1099-K Notices Bewilder Taxpayers – To Match or Not to Match?

TaxConnections Blog PostDo you have tax clients who run small businesses or decided to sell their household items on e-bay this past year? Or perhaps you are a CPA who accepts credit card payments from your clients? If so, you may have already received a notice from the IRS or should be aware of the latest updates on the IRS push for information matching with Form 1099-Ks (Payment Card and Third Party Network Transactions). Some AICPA members have received 1099-K mismatch notices assessing thousands of dollars in penalties.

Less than a year ago, the AICPA raised the topic in a blog post about a major initiative that requires merchant card companies to report gross receipts on Form 1099-K. At the time, the IRS was carrying out a compliance program that sent notices to small business taxpayers to match their sales information with merchant provided Form 1099-K reports. The program was used to ensure business taxpayers were reporting adequate income from their credit card receipts. A driving force behind this decision was the growing US tax gap, as IRS data indicated that a major source for the gap was related to underreporting of business income on individual tax returns.

As a result, many taxpayers, especially self-employed Schedule C filers, are beginning to receive notices related to Form 1099-Ks. In these notices, the IRS is providing basic instructions such as “Read the notice thoroughly and complete any worksheets” and “gather tax records including the 1099-Ks that were received and determine accuracy of the notice about the underreporting of gross receipts.”

According to the IRS, these notices are being sent to taxpayers who “may have underreported their gross receipts” or their Form 1099-Ks show an “unusually high portion of receipts from credit card payments” that do not match the receipts reported on their filed tax returns. However, back in October 2010, the IRS stated it would not require businesses to reconcile their gross income with third-party receipts. These notices seem to be a direct contradiction to that statement.

CPA and business owner Jonathan Horn (chair of AICPA’s Individual and Self-Employed Tax Technical Resource Panel), explains: “The IRS is on record saying they are not going to ask people to reconcile, but now they ask taxpayers to prove why their numbers are right . . . these underreporting notices imply ‘we think you’re wrong; prove that you’re innocent.’”

Horn points out there are many obstacles and issues the IRS would face if it attempted to match third-party receipts to 1099-K reports. For example, some businesses allow customers the option for cash back on credit cards, but the Form 1099-K does not account for cash back and gross sales amounts separately. This creates a situation where a credit card may show $200 in receipts, while only $100 resulted from the actual sale of merchandise and the other $100 was cash back to customers.

Many small business owners are self-employed Schedule C filers with very few accounting resources. It is clear that the matching of gross receipts on individual returns to information reported by merchant card companies is a growing issue for them.

By Amy Wang – Edited and posted by Harold Goedde CPA, CMA, Ph.D. (accounting and taxation)

In accordance with Circular 230 Disclosure

Dr. Goedde is a former college professor who taught income tax, auditing, personal finance, and financial accounting and has 25 years of experience preparing income tax returns and consulting. He published many accounting and tax articles in professional journals. He is presently retired and does tax return preparation and consulting. He also writes articles on various aspects of taxation. During tax season he works as a volunteer income tax return preparer for seniors and low income persons in the IRS’s VITA program.

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1 comment on “1099-K Notices Bewilder Taxpayers – To Match or Not to Match?”

  • James Kronenberg EA CPA MBA

    Harold – as a member of the professional tax practitioner community, appreciate your time & effort to report on this evolving tax compliance matter for small businesses. Needing two clarifications if you please – (1) Wondering why the “cash back” is not reported as “returns & allowances” on the appropriate tax forms for small businesses so that the gross receipts reported would not be understated and the correct amount gets reported as taxable (2) Not sure why a merchant processing “credit” card transactions would be providing “cash back” – are you really referring to “debit cards” that have a credit card feature for processing at the Point of Sale (POS) so no PIN entry by customer is necessary ?

    Could a small business that has merchant processing services make the necessary POS accounting entry adjustment so that the entire amount is reported as gross receipts (sales revenue) but treating the customer’s “cash back” as returns & allowances in order to match gross receipts to 1099-K amounts reported ? Looking forward to any clarifications you might have. Thanks !

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