What Is a Payment Settlement Entity (PSE)?
Gain a clear understanding of what a Payment Settlement Entity is and the specific IRS compliance duties involved in reporting payment transactions.
A Payment Settlement Entity, or PSE, is an organization that acts as an intermediary in financial transactions between buyers and sellers. Its primary function within the U.S. tax system is to report these payment transactions to the Internal Revenue Service (IRS). This reporting is designed to help the IRS monitor taxable income that flows through digital and card-based payment channels. By tracking and reporting these funds, PSEs play a part in tax compliance and administration.
Identifying a Payment Settlement Entity
The IRS defines a Payment Settlement Entity under two classifications: a Merchant Acquiring Entity (MAE) and a Third Party Settlement Organization (TPSO). An MAE is typically a bank or other financial institution with a contractual agreement to make payments to merchants who accept payment cards, such as credit or debit cards, for goods or services. When a customer uses a card to make a purchase, the MAE is responsible for settling that transaction and transferring the funds to the merchant’s account.
A TPSO is an organization that manages a payment network facilitating transactions between buyers and sellers. These entities have a contractual obligation to make payments to the participating sellers, or “payees,” within their network. Common examples include online marketplaces where numerous vendors sell goods, such as Etsy, or payment applications like PayPal and Stripe that allow businesses to accept payments online.
Core Reporting Requirement Form 1099-K
The reporting duty of a PSE is to file Form 1099-K, Payment Card and Third Party Network Transactions, for each payee. This form requires specific information, including the payee’s name, address, and Taxpayer Identification Number (TIN). It also requires the gross amount of reportable payment transactions for the calendar year.
A “reportable payment transaction” encompasses any payment made with a payment card or through a third-party network. The “gross amount” reported on Form 1099-K represents the total, unadjusted value of all transactions. This means the amount is calculated before deducting any fees, credits, refunds, or chargebacks that may have occurred during the year.
For TPSOs, a minimum reporting threshold determines whether a Form 1099-K must be filed for a payee. This threshold has been subject to frequent changes, and for the 2024 tax year, the IRS has indicated a threshold of $5,000. Because these figures can change, any entity that might be a TPSO should consult the official IRS website for the most current reporting requirements.
The Filing and Furnishing Process
Once a PSE has accurately completed Form 1099-K, it must adhere to a two-part submission process. The first step is to “furnish” a copy of the form to the participating payee. This must be done by January 31st of the year following the calendar year in which the reportable transactions occurred.
The second step is to “file” the forms with the IRS. If filing by mail, the deadline is February 28th. For those filing electronically, the deadline is extended to March 31st. The IRS mandates electronic filing for entities submitting 10 or more information returns in a calendar year, which includes the aggregate of all types of returns. Most PSEs use the IRS Filing Information Returns Electronically (FIRE) system for this purpose.
Backup Withholding Obligations
Under certain conditions, a PSE is required to perform backup withholding on payments. This obligation is triggered if a payee fails to provide a correct Taxpayer Identification Number (TIN) or if the IRS notifies the PSE that the TIN provided by the payee is incorrect. Backup withholding is a mandatory requirement in these circumstances.
When backup withholding is required, the PSE must deduct and withhold tax from the reportable payments at the current rate of 24%. This rate applies to the gross amount of the payments being made to the payee. The withheld funds are not kept by the PSE but must be deposited with the IRS according to a set schedule.
The total amount of backup withholding for the year must be reported to the IRS on Form 945, Annual Return of Withheld Federal Income Tax. This form is separate from Form 1099-K and is due to the IRS by January 31st of the following year. The PSE must also report the amount of federal income tax withheld on the payee’s Form 1099-K in Box 4.