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Vol. 16, No. 2

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Features

 

New Online Tax Reporting Requirement Hidden in Home Tax Credit Bill

The Housing Assistance Tax Act of 2008 made headlines as part of the larger Housing and Economic Recovery Act of 2008, or HERA, which President Bush signed into law. Speaker Nancy Pelosi (D-CA) introduced the bill that ultimately became HERA, HR 3221, titled “A bill to provide needed housing reform and for other purposes.” It was ostensibly introduced to kick-start a then-declining housing market, with $15.1 billion in tax incentives, including an early version of the first-time homebuyers’ credit, a property tax deduction for taxpayers who don’t itemize, and significant changes to the rules for low-income housing credits.

What really wasn’t publicized in the bill, though, was the “for other purposes” part. One of the most dramatic changes in HERA has absolutely nothing to do with housing.

Tucked into the middle of the law is a new requirement that banks and credit card merchants report payments to the IRS. This reporting obligation, scheduled to take effect in about a year, will have a significant impact on small businesses—including law firms—receiving funds via a third-party processing service.

HERA’s stated purpose is to “improve voluntary tax compliance by business taxpayers and help the IRS determine whether their tax returns are correct and complete.” Here’s how it works:

Credit card or third-party merchants will now report certain payments for goods and services to the IRS via a new form 1099-K, “Merchant Card and Third-Party Payments.” The look and feel of the 1099-K is very similar to that of two current forms that banks and other financial institutions use: the 1099-INT for reporting interest and the 1099-DIV for reporting dividends. You can view a draft 2011 form 1099-K online, downloadable as a pdf, at http://www.irs.gov/pub/irs-dft/f1099k--dft.pdf.

The IRS’s proposed HERA regulations, http://www.irs.gov/pub/irs-news/reg-139255-08.pdf (also downloadable as a pdf), require the use of Form 1099-K for “reportable payment transactions.” A “reportable payment transaction” is an exchange in which a business or nonprofit accepts a payment card (such as a credit or debit card) or settles the payment through a third-party network (such as PayPal). There are exemptions in certain circumstances, such as where the total amount of payments settled in this manner for the year is under $20,000.

What does this mean for taxpayers? Businesses, including law firms, having a credit card merchant account, PayPal account, or any other third-party processing account otherwise meeting the regulatory criteria will receive a Form 1099-K from payment service providers after the end of the year, just as they now receive other 1099 forms. The form 1099-K will report the gross amount paid out to the taxpayer: There’s no consideration of offsetting fees or chargebacks.

Reporting only gross payments is naturally a concern: taxpayers with significant adjustments may receive 1099-K forms that don’t accurately reflect their economic realities. It’s important, then, that taxpayers who receive payments from any third-party provider keep excellent records to support their tax returns.

The IRS is of course aware that income from hundreds of millions of dollars exchanging hands is unreported every year. The IRS attributes a significant slice of these unreported exchanges to online transactions and service-based businesses with no tangible inventory to track. Bloggers, law firms, service providers, and other small businesses have been able to stay under the reporting radar if their income comes from multiple sources or if they’re paid from companies or individuals that may not be required to report the payments directly. As this new IRS reporting requirement is a first effort to try tracking that income in a consistent manner, there are bound to be some problems.

Form 1099-K makes its official debut for tax year 2011. Before that happens, the IRS will have to sort through public comments about the new form and its proposed regulations. As a result of the heavy snowfall in Washington, D.C., the public hearing originally to be held on February 10 is being rescheduled, but the final regulations will be published before the end of 2010.

If all goes as scheduled, the first 1099-K forms will have to be filed with the IRS and furnished to participating taxpayers by early 2012. So get ready—change is coming!

Kelly Phillips Erb, a/k/a Taxgirl, is the author of Taxgirl.com, one of the ABA’s Blawg 100 picks in 2008 and 2009. She concentrates her Philadelphia practice at The Erb Law Firm, PC, on tax issues. Contact her at taxgirl@erblaw.com or visit her blog at http://www.taxgirl.com. This article is adapted from one that appeared on her blog on Dec. 15, 2009.

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