Wednesday, November 28, 2012

IRS Initiating Form 1099-K Compliance Program

A new IRS compliance program aimed at finding underreporting of gross receipts by taxpayers who receive Form 1099-K information returns from credit card companies or third-party transaction networks launches this week, a senior IRS official confirmed November 27.

Ruth Perez, deputy commissioner of the IRS Small Business/Self-Employed Division, told Tax Analysts that the first notices under the program will be sent out later in the week of November 26. "Our initial footprint in this area is going to be small while we learn," she said, adding that the initiative will touch a variety of businesses of different sizes.

Under section 6050W, entities that process credit card, payment card, and third-party network transactions must track the gross amounts of those transactions by merchant and report monthly and annual gross amounts to the IRS, as well as provide statements to payees. In a November 16 post to its website, the IRS announced that it will be sending out new notices related to Form 1099-K, "Merchant Card and Third-Party Network Payments," to taxpayers who may have underreported their gross receipts. A taxpayer may receive a notice if a mismatch occurs between amounts on the taxpayer's tax return and Form 1099-K statements the IRS received, as the discrepancy shows "an unusually high portion of receipts from credit payments and other Form 1099-K reportable transactions," the Service said.

An unresolved point of contention between the IRS and taxpayers has been the required reporting on Form 1099-K of gross payment amounts that don't line up with a taxpayer's net, taxable, or gross income on a tax return. Practitioners believe the IRS went astray in its decision in the final regulations to base reporting on transactions rather than payments. The preamble to the final section 6050W regulations admits its definition of gross amounts "is not intended to be an exact match of the net, taxable, or even the gross income of a payee." 

The IRS made an informal announcement earlier in the year that it would not require reconciliation of gross receipts and merchant card transactions on Form 1120, "U.S. Corporate Income Tax Return," and other business income tax forms. In a February letter to the National Federation of Independent Business, then-IRS Deputy Commissioner for Services and Enforcement Steven Miller wrote that "there will be no reconciliation required on the 2012 form, nor do we intend to require reconciliation in future years." 

The sample notices posted on the IRS website offer a variety of responses required from taxpayers. The least intrusive letter simply asks the taxpayer to review the provided information for accuracy, while another letter requests that the taxpayer send the IRS written notice of any inaccuracies on the Form 1099-K. A third letter requires the taxpayer to fill out a form verifying reported income and explain why its gross receipts from card payments were higher than anticipated, which could lead to the IRS proposing adjustments to the tax return. (For the letters and form, see

Practitioners have expected the IRS to use Form 1099-K reported amounts as general indicators of tax noncompliance through a matching process. 

The notion of a compliance program requiring documented responses has raised concerns that reconciliation might be resurrected later. The turnaround time has been quick from when many business taxpayers filed their 2010 tax returns in September to the current issuance of letters suggesting underreporting.

To taxpayers who worry that the compliance initiative is a new effort to require reconciliation of discrepancies between Forms 1099-K and the taxpayer's tax return, Perez emphatically dismissed the notion. "This is not another attempt at reconciliation," she said.

Perez said the IRS has been working hard to develop a "strong and well-reasoned implementation plan for compliance efforts" concerning section 6050W. The agency will have a learning period in handling Forms 1099-K, she acknowledged, saying, "It's the first year we have this information." But the IRS is "doing a good job in developing different approaches to use this information as effectively and efficiently as possible," she said. The IRS made the letters available online as soon as they were ready in order to give taxpayers advance notice, she said.

In all its efforts, the IRS is making sure it has a "balanced approach to ensure taxpayers are not unreasonably burdened," Perez said. That means the Service is conducting outreach on several levels, she said, adding, "We are dedicated to having an open forum on this issue and will make necessary adjustments as we hear back from stakeholders and gain experience from our people."

Deborah Pflieger of Ernst & Young LLP said the Form 1099-K compliance initiative makes sense. "As someone who has seen large merchant payers spend significant amounts of time and money adjusting to the new reporting requirements, I am relieved at the idea that the IRS is actually going to be using the data it receives," she said. Form 1099-K information allows the IRS to "effectively conduct a smell test to see which taxpayers have significant differences in gross receipt amounts between the form and their tax return that is unlikely to be simply the product of sales returns or other adjustments such as changes from cash to accrual accounting," she said.

"These letters to taxpayers are a shot across the bow that the IRS is looking to ensure accurate reporting to close the tax gap," Pflieger said. Although Form 1099-K matching will never be as easy as the matching process the IRS has in place for interest and dividend reporting on individual taxpayers' returns, section 6050W gives the government a good tool to pinpoint outlier merchants, she said.

Benson Goldstein, senior technical manager for taxation at the American Institute of Certified Public Accountants, said, "One of the issues that needs to be addressed going forward is the compliance burden for businesses that these notices might create. We will be talking to our members to learn about their experiences with this program so that we can interact with IRS leadership to provide feedback as appropriate."

Article reprduced from TaxNotes Daily