The Sharing Economy, The Tax Gap, and Reporting Requirements

Companies should take note of shifting 1099-K thresholds at the state level.

The explosive growth of the “sharing economy” — including peer-to-peer business transactions for goods and services — has attracted attention from governments looking for their piece of the market, which is estimated to grow to $335 billion by 2025. 

These businesses may have become accustomed to the high federal thresholds on the 1099-K, which reports Payment Card and Third Party Network Transactions, but need to be mindful as states adjust their own thresholds to close their budget gaps and increase reporting levels.

The 1099-K

The 1099-K debuted in 2012 as a response to the burgeoning sharing economy. Businesses ranging from credit card companies to sharing economy businesses (e.g. AirBnB), to payment facilitators (e.g. Paypal) must all issue 1099-Ks for their payees if they qualify based on the instructions and current federal thresholds.

The applicable thresholds for the 1099-K covers a wide range of payments. Companies that manage payment card transactions, like credit card companies, have no applicable threshold and are required to report all amounts paid. Third party network transactions, on the other hand, have a significantly higher threshold than payment card transactions AND other 1099 forms: most notably, the 1099-K third party network transaction threshold dwarfs that of the 1099-MISC, a form that also occupies the sharing economy space. Rather than employing a lower threshold of $600 like the 1099-MISC (or no threshold like Payment Card Transactions), the 1099-K employs a much higher threshold in excess of $20,000 paid AND more than 200 transactions per payee within a calendar year for third party network transactions.

The 1099-K Threshold’s Effect on the Tax Gap

While independent contractors typically receive a 1099-MISC from the payor, the payments to participants in the sharing economy are typically reported on the 1099-K. With such a high reporting threshold for third-party network transactions, many payees are not required to report their transactions and resulting income, which leads to under-reporting or a complete omission. An IRS study found that taxpayers skipped reporting on only 7 percent of their income ($15 billion) if the IRS received notification of payment. However, when no notification was issued, 63 percent of income ($136 billion) went unreported.

While this could simply be attributed to greed, it is more likely the consequence of a confusion, a lack of education relating to reporting obligations, and understanding valuable write-offs. The 1099-K reports gross amounts paid, which does not necessarily match what a payee sees after taxes and fees: this discrepancy has the potential to discourage reporting if a filer is unaware of how the change occurred. Also, many micro businesses or sole proprietorships are not necessarily aware of certain valuable write-offs from which they could benefit, which could result in an obligation to report income for the sake of consistency in records.

           The maintenance of such a high threshold for required reporting ignores a large percentage of businesses. While these transactions seem inconsequential on an individual scale, their accumulated value is a critical and untapped resource for governmental revenue.

States Look to Fill the “Reporting Hole”

The high threshold requirements for Form 1099-K creates a “reporting hole” between it and the $600 threshold on the 1099-MISC. While voluntary steps by larger organizations are a good start, there is no imminent change on the horizon from a federal perspective. However, states are beginning to take steps to use this resource to bolster existing budgets.

Governor Charlie Baker of Massachusetts released his budget proposal for FY 2018 back in January 2017, which includes a requirement for credit card companies to report 1099-K income to the state when an individual earns more than $600 from credit or debit card transactions in a calendar year. Governor Baker seeks to close the reporting hole left by the high 1099-K threshold, thus increasing reported income and the number of forms required to do so.

This is further bolstered by the Massachusetts House Ways and Means Committee’s budget released in April 2017, in which the Department of Revenue is given broader discretion in requiring additional reporting from credit card and third party processor transactions using 1099-K forms. If approved, this will not only increase the number of forms reported in Massachusetts, but could also potentially increase revenue for areas in dire need of taxpayer funding.

Other states are also looking towards the 1099-K as a reporting asset for tax revenue generation. The Vermont House Ways and Means Committee is currently considering a bill that would institute the $600 threshold on third-party payment transactions like those done through PayPal. This would have a similar effect on reporting requirements on a state level in Vermont, which is seeking to generate an additional $5 million to begin closing its own tax gap.

While this trend is still emerging, it is a logical step toward closing an otherwise neglected reporting hole created by the 1099-K threshold. This would generate much-needed revenue for states while creating additional complexities in reporting as states adopt different requirements.

Looking Forward

While the IRS has not indicated any changes to elevate reporting standards or close loopholes related to thresholds, adjustment on the state level is beginning to gain traction as states aim to close their budget gaps and increase reporting levels.

This trend is likely to catch on nationwide if current models are successful because the sharing economy is an untapped resource that is likely to continue with positive growth. This will lead to an inevitable demand for compliance in reporting, and business leaders should consider which steps they can take to adapt for the future.