What Is a Third-Party Settlement Organization?

Companies that process payments on behalf of businesses or individuals fall into different regulatory categories, each with specific tax and reporting obligations. One such category is third-party settlement organizations (TPSOs), which handle transactions for sellers across various platforms.

Understanding how TPSOs operate is essential for businesses and individuals who receive payments through online marketplaces, crowdfunding sites, or mobile payment apps.

Conditions for Classification

To be considered a third-party settlement organization (TPSO), an entity must meet criteria outlined by the IRS under Section 6050W of the Internal Revenue Code. A TPSO facilitates payments between buyers and sellers through a third-party payment network rather than acting as a direct payer. This distinction sets TPSOs apart from traditional merchant acquiring banks, which process card transactions directly.

A TPSO must establish contractual agreements with payees, detailing how funds are transferred and disbursed. Unlike financial institutions, TPSOs do not hold funds in escrow or serve as custodians of user balances.

The IRS also evaluates the payment network’s structure when determining TPSO status. The organization must enable transactions between multiple unrelated parties, meaning it cannot be a closed-loop system where payments only occur within a single business entity. This ensures TPSOs function as intermediaries rather than direct service providers.

Transaction Threshold Requirements

TPSOs must report certain payment transactions on Form 1099-K if a payee’s aggregate payments exceed a specified threshold within a calendar year.

As of 2024, the reporting threshold is $5,000 in total payments. This change follows a phased implementation of a lower threshold initially proposed under the American Rescue Plan Act of 2021. If a seller receives $5,000 or more in gross payments through a TPSO in a given year, the organization must issue a Form 1099-K to both the payee and the IRS. The threshold applies to total payments received, eliminating the previous 200-transaction requirement.

Only payments for goods and services count toward the threshold. Personal transactions, such as reimbursements between friends or family, are excluded. This distinction is particularly relevant for users of peer-to-peer payment apps, where both business and personal transactions occur. TPSOs must implement systems to differentiate taxable payments from non-reportable transfers to comply with IRS guidelines.

Types of Transactions Covered

TPSOs process payments across various platforms, including online marketplaces, crowdfunding sites, and mobile payment apps. Each category carries distinct financial and tax implications.

Online Marketplaces

E-commerce platforms like eBay, Etsy, and Amazon’s third-party seller marketplace use TPSOs to process payments. When a buyer completes a purchase, the marketplace collects funds and disburses them to the seller after deducting fees.

Sellers must account for gross sales revenue, which includes the total amount received before deductions for marketplace fees, shipping costs, or refunds. The IRS considers the full payment amount when determining tax liability, so sellers must track deductible expenses separately. Additionally, many online marketplaces automatically collect and remit sales tax in jurisdictions with marketplace facilitator laws. Sellers should review their 1099-K forms to ensure reported amounts align with their records, as discrepancies can lead to IRS inquiries.

Crowdfunding Platforms

Websites like GoFundMe, Kickstarter, and Indiegogo allow individuals and businesses to raise funds for projects, charitable causes, or personal needs. Whether these transactions trigger TPSO reporting depends on the nature of the funds collected. Contributions made in exchange for goods, services, or equity are taxable income, while personal gifts are generally not.

For example, if a musician raises $10,000 on Kickstarter to produce an album and offers backers exclusive merchandise, the funds are classified as business income and may be reported on a 1099-K if they exceed the reporting threshold. Conversely, if a family raises money for medical expenses through GoFundMe and donors receive nothing in return, the funds are considered personal gifts and are not subject to income tax. However, large individual donations may be subject to gift tax rules, requiring the donor—not the recipient—to file a gift tax return if contributions exceed the annual exclusion limit, set at $18,000 per recipient in 2024.

Mobile Payment Apps

Services like PayPal, Venmo, and Cash App process both personal and business transactions, making it important for users to distinguish between taxable and non-taxable transfers. Payments for freelance work, selling goods, or providing services may be subject to TPSO reporting if they exceed the $5,000 threshold.

A common issue arises when users receive payments labeled as “friends and family” versus “goods and services.” Payments marked as “friends and family” are generally not reported on a 1099-K, as they are considered personal transfers. However, if a user consistently receives large amounts through personal payment designations but is actually conducting business, the IRS may scrutinize their tax filings. To avoid misclassification, business owners should use dedicated business accounts on these platforms and maintain clear records of income and expenses. Additionally, self-employed individuals receiving payments through mobile apps must account for self-employment tax, which includes Social Security and Medicare taxes, totaling 15.3% of net earnings.

Reporting Obligations

TPSOs must issue Form 1099-K to payees who meet the reporting threshold. The form details the gross amount of reportable transactions processed through the platform during the year and must be furnished to both the recipient and the IRS by January 31 of the following year.

Failure to provide accurate information can result in penalties under IRC Section 6721, with fines starting at $60 per form for late filings and escalating to $310 per form if not corrected within a reasonable timeframe. Large businesses can face a maximum annual penalty of $3,783,000.

To ensure compliance, TPSOs must collect and verify taxpayer identification numbers (TINs) from users receiving payments, typically requiring a Form W-9 for U.S. persons or a Form W-8 for foreign individuals and entities. If a payee’s TIN is missing or invalid, the TPSO may be required to implement backup withholding at a rate of 24% under IRC Section 3406. This means a portion of the payee’s funds would be withheld and remitted to the IRS as a preemptive tax payment, which the payee can later claim as a credit when filing their return.

Distinguishing from Payment Facilitators

While TPSOs and payment facilitators (PayFacs) both enable electronic transactions, they operate under different regulatory frameworks. TPSOs process payments between buyers and sellers across a decentralized network, whereas PayFacs act as aggregators that onboard merchants under a master merchant account with an acquiring bank.

PayFacs, such as Stripe and Square, assume responsibility for underwriting and risk management, assessing the legitimacy of businesses before allowing them to accept payments. Unlike TPSOs, which primarily facilitate peer-to-peer or marketplace transactions, PayFacs provide direct merchant services, including fraud prevention, payment dispute resolution, and compliance with card network rules. Since PayFacs operate under agreements with acquiring banks, they must adhere to Payment Card Industry Data Security Standards (PCI DSS) and other financial regulations governing merchant accounts. TPSOs, on the other hand, do not directly manage merchant accounts but facilitate payments through a broader network, often without assuming liability for individual transactions.

Merchant Relationship Considerations

Businesses using TPSOs for payment processing must understand how these relationships impact financial reporting, tax compliance, and operational flexibility. Unlike traditional merchant accounts, which provide direct access to payment networks, TPSOs act as intermediaries, meaning sellers may experience delays in fund disbursement, restrictions on transaction types, or limitations on chargeback protections. These factors can influence cash flow management, particularly for small businesses or independent sellers who rely on timely access to funds.

TPSOs impose contractual obligations related to dispute resolution, transaction fees, and compliance with platform policies. Sellers using online marketplaces or crowdfunding platforms must adhere to the specific rules set by the TPSO, which may include restrictions on product categories, refund policies, or account suspension criteria. Businesses exceeding reporting thresholds must ensure that income reported on Form 1099-K aligns with their financial records to avoid discrepancies that could trigger IRS scrutiny. Proper bookkeeping, including maintaining detailed records of expenses, refunds, and chargebacks, is essential for reconciling reported income with actual earnings.