H.R. 3937, which recently passed out of the House Ways and Means Committee on a party-line vote with Republican support, would undermine efforts to narrow the tax gap—the amount of tax that is legally owed but not paid—and would make it harder for honest tax filers to track the income that they need to report on their tax returns. It would do so by reversing changes to third-party settlement organization (TPSO) reporting requirements made by the American Rescue Plan Act of 2021 (ARPA).
TPSOs are digital marketplaces, payment services, and platforms that facilitate transactions between buyers and sellers. ARPA lowered the threshold for when they must report information to the IRS. H.R. 3937, authored by House Ways and Means Committee Chair Jason Smith (R-MO), would reverse this change, raising the reporting threshold to $20,000 made through 200 or more transactions per year. Congress should reject the proposed changes and, instead, provide timely and clear guidance on the changes made by ARPA and extend information reporting to the full range of entities that facilitate online transactions between buyers and sellers.
Information reporting doesn’t change the amount of taxes owed but does boost tax compliance
The nation’s tax code is largely based on voluntary compliance: relying on tax filers to honestly report the income they receive and the amounts they are due as credits, deductions, and other offsets. The tax code uses third-party information reporting—reports filed by entities making payments (“payors”) with the IRS and provided to tax filers (“payees”)—as a tool to boost compliance and accuracy. Businesses report amounts paid as wages to employees on forms known as W-2s and report on payments to independent contractors and others on forms known as 1099s. A wide array of transactions are subject to 1099 reporting, from payments for services provided by people other than employees to legal settlements to rents and royalties. Reporting encourages compliance by providing tax administrators with information on potentially taxable transactions, while providing tax filers information they can use to completely and accurately report the income they receive on their income on their tax returns.
Information reporting does not affect the amount of tax a payee owes; it is simply a tool that helps ensure that tax filers pay the amount they legally owe. Third-party information reporting is strongly correlated with tax compliance. IRS researchers report that only 7 percent of income subject to “substantial” reporting is misreported, while 55 percent of income subject to “little or no” reporting is misreported. This underreported income is associated with a substantial fraction of the tax gap—taxes that are owed but not paid—a full 25 percent of the gap in the most recent period examined, equivalent to an annual loss of $126 billion.
H.R. 3937 would affect platforms prevalent in the gig economy
Third-party settlement organizations are online marketplaces, such as Etsy and eBay; payment processing services, such as PayPal and Venmo; and gig economy platforms, such as Uber, DoorDash, and Airbnb. A wide array of organizations engage in one or more of these functions, and new TPSOs arise regularly. All play key roles in facilitating transactions between buyers and sellers of goods and services and, as such, in facilitating transactions that generate income subject to tax. Organizations that operate networks that simply process electronic payments—such as wire transfers or direct deposit payments—are not considered TPSOs and are not required to report.
ARPA lowered the threshold at which TPSOs are required to file information reports known as 1099-Ks to payments totaling $600 or more in a calendar year. Prior to ARPA, TPSOs were only required to file reports if payments to a payee in a given year exceeded $20,000 made through more than 200 transactions. The ARPA requirement is similar to those applying to payments to independent contractors, while credit card companies are subject to more extensive requirements and must report all payments they make to merchants. Reporting is not required for payments made outside a business relationship, such as when friends use Venmo to split a dinner bill. Notably, ARPA’s changes did not affect tax filers’ obligation to report all income received as part of a trade or business regardless of whether it is reported to the IRS by a third party. Similarly, ARPA’s changes to reporting requirements did not affect filers’ ultimate taxable income—the amount remaining after any allowable deductions are claimed.
ARPA’s requirement was slated to take effect for payments made in 2022, but in December of that year, the IRS delayed implementation of the lower threshold, noting that “reporting does not impact a taxpayer’s responsibility to accurately report ALL income, whether or not they receive a Form 1099-K.” Reversing this change would cost an estimated $9.7 billion in revenues lost to noncompliance from 2023 to 2033, according to the Joint Committee on Taxation. Congress should avert this loss by rejecting proposals to reduce the reporting requirements. Doing so would discourage tax avoiders and help honest filers accurately prepare their returns.
Congress should promote consistency across payment mechanisms, not lower thresholds
Prior to the enactment of ARPA, a business receiving payments solely from credit and debit card companies would receive a 1099 documenting all payments made by their customers, while one receiving payments solely through Venmo would only receive a report once the amount earned reached $20,000 made through more than 200 separate transactions. If the same business made a payment by check for a service provided to a nonemployee, reporting would be required for amounts of $600 or more. As illustrated by these examples, the inconsistency in reporting requirements depends solely on the form of payment, not on the type of goods or services that gave rise to the payment.
ARPA sought to minimize these inconsistencies. Although it made substantial progress toward doing so, some disparities remain—for example, when payments are made through a service that moves money directly from one account to another, such as Zelle, rather than one that moves it through a third-party platform, such as Venmo. Congress should close this loophole, rather than create new ones, lest such systems become the payment method of choice for those seeking to avoid paying the taxes they legally owe. Timely guidance and instructions from the IRS can minimize legitimate concerns that nonbusiness transactions will inadvertently be included in an information return. Platforms such as PayPal already have systems in place to identify payments to friends and family, and recipients of funds can request a corrected information return if they mistakenly receive a 1099.
Raising the threshold for reporting independent contractor payments would encourage tax avoidance
Under current law, people engaged in a trade or business must report payments totaling $600 or more in a single year to an individual payee to both the payee and the IRS. This requirement applies to amounts paid for nonemployee compensation, and certain exclusions apply, including for payments made to corporations or for amounts covered by separate reporting requirements, such as dividends and interest payments. H.R. 3937 would increase the threshold for reporting payments made to an individual in the course of a trade or business from $600 to $5,000 and index it for inflation after 2024. This requirement applies to payments made as compensation to people other than employees—independent contractors—and to other payments made in exchange for a service provided as a trade or business. The proposed change would undermine tax compliance and increase tax evasion. The Joint Committee on Taxation estimates that this change would reduce tax collections by $14.5 billion from 2023 to 2033.
Conclusion
Congress should reject efforts to roll back information reporting requirements, a proven tool for ensuring that taxpayers accurately and completely account for their income on their tax returns. Legitimate concerns about the potential of reporting on nonbusiness transactions can and should be addressed through guidance.
This article was published by the Center for American Progress.
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