Payment Settlement Entities and IRS Reporting Requirements

Payment Settlement Entities and IRS Reporting Requirements

May 3, 2022
Payment Settlement Entities and IRS Reporting Requirements
The Internal Revenue Code (IRC) requires entities making
Reporting Requirements for Payment
certain types of payments, including wages paid to
Settlement Entities
employees and business payments to contractors, to file
Generally, merchant acquiring entities are required to file a
information returns with the Internal Revenue Service
Form 1099-K with the IRS (and send a copy to the
(IRS). Information returns are intended to improve
taxpayer) reporting the gross amount of reportable
voluntary compliance with tax law by providing
transactions for all payees. There is no de minimis
information about potentially taxable transactions to the
exception.
IRS and taxpayers.
Starting in 2022, third party settlement organizations are
The information reporting requirement for certain
required to report to the IRS the aggregate amount of
transactions processed by payment settlement entities has
payments to users that exceed $600 in a calendar year. This
been of legislative interest in the 117th Congress. This In
reporting threshold is the same as the threshold for
Focus reviews that reporting requirement (codified at IRC
payments made by other businesses that are not made
§6050W), its legislative history, current legislative
through a third party settlement organization (26 U.S.C.
proposals, and related policy considerations.
§6041). Reporting requirements do not change the tax
obligations of taxpayers. Taxpayers are required to report
Payment Settlement Entities
all the income they receive, in any form they receive it,
Section 6050W applies to payment settlement entities.
whether it is reported by a third party to the IRS or not,
Payment settlement entities broadly include merchant
unless the income is statutorily or otherwise excepted from
acquiring entities and third party settlement organizations.
the computation of taxable income.
As the IRS has explained, a merchant acquiring entity is
The reporting changes do not mean that taxpayers will need
“the bank or other organization that has the contractual
to pay taxes on the whole amount reported to the IRS.
obligation to make payment to a merchant or other business
Taxpayers may claim any allowable deductions against
... in settlement of payment card transactions.” For
their receipts for amounts reported to the IRS by payment
example, if a customer pays for a good or service with a
settlement entities. For example, suppose a seller receives
credit card, the credit card company that pays the merchant
$1,000 from a third party settlement organization for selling
would generally be the merchant acquiring entity.
goods. Although the $1,000 would be reported to the IRS,
the seller could deduct the cost of making the goods. If the
Third party settlement organizations include entities that
materials to make the goods cost $700, then the taxable
make payments to payees of third party network
income (profit) would be $300.
transactions. They generally function as intermediaries
between buyers and sellers of goods or services, and charge
Legislative History
a fee for serving as an intermediary. Examples of these
Section 6050W, which was enacted in the Housing and
types of entities include some online auction or marketplace
Economic Recovery Act of 2008 (P.L. 110-289), required
services (such as eBay and Amazon), some gig economy
an information return to be filed by a third party settlement
platforms (such as Uber and Airbnb), and some
organization for payees whose gross amount of reportable
cryptocurrency processors (such as BitPay and CoinBase
transactions exceeded $20,000 and who settled over 200
before 2020).
transactions. These payments were also reported to the IRS
on Form 1099-K. With these thresholds, only relatively
Whether a specific entity is a third party settlement
frequent users of third party payment networks would
organization partially depends on the entity’s legal
exceed both thresholds, and thus have payment information
structure. Two entities may perform a broadly similar
reported to the IRS.
service while one takes the position it is a third party
settlement organization, whereas the other does not. For
The provision was intended as a revenue offset for the bill.
example, the payment service Venmo will issue an
The Joint Committee on Taxation (JCT) estimated that the
information return to applicable users under Section
new reporting requirements would increase revenue by $9.5
6050W, while the bank transfer service Zelle maintains it is
billion from FY2008 to FY2018. This estimate largely
not a third party settlement organization and will not issue
reflects anticipated increased tax compliance. IRS studies
an information return under Section 6050W.
suggest that a substantial portion of uncollected taxes are
the result of underreported business and self-employment
income that is not subject to third-party reporting to the
IRS.
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Payment Settlement Entities and IRS Reporting Requirements
The Bipartisan Budget Act of 2018 (P.L. 115-123) amended
Taxpayer confusion related to Section 6050W reporting
how Section 6050W applied to people with a foreign
may affect IRS enforcement resources. Currently, for
address. The original version of Section 6050W provided
individual taxpayers, the amounts reported on Form 1099-K
