Legacy Law Blog

When using a payment service for business transactions, it’s essential to understand the tax implications to ensure compliance with IRS and state regulations. Here are some tax tips for using these platforms.

Keep Business and Personal Transactions Separate

Always separate personal transactions from business transactions. Whenever possible, use different accounts to prevent confusion and simplify recordkeeping. Set up a business profile on your payment service platform. Mixing personal and business payments in the same account can make it difficult to track expenses and income, leading to time-consuming sorting later. By maintaining separate accounts, businesses can avoid this hassle and ensure clearer financial management and compliance with Internal Revenue Service (IRS) guidelines.

Report Business Income

Report all income received through a payment service for business purposes. This includes payments for goods, services and any other business-related transactions. Businesses need to track which payment services are used to process payments for goods or services and report this income to the appropriate taxing authority. Many payment services will issue tax documentation to businesses at the end of the year. Businesses should not assume that the absence of these forms means that the income received through the payment service should not be reported to the IRS or the state.

Prepare for IRS Form 1099-K

Payment services will issue IRS Form 1099-K if a business meets certain thresholds. For tax year 2024, the threshold is $5,000 and for 2025, it is $2,500. IRS Notice 2024-85. Be prepared to receive a 1099-K and to be able to verify that the form is accurate. States will also have their own tax reporting thresholds that will require income reporting for businesses. In Michigan, the threshold aligns with federal guidelines. See the Michigan Association of Certified Public Accountants website for more information. These thresholds vary for each state and can be triggered by total amount of payments received, total number of transactions in a year, or both.

Keep Accurate Records

Maintain detailed records of all transactions, including dates, amounts and the nature of each transaction. This will help you report accurately and can be crucial if you are audited. The IRS has up to six years to audit a tax return if it believes that a taxpayer omitted more than 25% of their income. Due to the unconventional ways that businesses are using payment services and the evolving nature of the reporting requirements from the IRS and the states, it is more important than ever that businesses keep precise and complete records.

Expect to Pay Taxes on Income

Understand that income received through a payment service for business purposes is taxable, and you are responsible for reporting it even if you do not receive an IRS Form 1099-K. This ties directly into Tip #3. If a business receives business-related income from any source, it should expect to pay tax on that income. By anticipating the payment of taxes at the end of the year, businesses can set aside funds to cover future tax liabilities when they come due.

Avoid "Backup Withholding"

Backup withholding is a way for the IRS to try to make sure it receives taxes from businesses by hanging onto income if identifying information isn’t provided to a payment service. Payment services may withhold taxes at a rate of 24% if a business does not provide a tax identification number or if the business has underreported income from a prior tax year. See IRS Topic no. 307, Backup withholding for more information. Verify that the business’ account information is up to date and the tax identification number is on record with payment services to avoid unnecessary withholding.

Deduct Payment Processing Fees

Payment processing fees are generally tax deductible as business expenses. Keep records of these fees to claim them on your tax return. As with income, the failure to keep adequate records of these fees as they are incurred may result in missed business expense deductions and the resulting higher overall income tax. In addition, businesses should report the gross amount billed for goods and services and then record the fees as a business expense instead of reporting the net amount deposited into their accounts. Failing to do so will result in an understatement in the adjusted gross income reported by the business on its income tax return.

Be Aware of Sales Tax Obligations

If you sell goods or services through a payment service, you may also be responsible for collecting and remitting sales tax depending on your location and the nature of the transaction. Businesses will need to determine which transactions are taxable based on what was sold and the location of the business, collect the right amount of any sales tax, and send it to the relevant government agency when it is due. Many businesses have ignored sales tax for prior transactions without any repercussions. Once the $600 annual threshold included in the American Rescue Plan Act is phased in over the next two years, this will no longer be an option. And if an audit uncovers that sales tax obligations were not met, the balance will be due along with penalties and interest. See Understanding your Form 1099-K on the IRS website.

Stay Informed

Keep up to date with IRS or state regulations and any changes to the tax laws that may affect how you use payment services for business transactions. Many of these payment services are new or evolving to meet the needs of consumers and businesses. The IRS and states are constantly revising and updating the tax laws and reporting requirements for businesses in response to these new regulations. It is important to stay up to date on any changes that might affect these types of transactions.