The "tax gap" is the gap between taxes owed and taxes paid, which is a direct result of the gap between income that is taxable and what income is reported. Experts estimate that over $400 billion in taxes a year go uncollected. The last IRS study showed that the under-reporting of business income from small businesses accounted for 25 - 30 percent of the tax gap.
1099s are information returns that businesses must file to report certain transactions. For example, a corporation issues a 1099-DIV to shareholders to whom it has paid dividends. For a short time, as a step to closing the tax gap, the law was going to require the issuance of 1099s for all payments, including goods and services, totaling $600 or more in a calendar year for each vendor. This form 1099 provision was set to begin in 2012, but it was repealed in April 2011 after a great hue and cry was raised about the burden it placed on small businesses.
Here is another 1099 provision that has not been repealed. The Housing Assistance Tax Act of 2008 added a provision of the Internal Revenue Code that requires card payment networks, that is, companies that process credit and debit card payments, (PayPal is an example) to send a new kind of 1099. Beginning in 2011 there will be a new tax form called the 1099-K, Merchant Card and Third Party Network Payments. The IRS believes that some small companies do not report all of their credit or debit card revenues or revenues from third party payments like Paypal. The new 1099-K will be used by the IRS to make sure that small businesses will not be able to hide receipts from the IRS anymore.
Until the enactment of the legislation requiring 1099-Ks, the IRS had been taking the word of the business owner that he was reporting all of his income because they did not have access to the credit card revenues of small companies. The only way to check if a company was cheating on its taxes was to do an audit of a particular return. The IRS knows that there are hundreds of millions of dollars exchanging hands every year that go unreported. Much of this is a result of online transactions.
The IRS commissioner said "[b]eginning 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."
In order to trigger the reporting requirement, merchants must execute at least 200 transactions in a year that add up to at least $20,000. Payment providers will only submit 1099-K forms for sellers that meet both thresholds.
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, returns or sales tax.
Reconciling the 1099-Ks with the tax returns is going to be a problem. If your company receives debit and credit card payments and is above the reporting threshold, you should prepare for the 1099-K. This is just the first step in additional reporting requirements being implemented over the next several years by the IRS. How effective the 1099-K will be in closing the "tax gap" remains to be seen. The group that will be most affected are those who flagrantly under report and receive most or all of their income from cards.
The 1099-K form might discourage people from selling things on eBay and being paid through PayPal, for example, because they will now receive a 1099-K reporting the payments received by them. On the other hand, those who have businesses that are not on eBay or report all of their income from eBay argue in favor of the 1099-K. They feel that if someone is selling products online, not paying taxes on the revenue and, also, have no overhead because they are only online; then they have a very unfair competitive advantage.
There is no doubt that the new 1099-K is going to generate a lot of paperwork. If it results in more people properly reporting their income, it is worth it. Closing the tax gap should be done before increasing the taxes of already compliant taxpayers.
