulations” (Bayless Manning, Hyperlexis and the Law of Conservation of Ambiguity: Thoughts on Section 385, 36 Tax Law. 9 (1982)), sometimes has its own set of tax “truths.” For example, that income is only taxable (and self-employment tax only applies) if you think you’re running a real business, not just a side hustle. If there’s enough cash for it to feel significant in your life. If the IRS finds out about it.
read more...There is, of course, much overlap between the professional and lay conceptions. Unfortunately, however, it is not perfect. Hence the common scenario faced by Low Income Taxpayer Clinic clients across the nation. They drove for Uber, Lyft, or DoorDash. Or maybe they used eBay to sell household items that would have otherwise been offloaded in a garage sale. In any event, they surely didn’t keep complete records showing mileage, basis, or anything else helpful. And just as surely, they didn’t report any of the income on their Form 1040 and were shocked when the IRS nevertheless found out and proposed a tax deficiency.
In the clinics, our job has generally been to search out ways to substantiate any business expenses and prove them to the IRS through whichever procedure is still available (responding to an audit, filing an appeal with the IRS Independent Office of Appeals, litigating in Tax Court, or down the line, submitting an audit reconsideration or an OIC Doubt as to Liability).
These cases have not, however, overwhelmed our clinics because there has been a limit to when the IRS finds out about certain kinds of income. IRC 6041A requires that any business that pays someone $600 or more for their services must file a reporting form (a 1099-MISC through the 2019 tax year; a 1099-NEC thereafter). This catches some folks, yes. But it’s limited because it doesn’t cover individuals who pay other individuals (such as when you hire your teenage neighbor to mow your lawn), and it doesn’t cover payments for goods (as opposed to services).
So the real juice is in IRC 6050W, which addresses the responsibilities of Payment Settlement Entities (PSEs). These are credit card companies and “third party settlement organizations” (TPSOs), which are the businesses like eBay, PayPal, Etsy, etc., that act as intermediaries, ensuring that providers of goods and services get paid by the unrelated purchasers. (Companies like Zelle, who effectuate electronic payments without a contractual relationship with the payees, are not TPSOs.) These PSEs have been required to issue a 1099-K when the year’s worth of payments to someone aggregated to more than $20,000 and there were more than 200 transactions. So, pretty weak juice, actually. It snares some, but still let many oblivious taxpayers proceed with their side gigs, free from unpleasant tax consequences (unless they lived in one of the 9 or so locations that had already imposed lower limits for state income tax purposes).
This little loophole came to an end with the American Rescue Plan Act of 2021, which changed the reporting limit to situations where the aggregate is more than $600, regardless of the number of transactions, initially effective for the 2022 tax year. It was done with little fanfare, and LITCs have been bracing themselves for the surge of new cases.
There’s a whole host of people who might be surprised. To be sure, the people with still-pretty-small side gigs. The new de minimis limit particularly stings because the IRC 6050W regulations provide that what counts are the original payments. Adjustments for credits, refunds, processing, service, or shipping fees are not taken into consideration. Say someone was paid $610, but fees and refunds take them down to $300, and after cost of goods sold they’ve only netted $100. They are likely to think they didn’t even make enough to owe self-employment tax, but if they don’t proactively report the situation on their 1040, the IRS is going to think that they owe both income and self-employment tax on the transaction (for the former, assuming that they have enough other income to lift them above the standard deduction).
There will also be people caught by the new rule who didn’t think they were operating businesses at all – like the folks replacing their garage sales with Facebook Marketplace, who most certainly don’t have documentation for their basis in the items sold. Or those who had enough friends inadvertently tag the Venmos for their share of meal or gift expenses as “goods and services” instead of “friends and family.”
We also expect to see at least some cases from situations where employers pay independent contractors for services using a TPSO. When both a 1099-NEC and a 1099-K might be appropriate, only the 1099-K should be issued. But small employers accustomed to issuing 1099-NECs may continue to do so, causing the income to be reported to the IRS twice.
All of this is compounded by what we see in the LITCs: many people don’t get their mail, don’t open scary-seeming mail (and anything from the IRS definitely counts), or ignore any tax forms or notices they don’t understand, hoping that they’re not important.
Fortunately, we have one more year to get the word out and bring our professional and lay truths closer together. On December 23 the IRS issued Notice 2023-10 (blogged by Christine here), announcing that they are delaying the implementation of the reporting requirement until tax year 2023. A week later, they also updated their FAQs in Fact Sheet FS-2022-41.
