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As the new year approaches, many small businesses are bracing for a rude awakening. The 1099-K is here and the latest reporting requirement from the IRS is designed to eliminate unrestricted income for small businesses that use credit cards.
The new tax laws for issuing 1099s will bring about an unprecedented change in the way credit card income is reported to the IRS. “Payment settlement entities,” such as credit card companies, PayPal, banks and some third-party processors will now report deposits made to taxpayers. With unreported income estimated at more than $2 trillion in 2010, the IRS is determined to recapture a significant portion of “non-cash” dollars unrestricted through 1099-Ks. Much of this additional tax will be collected from small businesses selling through e-commerce portals such as E-bay or Amazon. Thus, for an e-commerce company that is using one of these modes of commerce yet is not reporting all of its income, the requirement of reporting all gross credit card income for 2011 counts as year will be
An example of a company changing its policies to comply with new IRS regulations is PayPal. PayPal revised its User Agreement this year due to new IRS reporting requirements. The following wording is added to Section 4.7 (Tax): “You acknowledge that beginning in 2011, PayPal will report to the Internal Revenue Service the aggregate amount of payments received by you in each calendar year across all of your accounts if You (i) receive more than $20,000, and (ii) receive more than 200 payments in that calendar year.”
Eliminating a portion of the estimated $425 to $475 million dollars that companies avoid on taxes each year is just the beginning of IRS goals. Here are 10 things every taxpayer should know about 1099-K compliance.
1. Month-to-month reporting is one factor that is important on the new 1099-K. Taking a look at the new 1099-K form, one interesting feature will appear that is quite different from any other 1099. Income reporting is “month-to-month” rather than annually. The IRS created this unique design to assist federal agencies in estimating the periods in which income will be earned. However, you can be certain that state agencies such as Sales and Use will also use this form in determining the proper period for sales tax assessment. In the future, it will be much easier for states to issue “thresholds” of income subject to “anticipated” income based on sales and use taxes as well as credit-to-cash ratios.
Additionally, reporting of income only in the last quarter of the year will also be eliminated. Companies that reported the correct amount of total revenue and earnings for the year, yet loaded the revenue into the last quarter in an attempt to delay tax payment, will be subject to correction when it comes to calculating interest.
2. The new 1099-MISC also provides instructions for taxpayers who exclude payments that are now reported on a 1099-K. Specifically, here is part of the new instructions for the 2011 1099-MISC.
“Payments made with credit cards or payment cards and certain other types of payments, including third-party network transactions, must now be reported on Form 1099-K by the payment settlement entity under section 6050W and subject to reporting on Form 1099.” are not. -MISC. See separate instructions for Form 1099-K.”
Beginning in 2011, taxpayers will report on 1099-MISC only those payments that are not subject to reporting on 1099-K. This can spell disaster for law firms or service companies like subcontracting services where clients pay by credit card and the firm historically issues a 1099-MISC at the end of the year.
Service companies should be careful. Companies that have historically received 1099-MISCs should look closely this year to make sure payers correctly calculated 1099-MISC income, excluding 1099-K income if applicable. In the event of an error, contact the company that issued the 1099-MISC immediately and request an amended form reflecting the correct amount of cash income.
3. Offshore bank account information will be taken for US taxpayers. In 2011 there is an exception to this rule that will be short term for companies where the payment settlement entity is unsure whether the entity is a US entity.
Offshore income capture has been a hot topic for the IRS for many years. Now it appears that the IRS has found a way to capture a portion of the income paid to offshore banks belonging to US taxpayers. While the 1099-K will only capture “non-cash” payments, it will eliminate most payments made through e-commerce to off-shore accounts.
4. Only a few taxpayers will be affected. For 1099-Ks, there is a two-fold requirement. First, the company must have a payout of at least $20,000. Secondly, the company should have at least 200 transactions. Each of these requirements must be met for the taxpayer to be affected. Thus, if a business has 10 transactions totaling $100,000, there will be no reporting requirement. In addition, if a company has 500 transactions totaling $19,000, there is no reporting requirement.
5. Net sales including chargebacks will be reported. As a result of using the gross method, it will be important to track charge backs, merchant processing fees, etc. to ensure proper recording of credit sales. This is consistent with the IRS’s position that the proper approach to reporting sales is gross, as merchandise expenses and charge backs as goods sold or bad debts expense.
The charge back issue was addressed by the IRS in its 1099-K guidance. IRS Sec. 6050W(a)(2) states that the gross amount must be reported and reporting net sales was inappropriate. However, the IRS also acknowledges that the information reported on a 1099-K is not intended to accurately match the net, taxable, or even gross income of a recipient. Thus, in theory, if there is a slight difference in your credit sales numbers, it appears that the IRS is not going to make an automatic correction, nor is the difference going to be an automatic audit flag.
6. The only relief in 2011 is a moratorium on the collection of back-up withholding for taxpayers whose payment settlement entities do not have tax identification numbers. However, effective 2012, any taxpayer who does not submit a taxpayer identification number will be subject to back-up withholding. What does this mean? This means that the payment settlement entity will withhold 28% of all gross payments processed and forward this money to the IRS.
7. Some types of credit cards are not required to be reported. For companies that have personal cards where the card can only be used with the company, there is no reporting requirement. For example, companies like Sears, Home Depot, etc. that have a credit card that can only be used at their stores have no need to report to the IRS. However, credit cards issued by malls, or where multiple taxpayers are able to obtain credit cards, are required to be reported to the IRS.
8. Convenience checking, cash advances and ATM withdrawals have their own requirements and are not reported on the 1099-K. If you use a credit card to obtain a cash advance, make a payment using credit card convenience checks, or make ATM withdrawals, these transactions do not trigger reporting to the IRS.
9. Government payments are not exempt. If you use a government benefits card (i.e. with food stamps, welfare, or unemployment), those transactions are not exempt and will be tracked and reported (if you’ve reached reporting limits).
10. The IRS will use the 1099K as an audit tool. Thus, taxpayers who have had a significant jump in revenue due to the new 1099K reporting requirement will be at higher risk of a prior year audit. This would be an inevitable result of 1099-K reporting.
For a more copy of the new 2011 1099-K forms, IRS instructions or other information, please visit http://www.accountingexpertwitness.com/News.html,
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