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Running a small business is stressful enough without any nasty surprises. The last thing you want when you’re worried where your next gig will come from and if that one guy will ever pay you is to have a monkey wrench thrown in your well-oiled machine at the last minute!
Unfortunately one place you’ll probably always get a nasty shock is with your taxes. Taxes for freelancers are generally way more confusing than everyone else just because you have to do so much legwork. And now, the IRS has introduced the form 1099-K, making tax time just that much more difficult!
What is the 1099-K? Well we’re glad you asked, because we’re here to help you out. While at first glance the 1099-K sounds complicated and seems like a giant monkey wrench for your taxes it’s actually not a huge problem. Let’s go through it.
What is the 1099-K?
The 1099-K came about because of a “tax gap” between the income that people were actually earning and what they were reporting on their taxes. It turns out some unscrupulous or just plain unknowing people were failing to report and pay taxes on the income they made. One way they were collecting this underreported income was via online payment processors like PayPal.
The IRS has long known about the huge disparity between how much reported income should be coming in from freelancers, online sellers and other small business owners and how much actually was coming in. And a 2008 law allowed them to try to tax some of this unreported income by mandating that online payment processors like PayPal report all income earned through their systems.
Starting in 2012, online payment processors were required to report each of their customers’ income to the IRS. Many small business owners saw 1099-K’s arriving in their mailboxes in early February 2012. Not only did they arrive in small business owners’ mailboxes, they arrived at the IRS, too. Now the IRS has a record of how much income you made via PayPal or other online payment processors, where before they could only guess.
Who Gets Form 1099-K?
Before you start panicking though, there is a caveat. The law that brought us 1099-K is only designed to go after larger online sellers, who make quite a bit of money through electronic means. Therefore you have to meet some conditions before receiving a 1099-K:
- Make over $20,000 in the calendar year from the payment processor
- Make that amount in over 200 transactions with the payment processor
Many service providers may hit the $20,000 threshold but not the 200 transactions. On the other hand, ecommerce sellers might sell 200 items, but never make the $20,000. Only if you meet both criteria will you receive form 1099-K in the mail in early February.
What Do I Do if I Get a 1099-K?
First off, don’t panic. The 1099-K only confirms the income you were already making. It doesn’t denote new taxes.
Second, check the 1099-K against your own records. We recommend setting up a free Outright.com account and importing all of your income and expenses. From there, you can see if the 1099-K matches up with the income you’ve recorded. After all, even the big payment processors can get it wrong sometimes.
Finally and most importantly, make sure you have recorded every single business expense you had over the year. While the 1099-K reports how much income you made to the IRS, it doesn’t report the expenses that you can ultimately claim as tax deductions to lower your tax burden. If you don’t keep track of all of your business expenses (including saving the receipts), then you may end up paying more to the IRS than you actually owe. And nobody wants that!
The 1099-K is a tool to catch tax dodgers, not to cause honest people more grief. If you keep up with your income and expenses, the 1099-K will become just another small part of your usual tax time routine.
Have more questions about 1099-K? Ask your tax questions over at the Outright Community!