While exchanging money through a mobile payment service like PayPal, Cash App, or Venmo can seem as simple as exchanging cash, the legal realities behind their use are much more complex.
These apps, which the IRS calls “third-party settlement organizations,” act as liaisons between a payer and payee. By sending or receiving money through one of these services, you have entered into a contract not only with the other party but with the company handling the transaction. These companies have an obligation to the IRS to ensure that all taxable transactions are reported. As the gig economy continues to grow toward its projected $455 billion in revenue for 2023, mobile payment is becoming more integral to the economy, and the IRS’s tax reporting requirements are becoming more stringent.
On this page, you will find a rundown of the various tax laws regarding mobile payment applications, including reporting requirements, exemptions, and penalties. Expertise.com’s lawyer directory can help you find a tax attorney to answer any further questions you may have.
Reporting Threshold for Third-Party Payment Processors
The IRS has different tax requirements for money exchanged as payment for work versus as a gift or reimbursement. Personal gifts are exempt from taxes unless they exceed $17,000 in value annually. However, income is not subject to a similar exemption.
Since third-party payment processors are used for work-related payments and personal exchanges of cash, money exchanged through them might be taxable or nontaxable. While the gift threshold still applies, the IRS has placed much stricter regulations on which transactions users must report.
Previously, a user of a third-party payment processor would only have to report the money they received for goods and services if it exceeded $20,000 and 200 transactions. A new law, which will go into effect in 2024, lowers that threshold to $600.
Starting in 2024, users of Venmo, Cash App, PayPal, and other third-party payment processors will receive 1099-K forms for their business transactions from the previous year. You must itemize your transactions made through these applications to ensure that no nontaxable gifts or reimbursements are taxed. Some platforms give you the option to mark whether or not a payment is business-related or to set up an account specifically for business-related transactions in order to make it clearer which payments are taxable and which are not.
Zelle users will not receive 1099-K forms as that service allows money to be exchanged directly between bank accounts.
Income Tax for Third-party Payment Processors
While third-party payment processors are commonly used for personal exchanges, an employer can legally use them to pay you for your work. You are responsible for the usual income taxes if you receive income through a third-party payment app.
Depending on your tax bracket, income taxes can be anywhere from 10-37% of your earnings. Income that is sent to your Venmo, Cash App, PayPal, or other third-party payment processor account is taxable even if you do not deposit it to your bank account until the next fiscal year.
Gift Exclusion Third-party Payment Processors
Most of the time, personal gifts and reimbursements are nontaxable. While the IRS’s new law means that you may now have to report gifts that you sent through a third-party payment processor, you will most likely not have to pay taxes for those gifts.
The IRS defines a gift as property you give to someone else without getting an equal amount in return, whether through money, labor, or property. You are only obligated to pay taxes on gifts that exceed $17,000 in value per year per recipient. In other words, if you sent $10,000 each to two different friends, you would not have to pay a gift tax. However, if you sent that $20,000 to one friend, you would owe gift taxes for $3,000 at a rate based on your income. If a gift exceeds the exclusion, the gifter—not the recipient—is responsible for paying the applicable taxes.
You do not have to pay gift taxes on charitable donations or political contributions sent through a payment app.
Backup Withholding Requirements for Third-Party Payment Processors
If you accept payment for sales or labor through a platform like Venmo, the IRS requires that you provide your Taxpayer Identification Number or that the platform reserves a percentage of your income for taxes. The second option is known as “backup withholding.” Currently, third-party payment processors have to reserve 24% of payments sent to your account after you pass the $600 threshold.
To avoid confusion, most third-party payment processors allow you to note whether or not a payment is for goods or services. You may also be able to set up a separate business account, which will automatically mark every payment you receive as income. The processor will only withhold 24% of those payments and will exclude personal gifts and reimbursements.
You can claim the withheld money as credit toward your income tax when filing your taxes. You can avoid backup withholding by providing your payment app with your Taxpayer Identification Number.
Third-Party Payment Processors and Independent Contractors
The new reporting requirements for third-party payment platforms can lead to some confusion for independent contractors who use those platforms. Usually, someone paying an independent contractor has to provide that contractor with a 1099-NEC form detailing those payments. At the same time, someone receiving more than $600 in payment over Venmo, Cash App, or another payment platform will now receive a 1099-K form from that platform.
The IRS does not require someone paying a contractor through a third-party application to file a 1099-NEC form. However, you would receive both forms if a client paid you partially through cash, check, or direct deposit and partially through a payment platform.
If you receive both a 1099-NEC and a 1099-K, it is important to compare the two to ensure that you pay the appropriate amount. If you end up overpaying, you can choose to receive a refund or use the overpayment as a tax credit.
Tax Reporting For Zelle Payments
The new reporting laws mean that users of Venmo, PayPal, Cash App, and similar third-party payment platforms will receive 1099 forms if their transactions exceed the $600 threshold. However, since Zelle facilitates direct transfers between bank accounts, the new law does not require that they do the same. Zelle has stated that they will not be sending 1099 forms to users.
This means that if you receive any income through Zelle, you are responsible for reporting it yourself. If you did not receive a 1099 or W2 form for any income, you must report it as self-employment income using a Schedule C form.
What Happens If I Don’t Pay Taxes on Third-Party Payment Processor Transactions?
Failing to pay your taxes on income received through a third-party payment platform can have serious financial penalties. At first, you will only be fined 0.5% of your unpaid taxes per month that they went unpaid, but that penalty will double ten days after the IRS sends you a notice. Failing to report your taxes incurs a fine of 5% of the unreported taxes per month. This fine also covers your unpaid taxes, meaning you will only owe 5% per month on taxes that you failed to report and pay.
Even if you do not owe taxes on your third-party payment processor transactions, you can be penalized for failing to report them. Failure to return important tax information like a 1099 form can be penalized by fines ranging from $50 to $580, depending on how long you take to return the requested forms. If you fail to file your taxes as a whole, you will owe a fine of either 100% of your taxes or $35, whichever is higher.
Do I Need a Tax Attorney if I Didn’t Pay Taxes on Third-Party Payment Processor Transactions?
If you unintentionally fail to report or pay taxes on taxable income, a tax attorney may be able to save you a hefty financial penalty. The IRS offers relief on penalties for taxpayers who fail to pay or report due to human error or extenuating circumstances. A tax lawyer can help you argue for penalty relief.
If you use apps like Venmo to split restaurant bills with friends, to pay a partner or roommate back for groceries, or for any other commonplace transaction as well as for business, you may have to sort through taxable and nontaxable payments. If the IRS incorrectly claims that you owe taxes on any nontaxable transactions, consulting a tax attorney could save you from overpaying and having to wait for a return.
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