THE NEW FORM 1099-K CREATES NEW PROBLEMS

Beginning with tax year 2011 payments made to businesses by credit card companies and “third-party networks” (resulting from customers using a credit card or PayPal to pay a vendor for merchandise or services) during the calendar year must be reported to the business, and to the IRS, on new IRS information return Form 1099-K.  

As a result of this new requirement the IRS has revised the 2011 Schedule C, in its current draft version, to break down gross receipts into three (3) separate categories -

Line 1a = Gross merchant card and third party network receipts and sales (see instructions)

Line 1b = Gross receipts or sales not entered on Line 1a

Line 1c = Income reported to you on Form W-2 if the “Statutory Employee” box on that for was checked

Line 1d = Total Gross Receipts

The instructions for Line 1a state –

“Enter on this line payments you received in your trade or business through merchant cards and third party networks.  These payments should have been reported to you in Box 1 of Form 1040-K, Merchant Card and Third Party Network Payments.  Also include on this line payments received through merchant cards and third party networks that may not have been reported on Forms 1099-K that you received.  Merchant cards include, but are not limited to, Visa and MasterCard.  Third party networks include, but are not limited to, Paypal and Google Checkout.”

FYI, the draft instructions for Form 1099-K have not yet been released.  However Box 1 of the Form 1099-K is identified as “Gross amount of merchant card/third party network payments”.

The separate reporting of income directly from Box 1 of Form 1099-K will cause problems to many Schedule C filers.  As fellow tax blogger Russ Fox EA points out in his TAXABLE TALK post “What the New Form 1099-K Hath Wrought: Changes on Business Tax Forms” –

“. . .the amounts on the Form 1099-K’s will not match true sales. First, these amounts will include sales tax, shipping, and other non-sales charges. Second, the amounts on the Form 1099-K’s will be reported using cash basis. Any business that is accrual basis will have matching issues. Third, the reporting will likely be meaningless for any business that reports on a fiscal (non-December year-end) year {although I should point out that a monthly breakdown of gross receipts is included on the draft 2011 Form 1099-K Boxes 5a – 5l - rdf}.”

I expect that, for expediency sake, Schedule C filers, and tax professionals should do as Russ suggests -

“The solution that I expect most businesses to use is to just use the Form 1099-K to populate this line. It’s simple, and guarantees that there will be no matching problems. Of course, that puts the cart before the horse but if you’re a business owner or a tax professional this solution is likely the one that lessens the risk of an audit.”

I expect this is what I will do for the very few clients where this will apply.

If a business determines that it has $100,000 of gross sales for 2011, and it receives Form 1099-Ks whose Box 1 total $48,000, it would enter $48,000 in Box 1a, $52,000 in Box 1b, and $100,000 in Box 1d on Schedule C. 

This method is not strictly a true reporting.  As Russ mentions, the amount entered in Box 1 of Form 1099-K will be the gross payments made by the third-party, and will include sales tax and other charges.  While shipping and other charges can be deducted out in the expense section of Schedule C, sales tax collections, and the remittance thereof, should not be reported anywhere on the Schedule C. 

If the amount reported in Box 1 is $50,000, and this includes $3,200 in sales tax collected, the true amount entered on Line 1a should be $46,800.  But if the lower amount is entered the number would not “match” the Form 1099-K received by the IRS, and could result in an inquiry or an audit.

I do not know if all third party payers have sufficient information to identify sales tax assessments included in gross payments, so correcting the Form 1099-K to report gross payments less sales tax, or also separately report sales tax included in the Box 1 amount, may not be the answer.

Similar changes have been made to 2011 corporation and partnership returns, and the 2011 Schedule E.  Lines 3a and 3b on the Schedule E are similar to Lines 1a and 1b on the Schedule C, and the instructions for Line 3a are basically the same as for the Schedule C.  While corporations and partnerships will experience the same problems as Schedule C filers, this should not cause problems for Schedule E filers, as there is no sales tax collected on monthly rental payments.

Another problem presents itself.  What about a customer who issues a vendor a Form 1099-MISC for “nonemployee compensation” in the amount of $5000, which was paid via credit card, or PayPal.  The business will receive a Form 1099-MISC from the customer and a Form 1099-K from the credit card processing company, or PayPal, for the same income!  How will this affect the IRS “matching” program?

TTFN