As hard as it is to believe, the IRS has concluded that some small businesses do not report all of their credit card income. They estimate that $120 billion in taxes go uncollected each year because of under reporting by small business. They would like to get their hands on these funds!
Recent media stories reported that small business welcomed a repeal of the requirement to issue 1099-MISC forms for all payments totaling more than $600, including goods and services. The general consensus was that the 1099-MISC reporting would put an undue burden on small business. Although there was great applause for this action, the Form 1099-K slipped past without much notice. Merchant Card and Third Party Networks like the very popular PayPal are now required to issue Form 1099-K to anyone with at least 200 transactions totaling $20,000 or more as part of the Housing Assistance Act of 2008. As with many new IRS initiatives, there will be exceptions for some taxpayers that do not meet this minimum requirement. There has been little to no discussion about the burden 1099-K reporting would place on Merchant Card, Third Party Networks, and especially small businesses without accurate accounting systems in place.
Experts generally agree that if the IRS sees some success from this effort, they will not hesitate to tighten up the limits or expand the reporting requirements. Having systems in place early will make it much easier to deal with changes that are sure to come.
According to Douglas H. Shulman, IRS commissioner, “Beginning in 2012, payment processors will be required to make an annual information report to the merchant and the IRS stating the gross amount paid to the merchant during a calendar year. This will help improve voluntary tax compliance by business taxpayers and help the IRS determine whether their tax returns are correct and complete.”
One of the problems many small business owners will encounter with the 1099-K reporting is that gross payments will be reported rather than the net amount actually received. This will require small businesses to keep track of the merchant and processing fees paid to ensure they are deducted as normal business expenses. Without deducting the processing fees, it would be easy for a small business to overstate their income.
If small business owners are using their PayPal accounts to receive money from friends and relatives as an easy means of transferring money, they may want to reconsider this practice. All of these funds will be reported on the 1099-K just like the actual sales income. If gifts or loans from friends and family are included in the amounts reported on the 1099-K, it may require some extensive explanation to the IRS about why the income reported on the tax return is significantly less than reported on the 1099-K.
Another little known aspect of the 1099-K reporting is that revenue is reported by month. This will cause many small business owners not making quarterly estimated payments to incur underpayment penalties. The IRS expects all small business owners to make estimated tax deposits each quarter. The monthly reporting of income will make it very difficult to claim that income was seasonal now that the IRS will be armed with the 1099-K information.
There have been numerous comments in a variety of forums and blogs about small business owners deciding to provide incorrect TIN or name information as a means to circumvent the reporting requirements. This practice is not recommended because the IRS will force the Merchant Card and Third Party Networks to begin withholding from these accounts at a 28% rate. Reviewing the accuracy of the information currently on file with your provider or filing an accurate W-9 or W-8 will prevent this problem from occurring.
Starting in 2012, it will become more and more important for small business owners to implement or adjust accounting systems as well as a deeper understanding of their businesses. Many small business owners are looking to CPA’s to help them with the accounting and incorporate that into their tax planning. Are you ready? Contact an INTAXACT CPA today!