Big Brother IRS is Watching You and Your Credit Cards
The IRS has recently beefed up its program of seeking out those taxpayers underreporting income who also receive a significant amount of receipts from credit cards. The IRS Form 1099-K is an information return that reports payment from credit card and other third party network reportable transactions. This 1099 is used if the taxpayer has accepted credit card payments or received payments through a third party network that exceeded $20,000 in gross annual reportable transactions and the aggregate number of those transactions exceeded 200 for the calendar year.
If you receive an IRS letter or notice, the inference is that gross receipts may have been underreported. The letter or notice will explain the reasons for the correspondence and provide instructions. Generally, the IRS will send a notice if it believes you owe additional tax or are due a larger refund, or if there is a question about your tax return.
It is important to respond to any notice or letter received although all Form 1099-K activities by the IRS allow taxpayers and practitioners like us at Abo and Company to offer explanations and corrections if a notice is received or an audit is begun related to this compliance effort
Again, the Form 1099-K notice is generally issued under the belief that you may have underreported your gross receipts. This is based on your tax return and Form(s) 1099-K that show an unusually high portion of receipts from card payments and other Form 1099-K reportable transactions. They couldn't be clearer in stating their mission: the IRS uses the information reported from third parties to ensure individuals and businesses meet their tax obligations. The IRS is integrating the new information supplied on the Form 1099-K into a variety of areas, including its compliance efforts, to ensure fairness and address non-compliance.
As is usually the case, the IRS provides instructions for Form 1099-K and we suggest business owners review this new form to familiarize themselves with the format.
We envision many traps for the unwary. For example, the new requirements require the banks and other credit card companies to report gross receipts. However, merchants and professional service firms like us or the law firms, medical/dental practices, etc. we represent, often have chargebacks, issue refunds, or have debit card transactions where the client or customer receives cash back. Under the proposed regulations, banks and other payment transaction services will be reporting only gross monthly and annual payments. Fees, chargebacks, refunds and other such items may not be netted against these gross amounts for 1099 reporting purposes. Accordingly, businesses and professional service firms should review their accounting procedures to keep track of these items separately. In other words, if you are accustomed to recording only a net deposit from a merchant account, it may be wise to separate those net amounts into gross receipts and the associated fees and refunds. That way your internal financial reports can be more easily reconciled to this new Form 1099-K.
In order to enforce compliance, the IRS requires the credit card processor to withhold 28% of all credit card sales of any merchant with discrepancies until all information is updated and accurate. When the merchant fixes all discrepancies, the 28% withholding should be returned. However, this may not occur until year's end. This could certainly cause financial stress for the business. To prevent this backup withholding, businesses should ensure that they provide their card payment services provider with the correct name, address, and ID# for the business. Once again, it will be up to the business owner to keep track of these items separately to be reconciled accurately with the IRS in order to avoid fees and penalties.
The Big Brother concern Abo and Company alluded to in our title? How about the likelihood that credit card transactions could become subject to backup withholding or garnishment if an enterprise becomes delinquent on their federal and/or state tax payments? Under the initial proposed regulations, the IRS made it clear that backup withholding would occur on gross card payments. You can imagine how the unsuspecting business owner could be caught off guard with such surprise garnishment, particularly if they are already strapped for cash.
Even the IRS has given guidance to help in addressing the inquiry which sounds like a direct excerpt from our own playbook:
Read the notice thoroughly and complete any worksheets.
Gather your tax records including the 1099-Ks that you received and determine if you agree with the notice about the underreporting of gross receipts.
If you have questions, use the contact information provided on the notice.
If appropriate, consult your tax professional for assistance (that be us).
We generally advise clients to retain these 1099s for their records and even use them to assist us in completing their tax returns. You should note that the information reported on the 1099-K should already be reflected in your income tax return as part of your total gross receipts, which are a combination of both payment card receipts and other forms of payment like cash and checks. Still we, as your tax preparers, will often run adding machine tapes of all 1099s received to ensure the tax return makes sense (it wouldn't be the first time we've found 1099s do not match a client's returns due to incorrect/excessive reporting from payors, calendar year reporting on 1099s when monies may not have even been received until a subsequent period, incorrect social security or federal ID # used in reporting, etc.)
In case you were wondering about the State taxing authorities, our understanding is that many of the states (i.e. yep, New Jersey and New York for sure) require payment processors to provide copies of Form 1099-Ks issued to their residents. Regardless, states generally have the ability to obtain data from the IRS.