Peirspictiochtai Ar An Saol

Income Taxes Due Versus Reporting of Income, Part Four

The Internal Revenue Service is responsible for collecting taxes due to the Federal government. (This image was provided courtesy of the Internal Revenue Service.)

The bedrock of the Federal income tax system is voluntary compliance.

That's what the leaders of the United States like to tout.

But underneath that bedrock are two-intertwining formations: the principle that the Federal government does not trust the citizens of the U S to report their income, and if the citizens can't be trusted to report their income, the citizens won't pay all of the taxes due.

Thus, the Federal government requires a variety of entities to report payments they have made to you.

To "help" with voluntary compliance, the Federal government also requires a variety of entities to withhold estimated taxes from payments made to you.

It is within these purviews that the U S Congress passed legislation – the American Rescue Plan Act of 2021 – and President Joseph (Joe) Biden signed that legislation into law.

Through this law, if you receive $5,000 or more through "Payment Card and Third-Party Network Transactions" during Year 2024, you'll be receiving a Form 1099-K detailing those payments. That Form 1099-K will likely be sent to you in January of 2025.

A copy of each of the Form 1099-K will also be sent to the IRS.

"Payment Card and Third-Party Network Transactions" are provided to many Americans by a number of digital platforms.

Eventbrite, Mercari, Poshmark, and Rover are a few examples of these digital platforms.

It's important to understand that reporting of all income to the IRS has been required for decades.

For many Americans, though, they may have "forgotten" that they have been accountable to report all income to the IRS and that they have been responsible for then paying Federal income taxes on their income.

The updated requirements regarding the issuance of Forms 1099-K through digital platforms will likely provide the IRS with a more detailed accounting of some of that "forgotten" income.

But not all of the payments that may be listed on a Form 1099-K may actually be subject to Federal income taxes.

In a news release issued by the IRS on November 21, 2023, the Federal agency indicated that "Reporting requirements do not apply to personal transactions such as birthday or holiday gifts, sharing the cost of a car ride or meal, or paying a family member or another for a household bill. These payments are not taxable and should not be reported on Form 1099-K."

"However, the casual sale of goods and services, including selling used personal items like clothing, furniture and other household items for a loss," the IRS news release continued, "could generate a Form 1099-K for many people, even if the seller has no tax liability from those sales."

Fact Sheet 2023-27 from the IRS included an example:

"You receive a Form 1099-K that includes the sale of your car online for $21,000, which is less than you paid for it…[You'll report in your annual tax filing that the funds are] Other Income: 'Form 1099-K Personal Item Sold at a Loss, $21,000'…[And you'll indicate that there are]…Other Adjustments: 'Form 1099-K Personal Item Sold at a Loss $21,000'. These 2 entries result in a $0 net effect on your adjusted gross income (AGI)."

Translation: In this case with these facts, you had no taxable income and, thus, you owe no additional Federal taxes.

A summary of terms is important to understand your accountability and your responsibility:

"Gross Income" is your total income from every source – your "regular" job, a side hustle, a gig assignment, the rent you receive from a tenant leasing space at your home, the proceeds you get from selling items at a garage sale, and any other types of money you receive for services you provide or products you sell.

"Deductible Expenses" are those costs you incur to secure the gross income. Not all costs that you have are considered deductible by the IRS, but many expenses are allowable to reduce your gross income.

"Net Income" is your Gross Income minus your Deductible Expenses. Your Federal income taxes are typically based on your Net Income – not your Gross Income.

"Estimated Taxes" are what you are required to pay based on your estimated Net Income during a specific time period. Estimated Taxes are due to the IRS four times annually with different time periods for each payment date. Please keep in mind that you may have to pay both Federal income taxes as well as Federal self-employment taxes on your taxable income. Self-employment taxes include both the employer and employee portions of Social Security and Medicare taxes. If you earn taxable income on your own, you're in essence both the employer and the employee. As such, you have to pay both portions of the Social Security and Medicare taxes. You do get to deduct half of what you pay in self-employment taxes from your gross income.

"Gifts" are exactly that – gifts given without the provider getting any services or products in return. Gifts are not typically considered income subject to Federal income taxes.

"Reimbursements" are exactly that – funds being paid back to you – reimbursing you – for expenses that you have incurred for someone else. Reimbursements are not typically considered subject to Federal income taxes.

"Record Keeping" is likely one of the most critical tasks that await you. This is especially true if you haven't been keeping track of your income and expenses as well as keeping track of gifts received and costs reimbursed by others.

You can use computer software to keep track of these different items. Or, you can use pieces of paper where you list each item.

Whatever method you choose, it's important for you to keep good records.

It's best for most of us – who don't have picture-perfect memories – to keep records as we secure income and incur expenses. That way, you're not faced with the dilemma in early 2025 of trying to figure out your actual Net Income.

In addition to keeping good records, separating income that is likely taxable from payments that are not taxable is another critical task that will likely help you now and in future years.

If you routinely use digital platforms for both business purposes (selling products, offering your services, etc.) as well as for personal purposes (getting reimbursed by a roommate for utility bills, receiving a gift from a relative, etc.), it may be best for you to have two separate accounts for each digital platform utilized.

The same is true for your bank accounts. It may be best for you to have one bank account that you use for business purposes and a second bank account that you use for personal purposes.

It may seem overkill to have separate accounts on the same digital platform and to have separate bank accounts, but this approach does two things: One, if you ever have to prove to the IRS what income and which expenses are business-related, you'll have the records to show those facts. Two, this approach will allow you to determine if the business activity you're engaged in actually is producing the Net Income you think is being produced.

For example, if you drive your car for a ridesharing app, you're able to see the payment amount made to you through the app. Until you do the record keeping and separate out the expenses directly related to your work, you may not realize that you may be making below the minimum wage for the hours you put in to earn the Gross Income or if you're earning a Net Income for which you're comfortable.

To do this second approach, you need to be brutally honest with yourself.

Only include direct expenses related to the business activity. If you blend in personal expenses and "pretend" that they are business expenses, you're not being accountable or responsible.

As noted previously, the Federal tax code is quite detailed, and there are specific rules and forms to follow and complete. Please contact the IRS or an accountant, attorney, or another tax professional of your choice to determine what your personal responsibilities are regarding taxes.

Peirspictiochtai Ar An Saol – Gaelic – Irish – for "Perspectives On Life" is a column focused on aspects of accountability and responsibility as well as ways people look at life.

Contact Richard McDonough at PeirspictiochtaiArAnSaol@protonmail.com.

© 2024 Richard McDonough