There has been much concern and misunderstanding this year about how hobby income is taxed under the provisions of the US Bailout Act of 2021. Payment apps such as PayPal and Venmo are now required to declare annual gross transactions for goods and services exceeding $600 to the IRS. This lower threshold means more people will receive a 1099-K this year for transactions involving payment apps. If you’re a hobbyist selling collectibles using a payment app, it’s important to understand how this new requirement will affect your tax returns.
What is a 1099-K?
Under the new law, if the total transaction amount for goods and services reaches $600 for the year, the payment application will send a 1099-K to both the IRS and the payment user. the payment app that received the money. The 1099-K is simply an information return intended to assist with voluntary tax compliance. This 1099-K does not calculate profit and loss or any tax liability – it simply reflects the total amount of money that has been received by the payment application user. The declaration of income and the calculation of the tax liability are carried out by the taxpayer on the form 1040 filed at the end of the year. The IRS enters the information from the 1099-K into the Information Returns Processing System to compare what the payment app user is reporting on their tax return. This may indicate to the IRS that an audit is needed to ensure that the taxpayer has reported their income correctly. This typically occurs if the amount on the 1099-K is relatively large, but no corresponding income is reported on the taxpayer’s Form 1040.
How does a hobbyist show that there were no gains on the sale of collectibles?
For the sale of collectibles, the 1099-K issued by the payment application will typically show transactions that exceed reportable revenue. If the IRS chooses to audit an amateur to ensure that there is no error in calculating taxable income, then an amateur will be obliged to produce documents that support the calculation and reporting of income. This is not a new requirement, but many fanciers did not bother to keep records because the risk of an audit was relatively low.
The good news is that hobbyists no longer need to keep a shoebox full of documents; electronic transactions have made record keeping much easier. Purchase receipts, bank statements, canceled checks, and other types of documents that could be used as proof of a collectible’s original purchase price are all commonly available online. Enthusiasts should ensure that supporting documents include the amount, date and character of the transaction. This can be difficult if the item is purchased from a private seller, so supporting conversations via email or text would also be helpful.
Does this new threshold mean that amateurs will have to pay more taxes than in previous years?
It is important to understand that the taxable amount of these transactions has not changed, nor have the reporting requirements for the amateur taxpayer. The Internal Revenue Code requires taxpayers to declare all their income whatever source is derived before and after this recent gear change. Nor does it mean that the full annual transaction amount is now taxed simply because it is included on the 1099-K. This new provision simply imposes an additional reporting burden on payment applications.
If a hobbyist sells a collectible for less than the original cost of the item, the money received in connection with the sale is generally not taxable. If a hobbyist sells an item for more money than the original cost of the item, the hobbyist is required to report the gain to the IRS on their income tax form. On Form 1040, this amount can be reported as other income or as a capital gain. Although other income is the easiest way to report a gain on the sale of personal property, reporting it as a capital gain can provide tax savings in certain situations. For most taxpayers, there will be no capital gains tax on the reported gain because the taxpayer’s overall income will be too low to trigger a tax charge.
Although the tax liability has not changed, a hobbyist may pay more taxes this year if they did not pay taxes before due to incorrect tax reporting in previous years. This is exactly the problem that this new provision of the law aims to correct. The information statement is intended to inform fans who may not have been aware of the incorrect reporting and payment in previous years. Under this new law, the IRS is unlikely to accept lack of knowledge as an excuse for nonpayment if the amateur taxpayer was notified of transactions on a 1099-K.
Can a hobbyist avoid tax reporting by using PayPal transactions between friends and family instead of goods and services?
Apart from the additional protections provided by PayPal Purchase Protection that are included in a transaction using the Goods and Services – G&S – designation, using the designation for the sale of collectibles can still make sense. The 1099-K calculates the total amount of annual transactions, saving a hobbyist a lot of time and effort trying to track and calculate total transactions throughout the year. It also serves as a check to ensure that transactions have not been inadvertently missed during the taxpayer’s calculation of any taxable amount. Accurate reporting of income is important, and failure to report accurately could result in penalties and interest.
The taxpayer is still required to accurately declare his income whatever source is derived to the taxman. No tax provision changes the nature of a transaction depending on the options selected when paying with a payment application. Therefore, a hobbyist cannot avoid taxation simply by asking a buyer to choose the F&F option at checkout, even if the 1099-K is not automatically triggered. Attempting to disguise income from a collectible as a tax-free gift from a friend or family member can also result in heavier penalties.
The penalties for a clerical error or an error on a tax return are significantly lower than willful misrepresentation resulting in tax evasion. If the taxable income from the sale of a collectible is not declared, a misrepresentation has occurred; the only question that remains is whether it was intentional. It will be very difficult to claim that the misrepresentation was not intentional if the seller demanded that a buyer designate the transaction as a transaction between friends rather than a sale of goods in order to avoid the issuance of a 1099 -K. Tax evasion can result in a felony conviction of up to $100,000 in fines and five years in prison.
Choosing the F&F option over G&S may reduce the likelihood of an IRS audit if no 1099-K is issued by year-end; however, this is really only an advantage for someone who intends to misrepresent income to avoid tax. Use of the F&F designation may not trigger automatic reporting of information, but it certainly does not prevent the IRS from accessing transaction information. The IRS has a variety of other methods for tracking income and reporting discrepancies, so an audit isn’t entirely out of the question in all cases. In fact, the IRS can investigate potential tax evasion by requesting additional information from payment apps or even checking social media activity and emails in some cases.
What tax strategy should I use to avoid the maximum amount of taxes on the sale of collectibles?
Difficult to answer this question without knowing the specifics of the sale of collectibles. For example, if a hobbyist sells a lot of collectibles, it may be helpful to formally organize a business for the purpose of deducting business expenses. The answer may also depend on a variety of other factors, for example, the nature of the hobby, your total income from other sources, the amount of gain on the collectible, or the ability to keep records. . It is absolutely essential that a hobbyist selling collectibles for profit consult with a tax attorney and accountant to help develop the best tax strategy and ensure the accuracy of tax returns.
This article does not necessarily reflect the views of the Bureau of National Affairs, Inc., publisher of Bloomberg Law and Bloomberg Tax, or its owners.
Author Information
Joshua R. Dalrymple holds a doctorate from the Ford Foundation. Fellow of National Academy of Legal Studies and Research University of Hyderabad, India. He is a founding member of the law firm Patel & Dalrymple, PLLC in Lynchburg, Virginia, and a faculty member of Purdue University Global’s Department of Legal Studies.
We would love to hear your smart and original point of view: write for us