that a person with a foreign address could not be a
are frequently reported on Schedule C (Profit or Loss from
participating payee except as provided by the IRS. The
Business, Sole Proprietorship). The taxpayer from the
Bipartisan Budget Act of 2018 added that a person with a
example above, who sold used furniture for a loss, may
foreign address could not be a participating payee only
report the transaction using Schedule C. This would result
because that person receives payments in U.S. dollars. JCT
in a loss of $100, which would reduce the taxpayer’s
estimated that this change would reduce revenue by $10
income. However, this would likely be disallowed by the
million from FY2018 to FY2027.
IRS under IRC §183 and related regulations (sometimes
called the hobby loss rule), which prevents deductions for
The American Rescue Plan Act of 2021 (ARPA; P.L. 117-
activities not done for profit. The taxpayer’s primary reason
2) changed the de minimis reporting threshold for third
for selling the used furniture was likely to get rid of it and
party network transactions. As noted above, starting in
receive some amount of money for doing so, not to engage
2022, third party settlement organizations will need to file a
in a business for profit. Identifying and adjusting tax returns
Form 1099-K reporting the gross amount of reportable
with losses like this would require IRS resources and may
transactions for all payees with aggregate transactions
delay processing of those taxpayers’ returns.
exceeding $600. Unlike the previous threshold, there is no
requirement for the number of transactions. JCT
Legislation in the 117th Congress
estimated this change would increase federal tax revenue by
The Build Back Better Act (H.R. 5376), as passed by the
$8.4 billion from FY2021 to FY2031.
House, includes a provision that would extend backup
withholding to third party network transactions. Backup
Policy Considerations
withholding is when the IRS requires a portion of the
Increasing reporting of transactions with payment
payment (currently 24%) to be sent to the IRS. This is only
settlement entities potentially involves a trade-off:
for payments with a potentially higher risk of not being
increased reporting may improve tax compliance and
later reported on a tax return. This happens either when the
reduce the tax gap (i.e., the difference between taxes owed
person receiving the payment does not provide a taxpayer
and taxes collected), while also increasing complexity for
identification number (either a SSN or ITIN) to the network
some taxpayers.
making the payment, or when the taxpayer has failed to
report certain interest or dividend payments on previous
As mentioned above, the anticipated increased revenue
federal income tax returns. In the first case, the taxpayer
from increasing information reporting under Section
can end backup withholding by providing a taxpayer
6050W is largely related to increasing third-party reporting
identification number to the entity making the payment.
of business and self-employment income. These types of
income are often not subject to third-party reporting, and
Backup withholding is not an additional tax or penalty. The
the IRS believes they form a substantial portion of the tax
additional amount withheld is credited as tax withholding
gap.
on an income tax return and can be refunded if it is in
excess of the taxpayer’s tax liability.
In a 2021 study published in the Journal of Public
Economics, authors Adhikari, Alm, and Harris found that
Other bills introduced in the 117th Congress would change
the change to reporting requirements “modestly increased
the ARPA-enacted de minimis threshold. The Saving Gig
reported receipts without significantly increasing
Economy Taxpayers Act (H.R. 3425) and a similar bill in
deductions.” This change was larger for smaller firms, firms
the Senate (S. 948) would change the threshold back to
in business-to-consumer industries, and partnerships.
$20,000 in aggregate transactions and 200 transactions
Overall, the authors concluded the change implied a
annually. The SNOOP Act of 2022 (H.R. 6913 and S. 3546)
“modest increase in tax compliance.”
would make similar changes.
Increasing information reporting for payment settlement
The Cut Red Tape for Online Sales Act (H.R. 7079 and S.
entity transactions may increase tax complexity. Certain
3840) would increase the de minimis threshold to $5,000,
third party settlement organizations serve users acting in a
require a plain-language explanation of the taxability and
personal (i.e., nonbusiness) function. For example, consider
potential deductions for payments reported on Form 1099-
an online marketplace user who sells some used furniture
K, and apply backup withholding in certain situations to
bought for $800 for $700. This user did not earn income
payments reported under Section 6050W.
from this transaction, and it is not taxable. However, under
current law, the user will receive a Form 1099-K reporting
Anthony A. Cilluffo, Analyst in Public Finance
$700 in reportable transactions, which is also reported to
the IRS. Taxpayers who typically have relatively simple tax
IF12095
situations may not know how to report this transaction on
their income tax return while also claiming the correct
deduction for it.

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Payment Settlement Entities and IRS Reporting Requirements

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https://crsreports.congress.gov | IF12095 · VERSION 1 · NEW