Many taxpayers cheered in 2008 when the Housing and Economic Recovery Act, or HERA, was signed into law by President Bush. The bill was designed to provide "needed housing reform" and was intended to kickstart the declining housing market.
Of course, Congress never met a bill that couldn't be bulked up with other bits and that's exactly what happened with HERA. Tucked in the middle of the housing bill was a provision that had absolutely nothing to do with housing: a new requirement that banks and credit card merchants to report payments to the IRS.
The rule, which took effect in 2012, was meant to "improve voluntary tax compliance by business taxpayers and help the IRS determine whether their tax returns are correct and complete." Of course, they meant voluntary in the most mandatory kind of way.
Under the rule, certain payments for goods and services paid by credit card or third party merchants are reported to the IRS using a federal form 1099-K, Merchant Card and Third Party Network Payments (form downloads a as a pdf). For purposes of the form, a reportable payment transaction is a transaction in which a payment card (such as a credit card or gift card) is accepted as payment or any transaction that is settled through a third party payment network like PayPal. It does not include ATM withdrawals, cash advances against a credit card, a check issued in connection with a payment card, or any transaction in which a payment card is accepted as payment by a merchant or other payee who is related to the issuer of the card.
In simple terms, 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. That would include professionals like lawyers and architects who accept online or credit card payments for services, freelancers compensated via PayPal and Etsy sellers, affiliates, eBay merchants and other small businesses who accept credit cards, debit card or PayPal as payment.
But here's the tricky part: reporting is only required when gross payments to an individual payee exceed $20,000 for the year and when there are more than 200 transactions with the participating payee.
That doesn't seem overly complicated on its face. Except that there's an odd overlap. You see, in years past, taxpayers who provided certain goods or services worth more than $600 were responsible for issuing a form 1099-MISC to the payee. That rule is still good with one exception. Now, the instructions for the form 1099-MISC include this provision (instructions download as a pdf):
Payments made with a credit card or payment card and certain other types of payments, including third party network transactions, must be reported on Form 1099-K by the payment settlement entity under section 6050W and are not subject to reporting on Form 1099-MISC.(emphasis added)
Many taxpayers didn't blink and skipped right on by that last bit. I'll admit that I did. I knew about the form 1099-K but since it didn't apply to me, I didn't give it much thought. Then, a taxpayer asked whether they had to issue a form 1099-MISC if they paid by credit card. I said no. And then I said maybe. And then I did a little research.
The rules are not easy to understand. I thought the $20,000/200 transaction rule for the form 1099-K only obviated the need to file a form 1099-MISC if payments were above those thresholds. Most tax professionals that I asked agreed and told me they were telling their clients to file forms 1099-MISC "as usual" for the tax filing season and only issuing forms 1099-K where applicable.
Only that's not what the instructions say. The instructions indicate that the form 1099-MISC is not to be issued if payments are made "with a credit card or payment card and certain other types of payments, including third party network transactions." Payments that meet that criteria and are over the $20,000/200 threshold get reported on a form 1099-K. But those in the middle? They appeared to not be reportable despite a flurry of advice from tax professionals to the contrary.
It was confusing enough that I called up IRS and asked them to clarify for me.
In response, the IRS issued this statement:
A third party settlement organization is required to report any information concerning third party network transactions of any participating payee only if, for the calendar year:
The gross amount of total reportable payment transactions exceeds $20,000, and
The total number of such transactions exceeds 200.If a business makes payments via a third party settlement organization as well as cash or check to the same independent contractor, the TPSO will be required to report the amount of reportable transactions that exceed the de minimis thresholds on Form 1099-K. The amounts paid by cash or check would be reported by the business on Form 1099-MISC if the amounts are $600 or more in a calendar year.
The regulations state that reportable payments made under Section 6050W are not reportable under Section 6041. If reportable payments under Section 6050W do not meet the de minimis thresholds in a calendar year, no reporting is required.
