And you thought bank fees were bad… There’s a new form on the block, Form 1099-K, Merchant Card and Third Party Network Payments, making its debut in a few months, just in time for the 2012 filing season. The form is the result of new compliance reporting requirements for certain credit card and third party network payments (think PayPal). More compliance reporting. You already know where this is going.
Before we get into the nitty gritty, first, a little background.
A little over three years ago, President Bush signed into law a bill known as The Housing Assistance Tax Act of 2008; it was part of the Housing and Economic Recovery Act of 2008, or HERA. As per usual, the bill was cleverly named so as to sneak something past taxpayers garner support from taxpayers. Even the title of the bill, technically HR 3221, was meant to tug at your sensibilities: A bill to provide needed housing reform and for other purposes.
Cause, c’mon? Who didn’t want housing reform in 2008? Okay, maybe I didn’t. But I was in the minority. The bill passed, putting into place $15.1 billion in tax incentives, including the first effort at the first-time homebuyers’ credit. And then we moved on.
What was forgotten about was that little “for other purposes” bit in the bill. Smack in the middle of the bill was a new requirement for banks and credit card merchants to report certain payments to the IRS. The law was passed in 2008 but the new reporting requirement didn’t kick in until this year (2011); it will show up for the first time when forms 1099-K are issued in early 2012. Yep, that’s just a few months away.
The idea of the law was to “improve voluntary tax compliance by business taxpayers and help the IRS determine whether their tax returns are correct and complete.” Yes, they used the word “voluntary.” Only it’s not so much.
You see, you and I both know that there are hundreds of millions of dollars (if not more) exchanging hands that go unreported every year. This difference between what is actually reported versus actually earned is called the tax gap. A lot of the tax gap is thought to be the result of online transactions. And it’s true. Bloggers, etsy sellers, affiliates, eBay merchants and other small businesses have been able to stay under the radar if their income comes from multiple sources or if they are paid from companies that fail to file report that income (for whatever reason). The form 1099-K is an attempt to put an end to the underground/untaxed economy.
Here’s how it will work: certain payments for goods and services paid by credit card or third party merchants will now be reported to the IRS via the form 1099-K. The look and feel of the form 1099-K is very similar to the form 1099-INT used by banks to report interest and the form 1099-DIV used by banks to report dividends.
The form 1099-K will be required for “reportable payment transactions.” A reportable payment transaction is basically a transaction in which a payment card (such as a credit card or gift card) is accepted as payment or any transaction that is settled through a third party payment network like PayPal. It does not include ATM withdrawals, cash advances against a credit card, a check issued in connection with a payment card, or any transaction in which a payment card is accepted as payment by a merchant or other payee who is related to the issuer of the card.
What this means, basically, is that taxpayers who have a credit card merchant account, Paypal account or similar account and otherwise meet the criteria will receive form 1099-K from their service provider at the end of the year.
The IRS is still working out the details (though they are more or less settled). Exceptions may apply in certain circumstances, such as if the total payments settled for the year are less than $20,000 or if there are fewer than 200 transactions.
It’s the first year that the rule will be in effect which means that there are going to be some issues. And by some issues, I mean lots of issues. The biggest area of concern seems to focus on the fact that the form 1099-K will report the gross amount paid out with no adjustments for fees or chargebacks for returns or mistakes. That means that there are going to be some issues reconciling the forms against income actually received. And again, by some issues, I mean lots of issues.
I don’t want to be a big naysayer here. I actually believe that better compliance should be a goal for the IRS and I also believe that internet based transactions should not escape taxation just because they are easier to hide (yes, hide, as in deliberate).
I am a little skeptical, however, at how smoothly the process of reporting for the first year is going to happen. I don’t think the IRS has done a stellar job of prepping the public for the changes. And while I completely agree that taxpayers who have been receiving credit card and electronic payments should have been reporting their income all along, some clearly haven’t or there wouldn’t be a need for the form in the first place. In other words, if everyone reported just fine, there’s no tax gap, right?
But should that equal a blindside? I don’t think so.
And what about those taxpayers who have been reporting but now find themselves a little confused by – or in disagreement with – the forms they receive? Some financial institutions may be, er, too big to fail but maybe they’re not too big to make a mistake? Or two?
We tend to fear what we don’t know and right now, we just don’t really know how this is going to play out. The first forms will be issued in January 2012, assuming all goes as planned. But for now, you can check out a draft of the 2011 form 1099K (downloadable as a pdf). Are you ready for it?
