The IRS expanded its matching program to business tax returns starting with the 2011 tax year. Payment settlement entities (“PSEs”) such as credit/debit card companies (ex. Visa) and third-party payers (ex. PayPal) are now required to report payment card transactions made to merchants for goods & services. PSEs report on Form 1099-K, Payment Card and Third Party Network Transactions. The new form shows the gross amount of total reportable payment transactions in a calendar year. The 1099-K lists a company’s sales by month; the reported amount does not include adjustments for credits, cash equivalents, discounts, fees, refunds or other amounts.
The purpose of the new form is to find unreported business income. The IRS states on its website, “IRS uses the information reported… to ensure individuals and businesses meet their tax obligations. The IRS is integrating the new information supplied on the Form 1099-K into a variety of areas, including its compliance efforts, to ensure fairness and address non-compliance.”
Taxpayers were not required in 2011 to separately report amounts received from each 1099-K on their income tax returns. However, the IRS contacted many businesses if their reported gross income is less than the aggregate 1099-Ks issued. The IRS created four new letters based on its analysis of 1099-Ks. The request letters question business income reporting in various ways:
- Letter 5035 – Review the accuracy of information shown on the letter vs. what was reported on your filed tax return.
- Letter 5036 – Review the accuracy of information shown on the letter vs. what was reported on your filed tax return. File an amended tax, if necessary.
- Letter 5039 – Review the accuracy of information shown on the letter vs. what was reported on your filed tax return. Complete Form 14420, Verification of Reported Income with your response.
- Letter 5043 – This letter has the same basic language as noted in Letter 5036 above. The main difference is Letter 5036 doesn’t specify next possible actions by the IRS, while 5043 states the potential for IRS under-reporting assessment or audit.
Beginning in 2012, business owners will be required to report gross receipt amounts reported on 1099-Ks separately from payments received through other methods such as cash, check or barter. Since the 1099-K reports gross amounts, taxpayers must calculate items like charge backs and returns and separately report them as a reduction of income under “Returns and Allowances” on the tax return.
The 1099-K reporting program will certainly bring some small businesses who haven’t reported income within the IRS’ radar. But the 1099-Ks may potentially create new problems for compliant taxpayers. Let’s say you are a small service business who receives payments from a client through a credit card company. The PSE will report payments to the IRS on the 1099-K. The client is no longer required to provide you with a 1099-MISC – the payments have already been accounted for. A big problem can happen if the client doesn’t know this and issues the 1099-MISC anyways. The IRS may think you received twice as much income than you actually did.
It is becoming more important to work with a tax professional who knows income reporting requirements. Gary Kaplan has over 15 years of experience with these and many other emerging tax reporting issues. He can help you with your questions.
