In an effort to help close the "tax gap," the IRS has launched a new compliance program targeting the underreporting of income by business taxpayers that receive Form 1099-K information returns from credit card companies and third-party transaction networks.

On its website, the IRS stated the program would involve letters and notices going out to taxpayers who may have underreported their gross receipts. If your business receives a Form 1099-K because it accepts payment cards from customers, you may receive one of these letters.

Answers to Form 1099-K Questions

Q. What constitutes the "gross amount" of reportable transactions?

A. The "gross amount" of reportable transactions means the total dollar amount of aggregate transactions without regard to any credits, charge-backs, fees, cash equivalents, discounts, refunds or any other amounts.

Q. When are Forms 1099-K due?

A. Information reporting for payment card and third party network transactions are due to the IRS by February 28 (March 31, if filed electronically), of the year following the transactions.

Background: Under the Housing Assistance Tax Act of 2008, banks and other payment settlement entities (such as PayPal) must file the new Form 1099-K information with the IRS. Starting in 2011, Form 1099-K reports the gross amount of reportable transactions for the calendar year. Listed on the forms will be the names, addresses and taxpayer identification numbers of merchants and others accepting credit cards, debit cards, stored value (gift) cards and other third-party payments.

The purpose of the new requirement is to create a paper trail so that the IRS can compare a merchant's card transactions with income reported on the merchant's tax return. An IRS explanation about why the reporting is necessary states: "Third-party information reporting has been shown to increase voluntary tax compliance, improve collections and assessments within IRS, and thereby reduce the tax gap," which is the difference between the amount of tax money owed and the amount collected.

Exactly how the new IRS 1099-K compliance program will work is not known yet since the tax agency has never had this type of information before. But since the IRS now has the gross amount of reportable payment card transactions reported on a merchant's Form 1099-K, it can match the amount against other information reported on merchants' tax returns.

This is not the typical IRS matching program since the amount on the 1099-K will not be a direct match to what is reported on a taxpayer's return. The IRS will be using the information gleaned from the 1099-K along with information on the tax return.

Who will receive letters? The IRS will send letters to taxpayers based on their returns and Forms 1099-K, Payment Card and Third Party Network Transactions, that show "an unusually high portion of receipts from card payments and other Form 1099-K reportable transactions," the IRS stated.

The IRS has posted five different letters on its website, which will be sent to businesses. The letters inform taxpayers that:

"Your gross receipts may be underreported. We received Form(s) 1099-K, Payment Card and Third Party Network Transactions, showing your total payments from Merchant Card and Third Party Network transactions. The information from these form(s) and your tax return show an unusually high portion of gross receipts from card payments and other Form 1099-K reportable transactions. Your type of business consistently has a much lower portion of gross receipts from card payments and other Form 1099-K reportable transactions, and a higher portion of gross receipts from other sources (e.g., cash and checks)."

Each of the letters asks taxpayers to review the Form 1099-K and their computation of gross receipts for your business as reported on the tax return in question. Taxpayers are instructed to make sure they "fully reported receipts from all sources, including card, cash and checks."

Depending on the type of letter received, taxpayers are given various instructions including:

  • "If you don't find any inaccuracies in your review, no further action is required at this time."
  • Within 30 days, fill out and return IRS Form 14420, Verification of Income, which is used "to explain why the portion of your gross receipts from card payments and other Form 1099-K reportable transactions may be higher than expected."
  • "If you believe you filed your tax return correctly, please provide a written explanation telling us why the portion of your gross receipts from card payments and other 1099-K reportable transactions may be higher than expected."
Taxpayers are warned that "failure to respond may also result in a proposed assessment or further compliance action."

As with many other tax requirements, the new 1099-K compliance program makes it important to keep good records so you can respond to IRS requests for information. Consult with your tax adviser if you have questions about payment card reporting or receive a 1099-K letter.

For more information about the new compliance program from the IRS, click here.
 
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