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1099-Ks: Small businesses face new tax paperwork, penalties

IRS changes rules to stop under-reporting of credit card sales

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The jig is up for businesses who have kept the Internal Revenue Service in the dark about sales they've made using credit cards, PayPal or similar services.

Banks that issue credit cards, as well as third-party settlement organizations such as PayPal, have been enlisted by the IRS as as tax-collecting enforcers by the IRS: They are now required to withhold 28 percent of gross receipts from merchants that have not provided their companies' correct taxpayer identification number or tax filing name.

Many credit-card issuing banks already require a retailer to submit a W-9 to open a merchant account. However, if they submitted incorrect information to evade the law, they might get snagged.

Small businesses face new penalties for improper tax reporting

"Our law is pretty clear," says Michael Williams, a New York City-based CPA at Schulman Lobel Wolfson Zand Abruzzo Katzen & Blackman LLP. "It says income is income. You must report it."

The change is a result of the Housing Assistance Tax Act of 2008. It ushered in Internal Revenue Code Section 6050W, which required banks to send merchants 1099-K forms by Jan. 31, 2012, listing the merchant's gross annual receipts. Third-party settlement organizations such as PayPal and Google must do the same for merchants that have gross receipts greater than $20,000, and more than 200 separate payments in a calendar year.

Both banks and third-party settlement organizations will have to send a corresponding 1099-K form to the IRS by March referencing a business by tax identification number and tax filing name.

Payment processors had to start issuing 1099-Ks in 2012 for the 2011 tax year. For 2012, the IRS waived the 28 percent withholding penalty because the law was new, but this year, it will be enforcing this provision and imposing penalties on banks and payment processors that don't comply.

Closing the reporting gap
The law is aimed at raising revenue for the federal government, which is looking for ways to reduce a $385 billion tax gap that the IRS estimated for 2006. When Congress initially considered the proposal for the law in 2008, the Joint Committee on Taxation estimated that it would raise more than $9.5 billion over 10 years. Much of the tax gap has been attributed to merchants that have avoided paying some taxes because they didn't report all of their income.

Card issuers and payment processors aren't eager to withhold money their customers have earned using credit cards, according to Jeff Cronin, vice president of product marketing at Convey Compliance Systems, a Minneapolis-based provider of 1099 software and service for businesses.

"That's the last thing they want to do," he says. "They don't want to withhold on them." Convey has done direct mail and phone campaigns to collect information from merchants for its banking clients so they can avoid imposing the 28 percent withholding, he says.

Nonetheless, there may be a bit of a scramble this year, as credit card issuers and other processors catch up to the new requirements.

"We found a lot of clients didn't pay enough attention last year, when they got their free pass," Cronin says.

What to file
To avoid inadvertently triggering the withholding provision, merchants should be careful that their banks and third-party settlement organizations have a current W-9 on file for them and make sure that their federal tax identification number and tax filing name matches the information the IRS already has on file for them in their SS-4, the form they used to apply for their tax ID, say accountants.

"The only reason starting in 2013 that backup withholding would be triggered is if the merchant has failed to supply the basic information to their clearinghouse," says James A. Smith, CPA and managing director of  Smith, Jackson, Boyer & Bovard, PLLC, a public accounting firm in Dallas. "If the clearinghouse has that, there would be no reason for them to do backup withholding with one other exception: If you are delinquent in paying your taxes. If the merchant owes the IRS money, the IRS can notify all payees of any kind for that merchant to implement backup withholding."

It is also important for merchants to keep careful records of remittances so it is possible to compare them to their 1099-Ks to make sure there are no errors, he adds.

It's not anything to panic about unless you haven't been reporting your income -- in which case, it's game over.

-- James A. Smith
CPA, Smith, Jackson, Boyer & Bovard

"It's not anything to panic about unless you haven't been reporting your income -- in which case, it's game over," he says.

It's common for the number on the 1099-K to differ from a company's total gross receipts, because many businesses also accept other forms of payment, such as checks, he adds. "The merchant can attach a statement to their return reconciling the 1099-K to the amount they are actually reporting," says Smith.

Cronin anticipates some small merchants that have accepted credit cards will try to avoid the new requirements by encouraging customers to switch to another form of payment -- such as cash.

"It is possibly going to put some people in a situation where they are not going to want to take cards," he says.

See related: Paying small business taxes with plastic

Published: February 1, 2013


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