Impact of the new 1099-K rule in Fintech and the Online Economy Stocks
Shopify, Etsy, Ebay, Venmo, Cash App, AirBnB, Turo and the drag on effects of the new rule
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When you rent an AirBNB, it’s highly unlikely that you wonder about how the owner is taxed on that income. If you bought their stock, it’s even more unlikely. However starting in 2023, the tax rules will change substantially for AirBNB, and the implications are not favorable.
AirBNB, Etsy, Ebay, for tax information purposes fall into the category of payment processors. The same category that fintechs such as Cash App, PayPal, Venmo, reside in. As such, they are required to provide form 1099-K detailing the volume of transactions that they processed for any one individual.
Currently there is a threshold for reporting these transactions. Until 12/31/2022 the threshold had been $20,000 for any single individual entity. Legislation has now lowered this threshold substantially.
As of 1/1/2023 this threshold has been lowered to $600
Take a moment and ponder on the implications of this. Imagine you rent an AirBNB out for $200 per night. This means if you rented it out for 100 nights or less, you did not get any tax paperwork from AirBNB. The IRS was none the wiser. No filing, no problem. Expanding on this further, imagine that when you purchase the home it was 300k with a 3.5% mortgage. This means, you might have a monthly payment near $1,350 or about $16,000 annually. Obviously you have other expenses, but imagine the equity that you could have built up in your home if you didn’t respect the honor system.
Lets speculate even further however, because in my case I’m an unscrupulous tax evader. AirBNB asks me to supply a W-9 which requests my EIN for tax reporting. But because I’m an unscrupulous tax evader, I figure that I can set up an unlimited number of LLCs (especially in a state with favorable privacy laws). I can then also get a separate EIN for all of them, and submit a separate W-9 for each of the houses.
I can then rinse and repeat this process, I then lever up on low interest HELOCs and use it to fuel my tax free binging.
Whether these entities are US individuals, corporations or even foreign investors, I couldn’t say. To be fair, I can’t even say that one single person has tried to pursue this tax evasion strategy. But I’d be willing to bet on it. It doesn’t seem AirBNB would be incentivized to combat this, as it generates inventory and fees for them.
All that has changed. Every individual with $600 will receive a 1099-K, and if they ignore it because they’ve never seen it before, it’s going to create an income mismatch and automatically trigger either what we will call an “audit” (technically it’s not, but I’m simplifying). Take this same core concept, and apply it Turo, VRBO and any other rental platform. How many of those Tesla Turo HODLers were paying taxes? I’m gonna guess not all of them.
Etsy and Shopify are different stories, but will also face 1099-K issues. Running a retail business is hard. Competition is fierce and margins are tight. However for those just selling a passion product, it’s very reasonable to believe they may have earned less than 20k. It’s also very reasonable to believe that many individuals would think:
I’m spending more than I’m making
If I’m not making money then I don’t have to report this
Besides it will cost me more to file, than I’d get back
Of course none of this is true. You do have to report it and then claim your expenses, regardless of how much your preparer wanted to charge you and irrespective of what you’d get back.
Furthermore, if you aren’t making money, then by IRS definition you have a hobby not a business.
Hobby expenses (except for Cost of Goods Sold) are disallowed per the Tax Cuts and Jobs Act. This means that any tools purchased, software used, or home office expenses would be disallowed. Bonus though, it’s not taxed for Self Employment if it’s Hobby Income
The real problem for Etsy the company is what happens when these passion projects see 40% of any profits handed over for Federal Income, SECA and State Taxes? How many small business owners will decide it’s no longer worth the hassle? I’d bet a substantial amount have already come to that conclusion and substantially more will in the future. I’d also bet that these small owners make up an outsized portion of purchasing volume on Etsy. This too likely changes as they spend less time on the platform.
Now let’s talk about the FinTech platforms. If you regularly go out to eat with friends, you may use Venmo or Cash App to split the cab and tab. This is not income. Only for tax reporting purposes, if you receive more than $600 via any of these apps, they now have to issue you a 1099-K. You have to then file the $600 as income, and then back it out.
Tell me if you can see this happening:
Chad HODLs Tesla, AMC and Bitcoin (irrelevant but we know the type)
Chad gets a 1099-K for 5k because he uses Cash App for everything
Chad says this isn’t income (he’s right), I’m not filing this because (he’s wrong) I use Bitcoin and blah blah blah Tesla and AMC. The Blue Sheets!
Chad gets a letter from the IRS (hey Cash App reported 5k in income, pay us our money)
Chad calls the IRS, doesn’t want to wait 90 mins to talk to someone, and indignantly hangs up
He then jumps on X and says Elon Musk is the only man that can fix the IRS
The IRS sends another letter, Chad films himself burning it without reading and posts it to his TikTok
The IRS sends a 3rd letter, in a rage Chad rips it open and finds he’s been assessed tax, interest and penalties.
Chad prissy as can be goes to HR Block and proceeds to spend $250 to get this resolved
I deal with stupid things like this on a daily basis. This will happen.
Chad will get his situation resolved. However it will be an absolute pain in the rear.
What Chat will eventually find out is that if he uses Zelle (ACH Transfers) then he doesn’t have to deal with this garbage.
Will Chad still want to use PayPal, Venmo or Cash App to receive money? Would you?
Personally I don’t mind, because I know how to do the tax work (two entries on Schedule 1 for those interested). And the solution will spread on the internet. But I could certainly see this rule having an impact on both Square (don’t forget small service businesses (like Barbers) who process business income) and especially PayPal.
This isn’t all bad long term for platforms like AirBNB and Etsy. The new 1099-K rules will likely kill off excess inventory which can push prices down (especially for Etsy). Businesses who thrive will be able to flourish with less competition as some parties head to the sideline. This is healthy as it will allow thriving businesses to continue to thrive and to weather storms more easily. However in the short term, these rules could crimp immediate profits in the next 1-3 years.
Couple this with the resumption of Student Loan Payments, and millennials/Gen Z may have to set aside more money for adult stuff, and less money for discretionary stuff.
You could go the short route and short some of this stuff, but the simpler play is this:
Consider Buying Anything Tax Related (HRB, INTU, TRI, etc.)
For the record I’m long both HRB and INTU but for different reasons. HRB looks the better value IMHO.
Reasons why:
1099K for business income will lead to more Schedule Cs which are a high margin item. I’d estimate margins will expand 3-5% on this change alone.
More people will get notices from the IRS for failing to pay. Audit resolution is another high margin item.
Currently there is a systemic shortage of CPAs and large companies are better equipped to scale to meet the increased demand
If you are looking for shorts, of all the companies I’ve talked about the ones that I think could be most negatively impacted by these rules in the short run are Etsy (owner churn), Paypal (Venmo), Square (CashApp and small service businesses) and possibly AirBNB (tide’s going out, time to find out who’s swimming naked).
You’ll likely see the impacts starting in Q1 2024 for Tax Companies and likely Q2, Q3 for other businesses as users are caught off guard and start to adapt.
Find this useful. I don’t post often, but when I do, I hope it’s been worth your time.