What Is a Payment Settlement Entity (PSE)?

A Payment Settlement Entity, or PSE, is a financial institution or third-party organization that handles payment processing between a buyer and a seller. When a customer makes a purchase, a PSE is the intermediary that ensures funds are securely transferred from the customer to the merchant. Their function is to manage the technical and financial steps required to settle a transaction.

The role of a PSE includes everything from authorizing a credit card swipe at a local shop to processing a digital payment for a freelance service received through an online platform. Any entity that has a contractual obligation to make payments to a merchant for transactions accepted by that merchant can be considered a PSE.

The Primary Role and Types of PSEs

A responsibility of a Payment Settlement Entity under federal tax law is to report the payment transactions they process to the Internal Revenue Service (IRS) using Form 1099-K, Payment Card and Third Party Network Transactions. The purpose of this form is to provide tax authorities with visibility into the money flowing to businesses and individuals. The PSE is obligated to send a copy of this form to both the payee and the IRS.

There are two main categories of PSEs. The first is a Merchant Acquiring Entity, a bank or other financial institution with a contractual obligation to settle payment card transactions. When a customer uses a credit, debit, or stored-value card, the merchant acquiring entity processes that transaction and pays the merchant.

The second category is a Third-Party Settlement Organization (TPSO). TPSOs facilitate payments between buyers and sellers through a third-party network, such as an online marketplace or payment app like PayPal, Stripe, and Venmo. A TPSO has a contractual duty to make payments to the participating sellers within its network.

Understanding Form 1099-K Reporting

For individuals and businesses receiving payments, understanding Form 1099-K begins with the reporting thresholds. For payment card transactions, there is no minimum threshold. For TPSOs, the federal threshold for tax year 2024 is $5,000, with plans to reduce it to $2,500 for 2025 and $600 for 2026.

Regardless of these thresholds, all income from selling goods or services is reportable on a tax return, even if a Form 1099-K is not received. Some states have separate, lower reporting thresholds, which may result in receiving a form for a smaller amount.

The figure in Box 1a on Form 1099-K shows the gross amount of all payment transactions processed. This gross amount is a raw total and does not account for any adjustments, such as platform fees, credit card processing fees, or refunds. Consequently, the amount reported in Box 1a will not represent the actual net profit.

This gross figure is a starting point for tax purposes, not the final taxable income figure. The recipient of the Form 1099-K is responsible for calculating their net income by subtracting all legitimate business expenses from the gross amount reported.

Reconciling and Reporting 1099-K Income

Upon receiving a Form 1099-K, the first step is to reconcile the gross amount in Box 1a with your own business records. This involves comparing the form’s total to the sales data from your accounting software or other financial records to verify accuracy and identify discrepancies.

Once reconciled, the gross income figure must be reported on the appropriate tax form. For a sole proprietor or a single-member LLC, this income is reported on Schedule C (Form 1040). Corporations use Form 1120, S corporations use Form 1120-S, and partnerships use Form 1065. The amount from Box 1a should be included in the total gross receipts line on the relevant form.

After reporting the gross income, you must deduct all associated business expenses to calculate your net taxable income. Common deductions for online sellers and service providers include:

• The cost of goods sold
• Payment processing fees
• Platform fees
• Shipping and postage
• Marketing costs
• Home office expenses

By properly reporting gross income and subtracting all allowable expenses, you ensure that you are only taxed on your actual profit.