Watch Flippers and Hobbyists Beware: Information on the “PayPal Tax”

New Tax Law Requires Venmo, Paypal, et. al. to Issue 1099s for Transactions Totaling $600 or More Per Year

**This post is not legal advice; if you have questions, seek the advice of a lawyer and or tax professional**

For many of us, a huge part of the watch hobby is buying and selling watches. For some of you, nearly every watch is “catch and release.” Previously, unless you were selling many (MANY) watches each year, you really did not have to worry about the tax implications: this is a hobby, it’s for fun, and it’s not for profit. Right? For many of you, that might have just changed (a little bit).

In 2021, the US Congress passed the American Rescue Plan Act (ARP) primarily in response to the effects that the COVID 19 pandemic was having on regular folks and small businesses. The vast majority of the ARP is meant to help individuals and small businesses navigate lower and slower revenues, income, and productivity.  However, there is also a section of ARP which changes the reporting requirements for services like PayPal, Venmo, and Cash App.  The intent and motivation of this last bit is very clearly intended to elicit taxes on previously unreported “gig” income.

Previously, except for a handful of states with more strict requirements, the Internal Revenue Code only required these apps to issue a 1099 when an individual received more than $20,000 and had over 200 transactions. With the new requirement, PayPal and its colleagues are now required to issue a 1099-K for any individual or entity that receives $600 or more in any year, with any amount of transactions. The change began on January 1, 2022, and effects the taxes you will file beginning in 2023. If you think that sounds like a dramatic shift in policy, you are not alone.

First, what this is not: this does NOT change the taxes any of you are REQUIRED to pay. You have never had to pay taxes on personal items sold for a loss, and you still do not. You have always had to pay taxes on personal items sold for profit, and you still do. For the vast majority of people, this is an absolute nothing-burger. Most people sell very few items via PayPal and Venmo, and the occasional sale is rare enough that it can be neatly and simply tied to a memorable transaction. If you sell your old Honda for $2,000 via Venmo, it will trigger the issuance of a 1099-K (to the IRS). Assuming you paid more than $2,000 for the car, you do not need to pay any taxes on the sale. You can simply describe the 1099 in your return as “erroneous miscellaneous income – sale of personal car for loss.” You can and should keep a record of the sale (both before and after this rule change), but that is it the sum of your obligations.

Second, this does not affect “friends and family” transactions. That is to say, if you buy 10 yards of mulch to split with your neighbor, the reimbursement payment, via the appropriate “friends and family” tag will not trigger (or be counted against) PayPal’s or Venmo’s reporting requirement. I have seen many people suggest that they will now only sell via Friends and Family. While that decision may practically eliminate the possibility of a 1099 being issued, you need to be aware that, unless you are actually selling goods to friends or family, you may be committing tax fraud if you record an eBay or Reddit transaction as F&F. Again – please talk to your lawyer or tax professional before making these types of decisions. Also – if you are selling the watch for a loss, THERE ARE NO TAXES DUE. Don’t worry about it – sell it as “goods and services,” without fear.

The analysis on this issue really becomes tricky when you are buying and selling dozens of watches (watches, amongst other possibilities), some of them for more than you paid, with gross sales in the thousands or tens of thousands of dollars. Suddenly, you are going to get noticed by the algorithm (FINALLY!). This is what many people are currently stressed about, and for good reason.  There is clearly an increased risk of audit and tax liability now, where there was formerly little to none.

