New IRS Compliance Program Targets Businesses’ Cash Flow From Merchant Services Accounts

The IRS has launched a new compliance program to help close the gap between the tax revenue they receive and tax revenue they are actually due. They are looking for fraud in the form of underreported income. The new program specifically targets the underreporting of income by businesses that receive Form 1099-K information returns from credit card companies and third-party transaction networks. Third party transaction networks are services like PayPal®.

Why a new requirement?

The purpose is to create a paper trail so that the IRS can compare a business’s cash flow from card transactions with income reported on the company’s tax return.

An IRS explanation about why the reporting is necessary states: “Third-party information reporting has been shown to increase voluntary tax compliance, improve collections and assessments within IRS, and thereby reduce the tax gap,” which is the difference between the amount of tax money owed and the amount collected.

The IRS website says that the program will involve letters and notices going out to business taxpayers who may have underreported their gross receipts. If your business receives a Form 1099-K because it accepts payment cards from customers or third party payments from clients, you just might receive one of these letters.

All the details of how the new IRS 1099-K compliance program will work is not yet clear but the IRS will have the gross amount of reportable payment card transactions reported on a merchant’s Form 1099-K, and can match the amount against other information reported on merchants’ tax returns.

The amount on the 1099-K will not be a direct match to the gross income that is reported on a taxpayer’s return. The IRS will be using the information obtained from the 1099-K along with other information on the tax return.

Who will receive letters?

The IRS will send letters to taxpayers based on their returns and Forms 1099-K that show “an unusually high portion of receipts from card payments and other Form 1099-K reportable transactions,” the IRS stated.

The IRS has posted five different letters on its website, which will be sent to businesses. The letters inform taxpayers that:

“Your gross receipts may be underreported. We received Form(s) 1099-K, Payment Card and Third Party Network Transactions, showing your total payments from Merchant Card and Third Party Network transactions. The information from these form(s) and your tax return show an unusually high portion of gross receipts from card payments and other Form 1099-K reportable transactions. Your type of business consistently has a much lower portion of gross receipts from card payments and other Form 1099-K reportable transactions, and a higher portion of gross receipts from other sources (e.g., cash and checks).”

Each one of the different letters the IRS sends out asks taxpayers to review the Form 1099-K and the computation of gross receipts for your business as reported on the tax return in question. In the letters, taxpayers are instructed to make sure they “fully reported receipts from all sources, including cards, cash and checks.”

Depending on the type of letter received, taxpayers are given various instructions and a warning that “failure to respond may also result in a proposed assessment or further compliance action.”

As with many other tax requirements, the new 1099-K compliance program makes it important to keep accurate cash flow records so you can respond to IRS requests for information. Consult with your tax adviser if you have questions about payment card reporting or receive a 1099-K letter.

For more information about the new IRS compliance program on the 1099-K reporting, click here.

New IRS Compliance Program Targets Businesses’ Cash Flow From Merchant Services Accounts