Online Merchants Brace for New Reporting Requirements

The Housing Assistance Tax Act of 2008 made headlines as part of the larger Housing and Economic Recovery Act of 2008, or HERA, signed into law by President Bush. HERA was introduced as HR 3221 by Rep. Nancy Pelosi (D-CA), with the title: A bill to provide needed housing reform and for other purposes and was ostensibly introduced to kickstart a then-declining housing market. It included $15.1 billion in tax incentives, with a stab at the first-time homebuyers’ credit (this one to be repaid over 15 years); a property tax deduction for taxpayers who don’t itemize; and significant changes to the rules for low-income housing credits.

What really wasn’t publicized in the bill was the “for other purposes” bit… One of the most dramatic changes in the law absolutely nothing to do with housing: tucked in the middle is a new requirement that banks and credit card merchants to report payments to the IRS. It’s just now generating some interest because it takes effect in about a year.

The purpose of the law is to “improve voluntary tax compliance by business taxpayers and help the IRS determine whether their tax returns are correct and complete.” Interesting use of the term “voluntary.”

It works like this: certain payments for goods and services paid by credit card or third party merchants will now be reported to the IRS via a new form 1099K, Merchant Card and Third-Party Payments. The look and feel of the 1099-K is very similar to the 1099-INT used by banks to report interest and the 1099-DIV used by banks to report dividends.

Under the proposed Regs (downloadable here as a pdf), the form 1099-K would be required for “reportable payment transactions.” A reportable payment transaction is basically a transaction in which a payment card (such as a credit card) is accepted as payment or any transaction that is settled through a third party payment network like PayPal. Exemptions may apply in certain circumstances, such as if the total payments settled for the year are less than $20,000.

What this means 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 form 1099-K will report the gross amount paid out to the taxpayer with no adjustments for fees or chargebacks (an issue that is, admittedly problematic).

Clearly, there are going to be issues with respect to reconciling these reports against tax returns. I don’t think the IRS is actually expecting to match these up on a dollar for dollar basis, much as they don’t match forms 1099-B on a dollar for dollar basis. It is, however, apparent from the discussions surrounding the Regs that the idea is to “encourage” compliance with respect to reporting – in other words, they’re attempting to track dollars.

Let’s face it: the IRS may be a lot of things but it isn’t stupid. The IRS is aware that there are hundreds of millions of dollars exchanging hands every year that go unreported. These compliance issues are thought to largely be the result of online transactions. 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 outside of the United States that fail to file forms 1099-MISC for services rendered. This is a first effort to try and track that income in a consistent manner.

The form won’t be required until 2011. The form 1099K for that year must be filed with the IRS and furnished to participating merchants by early 2012.

The IRS is inviting taxpayers to take a look at a draft of the 2011 form 1099K (downloadable as a pdf).

Believe it or not, the IRS really wants your comments on the new form. They’re accepting public comments on the proposed regulations through Jan. 25, 2010 via email (be sure and put “Draft 2011 Form 1099-K” in the subject) and via USPS:

CC:PA:LPD:PR (REG-139255-08)

Room 5205

Internal Revenue Service

P.O. Box 7604,

Ben Franklin Station

Washington, DC 20044

A hearing on the matter is scheduled for Feb. 10, 2010 in Washington, DC. If you have something to say about the new rules, let the IRS know!