Let’s be clear: this is a dark time to be a “hobbyist.” Historically, individuals have been able to deduct losses for hobbies, but in 2017, Congress (a Republican Congress, to the extent you are keeping score) passed the Tax Cuts and Jobs Act (TCJA).  Under the TCJA, the deduction for a hobby (like buying and selling watches) was eliminated for the years of 2018 to 2025 (when the deduction will be automatically reinstated, without further intervention). Frankly, no one noticed or cared about this rule change, because most people don’t want to think about this stuff, are scared (perhaps rightfully so) of the tax code, and weren’t writing off hobby losses anyway.  Now, however, the hobby loss deduction is (or would be) incredibly important. What this all means is that, if you are a hobbyist, selling watches via PayPal, and, (for example) sell (A) 20 watches for $10,000 in losses, and (B) 1 watch for $10,000 in profits, you will receive a 1099-K from PayPal. Even though you netted zero, you will be required to pay taxes on the full $10,000 of additional income, with no deductions for the $10,000 in losses. YIKES!   

So, what are your options? To begin, let me just say, because it needs to be said, you should already have a pretty good idea of how much you spent on your watches, and (more or less) when you purchased them.  This is truer for some than others, but except for a very (VERY) tiny fraction of you, you probably know within a hundred or so dollars of how much you paid, and approximately what year the watch was purchased. For most of you this is probably good enough. If you say you spent $350 on that Turtle in 2020, but you don’t have a receipt, who is to say any different?  My advice to you (to all of you who are buying and selling any amount of watches) is to, immediately, get a notebook and account for every watch in your collection – even better if you have or can obtain receipts. If you must “guess,” as to the purchase price of a watch, it would be reasonable to base the purchase price on common pricing for the watch, in that particular watch’s condition, at the time you purchased that watch. If you are guessing, your guess needs to be reasonable. This is not rocket science, but, as with most tax-related things, the more accurate you can be, and the more complete your records are, the better.

As for how you make the reporting decisions, you have a few options:

1. For the vast majority of you: keep records of watches in and out, and pay taxes on your gains. if you are selling relatively few watches every year, mostly for less than you spent, you can keep reasonably neat records of your transactions, and report only the income from the occasional John Mayer G Shock that you got lucky on. Don’t overthink this. Your records don’t have to be perfect, but they need to be fairly comprehensive. The minimum is a simple paper ledger that you can get at Walgreens/Walmart/Office Depot, but, better yet, you can keep a cloud-based ledger, via a notes app like Evernote or Notion (where you can also upload and store the actual PDF receipts). The records are for audit purposes, so you are keeping them for posterity; Evernote notes don’t get stolen, lost, or burned in a house-fire. Also – I can’t say this enough- you ONLY need to pay taxes on the watches where you made a profit. If you made nothing, have confidence in your ledger, notes app, and/or receipts, report the entire amount as “erroneous income,” and zero out everything besides the actual income via a “negative” entry.
   
2. For power users: pull off the Band-Aid, and familiarize yourself with Schedule C. If the above doesn’t work for you, because you are in fact selling several watches each year, for more than you paid, you may want to consider just making this thing a business. You don’t need to do anything special to have a business. An individual, doing a thing (just about anything) with the intent to make a profit, can be a business. Unless you want to brand and market a business trade mark, you don’t need to register anything with your Secretary of State or get an EIN. You, doing business as yourself, and (importantly) by only your own name, is called a “sole proprietorship.” That happens all of the time, and its fine and good, and it means that you can also write off your losses against your profits (which is a GOOD THING!). The only (major) caveat to this approach, is that the IRS does require you to be (at least attempting to) make a profit for a business. Thus, to the extent that you are losing money every year, eventually the IRS (may) categorize your business as a hobby, which puts you back in category one. But that doesn’t happen overnight. For most of you, you will need to have made some profit in 2/5 of the 5 most recent years. Again, if you are going this route – talk to a professional, and get good advice on the front end (and again with regular intervals).

In summary, yes this is a change and yes it will affect many of us.  But I don’t think there is any need to panic.  With that said, this doesn’t affect the taxes you should be paying, and with some minor record keeping it should be a fairly insignificant departure from the status quo.  The IRS simply does not have the resources currently to initiate a major shift in audit frequencies.  For those of you who are still stressed, I strongly recommend spending some time with a CPA to discuss how you can protect yourself.