We are aware of a potential for 1099-MISC and 1099-K double reporting, and are constantly monitoring our case selection criteria to address this. We do expect to provide more guidance, but we also do not expect this issue to lead to an increase in examinations.
So, a few quick references:
- Section 6050W is the section of the Tax Code which spells out the reporting provisions for "payments made in settlement of payment card and third party network transactions."
- Section 6041 is the section of the Tax Code which explains how to report payments over $600.
- The term "reportable payment transaction" is defined in the Regs (the Regs are the official interpretation of the Tax Code by IRS) to mean "any payment card transaction... and any third party network transaction" as further explained in the Regs (isn't tax law fun?). As per the Regs, a payment card transaction is defined as "any transaction in which a payment card, or any account number or other indicia associated with a payment card, is accepted as payment." The term third party network transaction is defined as "any transaction that is settled through a third party payment network."
I also popped over to the IRS web site and checked out their FAQs. Here's what they had to say about the matter as it relates to potential double reporting:
Accordingly, the final regulations provide that payment card and third party network transactions that otherwise would be reportable under both sections 6041 and 6050W must be reported under section 6050W and not section 6041. The final regulations also provide that, solely for purposes of determining whether a payor is eligible for relief from reporting under section 6041, the de minimis threshold for third party network transactions in §1.6050W-1(c)(4) is disregarded because the section 6041 payor will be unable to determine whether the de minimis threshold applies.
So, taking all of these together, it's clear that payments reported on a form 1099-K are not also reportable on form 1099-MISC - which makes sense. However, if the payments don't meet the thresholds for reporting on the form 1099-K and would be otherwise reportable, no reporting is required - which doesn't make as much sense.
I pressed IRS on it since that statement together with the instructions seem to confirm that there is no reporting requirement for payments made "with a credit card or payment card and certain other types of payments, including third party network transactions" even if they're over that $600 threshold and even if they are under the $20,000/200 threshold.
It turns out, that's right. But, I asked, doesn't that create a giant reporting hole? The IRS advised me that was not an "inaccurate characterization."
As written, the reporting requirements are already confusing for taxpayers who worry about double-checking and over reporting (adjustments and chargebacks are not reflected on those forms 1099-K). The change in the reporting requirements also mean that taxpayers may be issuing and receiving unnecessary forms. Taxpayers and tax professionals are continuing to issue both in some cases to be "safe" and to avoid being an audit target.
Even the IRS is confused. An examining officer recently advised me that a taxpayer needed to file a form 1099-MISC even though the taxpayer made those payments using a third party provider. Failure to do so, the taxpayer was advised, would subject the taxpayer to failure-to-file penalties. Except that's not true.
Of course, none of this is new news. Some tax professionals, to be fair, have been advising clients since 2012 not to report certain transactions on a form 1099-MISC and others have advised taxpayers to request revised forms 1099-MISC to back out transactions which are more properly 1099-K payments. But it's clear that not all taxpayers, tax professionals and yes, even some in IRS, understand that to be the case. This, six years after the law was passed and two years after the law took effect.
But what about that hole? That giant reporting hole? If the idea is to move folks into compliance, anyone that falls in that reporting hole has an incentive not to comply - and clearly, taxpayers are making a purposeful effort to fall into that hole to escape reporting (if my internet search is any indication).
To be clear, just because you don't receive a form 1099-K or form 1099-MISC doesn't mean that you get a pass on reporting the income: it's still taxable, form or no form. Unfortunately, those that don't want to comply now have a much bigger space in which to try to avoid paying taxes. The IRS' saving grace? Those electronic payments are fairly easily accessible: it's just a matter of issuing a summons to the credit card processor or Paypal at audit (as some of my clients have found out). So the hole is big and deep but that also makes it fairly hard to hide.
There's a lot not to like about the new law. I call it new because it still is, really. This tax season, taxpayers and tax professionals were still struggling with compliance. I suspect that we'll see additional guidance from the IRS as the more and more taxpayers have questions about reporting income and payments.
