Decoding The New Tax Rules For Merchants

This article is a reprint of Wise Bread's contribution to OPEN Forum from American Express -- where small business owners can get advice from experts and share tips with each other.

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Banks and other payment settlement companies processing credit cards, debit cards, and electronic payments online now have to report annually to the IRS the gross amount of merchant (seller) transactions. If your business accepts payment in any of these ways, expect to receive your first information return by January 31, 2012, reporting your 2011 transactions. Needless to say, this is going to complicate your tax reporting.

1. The Information Return is Month-by-Month

There is a new Form 1099-K, Merchant Card and Third-Party Payments that will be used to report these transactions. The form provides an annual total, but also breaks down the transactions month-by-month. You’ll need to check your transactions against the amounts reported on the form to make sure you don’t have to report more income than you actually received. For example, your processor may report that you had $10,000 in transactions in March 2011, when in fact you only had $1,000.

If you note any problem with the form, contact the issuer immediately to straighten things out and have an amended 1099-K issued to you. The contact information for the issuer is on the form.

2. Gross Amounts are Reported

The gross amount of merchant card payments reported on this form do not take into account any adjustments for credits, cash equivalents, discount amounts, fees, chargebacks, refunded amounts, or any other amounts. For example, someone pays you for a $30 item and asks that you process the transaction for $50, so you give the customer $20 in cash. The 1099-K will show this as a $50 transaction, even though the sale was only $30.

You will have to enter on your return the full amounts reported to you; the IRS computer is looking for the amount from the 1099-K. The reporting, of course, does not prevent you from making subtractions from the amounts reported to reflect chargebacks or other differences in what is actually taxable to you. Work closely with your CPA or other tax advisor to make sure you don’t overreport income and fail to take offsets, such as chargebacks and refunds, into account.

3. Tax Returns Have Changed

If your business is incorporated or you file a partnership return, there is a new line to enter the transactions reported to you on the 1099-K. The 2011 Forms 1065, 1120, and 1120S have a new look and must be completed in a new way.

For sole proprietors and one-owner limited liability companies who report their business income and expenses on Schedule C of Form 1040, nothing has changed. Still, you’ll need to include the amount of the transactions on the schedule as reported to you on the 1099-K.

4. Small Sellers Are not Necessarily Exempt

Sellers with annual gross sales on their merchant accounts of no more than $20,000 or 200 or fewer transactions are exempt from this reporting; only those with annual gross amounts exceeding $20,000 and more than 200 transactions will have their transactions reported to the IRS. However, this “small seller” exemption does not apply to payment card transactions, such as credit and debit cards; it only applies to third-party settlement companies, such as online payment processors.

Store-value cards and gift cards may or may not be treated as reportable payment card transactions. Check with your tax advisor on what to do about this issue.

5. Backup Withholding

If you fail to provide a correct taxpayer identification number, such as an employer identification number (EIN) or Social Security number (SSN), you may become subject to backup withholding. This means that 28% of every payment you process will be withhold as federal income taxes. This can severely impact your cash flow.

Again, backup withholding applies to payment card transactions, but not to small seller third-party settlement company transactions.

Backup withholding was supposed to start after December 31, 2011. Fortunately, the IRS has postponed backup withholding to payments made after December 31, 2012.

Final Word

Many sellers, particularly those selling online, who previously assumed that their sales would go unnoticed by the IRS will no longer be able to avoid reporting income. All sellers should work now with their tax advisor to get ready for 2011 reporting.