Small Businesses Find a Loophole in the New Tax Law: Zelle

The payment service says it doesn’t have to disclose transactions to the IRS, but its users are still subject to the rules.

Early this year, Benson Gitau, owner of Houston appliance reseller Vendapp, noticed that his suppliers were no longer accepting payments through Venmo, PayPal or Cash App. “They’d just say, ‘I prefer Zelle,’” he says. The share of his suppliers using Zelle jumped to 60% from 15% in a few weeks. “A couple of them talked about why. It’s because, at the end of the day, with Zelle or cash, they decide what to show to the IRS.”

He’s referring to an IRS rule change that came into effect on Jan. 1, 2022, requiring third-party payment processors such as Venmo and PayPal to issue 1099-K forms to any users who receive more than $600 in payments via their apps and also file them directly with the IRS. Previously, Venmo and other apps issued 1099-Ks only for customers with gross payments exceeding $20,000 who’d made more than 200 such transactions. But small businesses nationwide have found a loophole: Zelle. Zelle says the new rule doesn’t apply to it, a bank-to-bank payment service, because it’s a network that doesn’t hold funds.

Gitau’s company continues to accept payments in a half-dozen forms (most often Venmo, Cash App or Zelle), like many businesses that were already documenting all of their income for the IRS. But gig workers and small-business owners, especially those just scraping by, are alarmed by the new law. “A lot of people think they’re just doing a side gig, or are small potatoes, so why should they pay taxes?” says Steven Rosenthal, a senior fellow at the Urban-Brookings Tax Policy Center. An IRS analysis of 2014-2016 estimated that unreported individual and small-business activities cost $144 billion in taxes a year and found that Americans report less than half of the income that isn’t automatically reported for them. Rosenthal suspects this is a drastic underestimate. “I think the level of noncompliance from small businesses is staggering,” he says.

Although Zelle offers a core service similar to those of PayPal, Cash App, Google Pay and other competitors, it was originally built as clearXchange, a peer-to-peer payment service for a consortium of major banks. Today it’s integrated into users’ bank dashboards and run by Early Warning Services LLC, which is jointly owned by seven banks (Bank of America, Truist, PNC, US Bancorp, JPMorgan Chase, Wells Fargo and Capital One). The service is an electronic network that manages automated clearinghouse (ACH) transactions. “ACH networks are not subject to 1099-K reporting,” says Wendy Walker, chair of the Information Reporting Subgroup of the IRS Advisory Council. A competitor, Chuck, which launched in January, is a similar bank-to-bank network.

A Zelle spokeswoman said in an email that payments sent through its network “are not subject to this law.” Small-business banking (SMB) users turn to Zelle “because it makes it easier to complete digital payments where they bank, enabling easier bookkeeping and accounting by having the SMBs’ data at one source,” she said, adding that they see a benefit in having money in their bank accounts, not held by third parties. The spokeswoman said Zelle couldn’t speculate on other reasons people might use its service and declined to provide 2022 data on user figures.

Rosenthal suggests exercising caution before jumping over to Zelle, pointing to the IRS’s push to harness technology to enforce long-dodged tax laws. “It’s a dangerous game for tax cheats to migrate to Zelle,” he says. “It wouldn’t be hard for the IRS to unravel that.” He sees two likely outcomes if people continue abandoning payment services that issue 1099-K forms in favor of Zelle: Congress could extend the law to include Zelle, or the IRS could investigate, perhaps seeking customer names from Zelle for “heightened auditing scrutiny.”

Accountants are professionally obligated to follow the tax code and continue to invite taxpayers to join them in compliance. “I always advise that it’s your responsibility to report all income earned from all platforms, even with companies like Zelle,” says Armine Alajian, founder of the startup business accountant Alajian Group. Alajian says her clients often employ the wishful thinking that they only need to report income that appears on a 1099 or W-2 form. “That’s not the case,” she says. “It’s up to the individual to report all their income.”