Responding to an outcry from small-business concerns, the Internal Revenue Service has taken some of the teeth out of a tax reporting regulation that the National Federation of Independent Business has called an “onerous and unnecessary” step for companies filing tax returns to comply with laws governing credit and debit cards.
The rule, part of the Housing and Economic Recovery Act of 2008, requires companies to explain any disparities between their own records of receipts for payment card transactions with numbers that their payment card processors must now report to the IRS.
It also requires payment processors – often banks and online businesses like PayPal that keep track of payment card receipts – to report the sum of transactions for each of their merchants in monthly increments on 1099-K forms.
Starting next year, the IRS would have asked companies to explain the differences between those numbers and their own internal records on their tax returns. This new process was an attempt “to increase voluntary tax compliance, improve collections and assessments within IRS, and thereby reduce the tax gap,” the IRS wrote on its website.
But after meeting with the NFIB and other industry groups, the IRS has agreed to strike the requirement that companies reconcile the two numbers. The IRS has no intention of requiring reconciliation in future years, IRS Deputy Commissioner Steven T. Miller said in a Feb. 9 letter to the NFIB.
Business groups like the International Franchise Association and the NFIB had protested the rule, saying it would increase the administrative burden on businesses. A company’s internal record of gross receipts would rarely match the amount its payment processors would report on 1099-K forms, they contended.
The 1099-K figure would include cash refunds, sales tax, tips, and other fees that merchants would not consider part of gross receipts, says Chris Walters, senior manager of legislative affairs at the NFIB. Businesses that sell lottery tickets get only a small part of a ticket’s sale price, for instance, but the complete revenue from the ticket appears up as a charge on a credit card statement, Walters adds.
At the same time, businesses will usually refrain from including the government portion of the sale in their gross receipts on their internal records. With this almost-guaranteed disparity between the amount reported on the 1099-K and a company’s internal record of receipts, reconciling the sums would require small businesses to invest time and capital in more-sophisticated accounting systems, Walters says.
But IRS has scotched the reconciliation requirement. Now, when it comes to reporting gross receipts and sales, company tax returns will revert to what they looked like in 2010. Still, since payment processors will continue to submit 1099-K forms, companies may have to change the way they keep their records, says Lewis Taub, tax director at McGladrey and Pullen LLP.
Variance between gross receipts on merchant tax returns and the numbers on payment processor forms could raise red flags at the IRS, Taub says. “The government may say that if the 1099-K is a much bigger number than what’s being reported by a company, then there may be a reason to do an audit,” he says. If the IRS received a 1099-K for a company that reported $5 million in revenue, but the company claimed total revenue of only $4 million on its own tax return, that disparity could spark an audit, Taub says.
Even without changing the way companies report their gross receipts, the 1099-K rule will allow the Internal Revenue Service to identify businesses that are not filing tax returns at all, says Walter. Less clear is how the IRS will compare the 1099-K forms to the tax returns filed by companies to decide whether or not to audit. “For people who file their tax returns all the time, there’s no direct link between the [two numbers, the sum on] the 1099-K and what’s on the tax return,” Walter says. “They just won’t have enough information.”
To respond to the uncertainty, Taub suggests that merchants that receive 1099-K forms should be able to explain why their numbers are different than what their payment card processors reported. That could mean that for small companies, the rule will still be “a burden, because [they will] have to really keep fastidious records now, maybe more than they ever did before, if they’re going to reconcile these numbers,” he says.
As a practical matter, under the new rule, companies must provide their tax identification numbers to each of their payment processors. If they don’t, or if they provide the wrong number, they could be subject to backup withholding. The IRS has postponed this penalty, and backup withholding will only apply to payments made after December 31, 2012.
There’s also an exemption for businesses on the smaller end. The rule does not require payment processors to submit 1099-K forms for companies that had fewer than 200 transactions that added up to less than $20,000.
Lawmakers have introduced a bill in the House, the 1099-K Overreach Prevention Act, to prevent the IRS from changing its tune and requiring companies to reconcile the numbers on 1099-Ks with their internal records in the future. The Senate introduced a companion bill this month.