The new FAQ provide more information about how to report the sale of personal items. The FAQ are quite detailed and will be helpful for those taxpayers who do get their notices, do read them, and are capable of navigating their way to the IRS website. So, all you wonderful tax advisors: time to help get the word out!
There are at least two axes (in the x, y, z mathematical sense) on which this needs to be recalibrated. First, the amount and volume needed to require a 1099-K. Maybe “$20K and 200 transactions” is too high a bar, but “$600 before fees and refunds, even for 1 transaction” is too low a bar. Second, qualitatively. If you sell merchandise from your house regularly, whether retail or wholesale, you are in business and reporting is appropriate; if you do a garage sale every year or three, you should not report and, frankly, the income should be exempted from tax (which could require an amendment to section 61 unless the IRS published a Rev. Proc. allowing you to claim a safe harbor basis equal to value for any item or set of items sold in casual sales for an annual aggregate amount of under, say, $5,000).
I and, I am, sure others enjoyed your first sentence homage to the first sentence of Jane Austen’s “Pride and Prejudice” (“It is a truth universally acknowledged, that a single man in possession of a good fortune, must be in want of a wife.”). Judge Holmes made a similar homage as the opening of his estate and gift tax opinion in Estate of Hurford, T.C. Memo. 2008-278 (“It is a truth universally acknowledged, that a recently widowed woman in possession of a good fortune must be in want of an estate planner.”).
That’s great! I didn’t realize. But it was a great first sentence to a book, and I’d bet has been riffed on many times over the past 200 years!
Some tax practitioners are known for playing the game of “trick the IRS computer” –- avoiding a CP2000 notice by adding non-income items to a return in one place, then subtracting them out in another even when not an allowable deduction. Now, for the first time, IRS is playing the game itself.
Consider the IRS FAQ on how to report the sale of a personal-use item. You might think this should go on Schedule D, like the sale of a personal residence. But the trick now is to add the proceeds to income, then subtract an equal amount as an adjustment:
“In the example of the refrigerator sale above, if you received a Form 1099-K for $600 for the refrigerator for which you originally paid $1,000, you should report the loss transaction as follows:
Form 1040, Schedule 1, Part I – Line 8z, Other Income. List type and amount: “Form 1099-K Personal Item Sold at a Loss …. $600” to show the proceeds from the sale reported on the Form 1099-K and,
Form 1040, Schedule 1, Part II – Line 24z, Other Adjustments. List type and amount: “Form 1099-K Personal Item Sold at a Loss…. $600” to show the amount of the purchase price that offsets the reported proceeds. Do not report the $1,000 you paid for the refrigerator because the loss on the sale of a personal item is not deductible.”
How will this procedure affect the selection of returns for audit, which in part may rely on gross income and quantity of adjustments? How will it affect state income tax returns that pick up selected line items from the 1040? If the refrigerator is sold the old-fashioned way, at a garage sale, are taxpayers not in compliance if they do not report it the same way also?
These questions were not asked last night in the House debate over repeal of the IRS appropriation to hire the mythical army of 87,000 agents. But maybe they should have been.
We need a new form or schedule for 1099K transactions?
Great post. I was part of the team at Joint Committee on Taxation that developed 6050W enacted in 2008. We put the $20,000 gross sales and minimum 200 transactions thresholds in the original statute precisely to avoid the situtation that the IRS now finds themselves in. These thresholds were created as a rough rule to filter out persons in a trade or business (more than $20,000 in sales and 200 transactions) from persons emptying out their attic on eBay. People in a trade or business are much more likely to have the necessary books and records, persons emptying out their attic not so much. The reason we rejected the general rule under 6041 of $600 was because the IRS would be flooded with millions of 1099-K forms that would be useless for information return matching because there would be no income associated with the gross sales amounts. Useless information returns are bad for tax administration, so we set the income and transaction tests high.
Thanks for the historical context, Michael!
I too would like to welcome Ms. Appleberry to this blog. Having presented to her LITC students several times I would enthusiastically commend her for running a great program in Ann Arbor! It was always a great thrill to visit the Law Quad and work with her students who genuinely strove to assist those in need.
Aw thanks, Greg! We loved having you visit our class!
RE: 1099-K Someone needs to look into this. I feel it is unfair and possibly illegal for the IRS to include elderly people drawing social security. These people are allowed by law to earn extra up to a certain amount without being taxed for it. However, the IRS requirements of the 1099-K want to tax any income over $600 they will get from selling personal items they have accumulated. This makes no sense at all. I am not a lawyer, but I do have common sense.