The Internal Revenue Service recently announced a one-year delay in the penalty provisions of newly mandated requirements for yearly reporting of merchant credit and debit card receipts by acquirers and processors. That's good news for companies that have been struggling to provide more processes and systems for collecting that information. Those companies also need to be ready to support backup withholding when TIN matching discrepancies arise and are not resolved in accordance with the new IRS procedures.
In a statement released in late October 2011, the IRS also said it would delay by a year the start of penalty assessments for filing incorrect TINs and related information, provided "good faith efforts" are made by acquirers and other covered organizations to file required information correctly. Backup withholding requirements are delayed, as well, until January 2013.
The reporting requirements set forth under IRS Code Section 6050W have been the source of much consternation for an industry still reeling from the financial sting of Payment Card Industry (PCI) Data Security Standard (DSS) compliance and backlash from the Durbin Amendment to the 2010 Dodd-Frank Wall Street Reform and Consumer Protection Act.
Section 6050W established a new annual reporting document - Form 1099-K - that processors and acquirers must generate yearly, just as they now complete 1099 forms for contract workers. The 1099-K reporting requirement, which was passed into law as part of the Housing and Economic Recovery Act of 2008, goes into effect in Jan. 1, 2012, when the first 1099-K reports need to be generated and filed. The reports can be filed with the IRS electronically or as paper documents.
Meanwhile, at least three states (California, New York and Hawaii) plan to follow the IRS lead with new information reports for state tax filing purposes; so far, only California has called for backup withholding. "On its face, perhaps, it seems easy," said Jeff Fortney, Vice President, ISO Channel Management at Clearent LLC, a Missouri-based processor. But it takes a lot of time, money and effort to comply with the new IRS rules, he added.
Aite Group LLC, a consultancy headquartered in Boston, estimated that 35 percent of U.S. merchants were not in compliance with IRS 6050W, and that as many as 560,000 merchants (8 percent of the total) could still be at risk for mandatory withholding at the end of January 2012. For example, the IRS noted in a statement about its decision to delay implementation of the penalty and withholding requirements that it "does not apply to a payor who erroneously fails to file an information return or payee statement."
Questions about the new IRS reporting rules also have been raised by government auditors. A report issued in July 2011 by U.S. Department of the Treasury said the new 1099-K form may actually hinder the stated purpose of the new reporting requirement: to match income from credit and debit card sales against income claimed by a business on its tax returns.
"We found that improvements must be made if this effort is to function as intended, which is to help reduce the tax gap," said J. Russell George, Treasury Department Inspector General for Tax Administration.
The tax gap refers to the total amount in taxes the IRS estimates it fails to collect each year due to income that is either underreported or not reported at all. In a report published in 2009, the IRS estimated the cumulative business sector tax gap was $345 billion a year between 1996 and 2001 (the most recent period for which complete data was available).
After accounting for taxes collected through enforcement actions and other late payments, the net amount of the tax gap was $290 billion a year, the IRS said. To put this into perspective, consider that the stop-gap spending bill passed by Congress in late September 2011 provided roughly $150 billion to keep the federal government running for not quite two months.
In a 2009 report - Update on Reducing the Federal Tax Gap and Improving Voluntary Compliance - the IRS said it was committed to narrowing the tax gap through increased enforcement and working with Congress on new legislative initiatives. In the case of the 1099-K requirement, the idea is to provide the IRS with a clearer picture of how much money a business brings in by comparing its yearly bankcard receipt tallies to amounts reported on the company's tax filings.
The requirements apply to all but the smallest merchants. The only businesses that don't require 1099-Ks are those that process fewer than 200 credit and debit card receipts, when the total of those receipts does not exceed $20,000. Failure to file the form, or to do it correctly, can result in hefty fines to the banks/acquirers responsible for filing the forms with the IRS.
The IRS estimated the information it collects via the new 1099-K will lead to the addition of almost $10 billion in tax revenues to federal coffers in the first 10 years. There are questions about the accuracy of that estimate, however. "While the Department of the Treasury made its own estimate of the benefits of this law, the IRS currently does not have a completed estimate of how much it expects to collect," the Inspector General's office wrote in its report.
That report also noted the impact of the new rules on the IRS could be substantial. "[T]his new requirement will add millions of additional information reporting documents to IRS computer systems," the Inspector General's office noted in a press release highlighting the report.
That report - Plans for the Implementation of Merchant Card Reporting Could Result in Burden for Taxpayers and Problems for the Internal Revenue Service - took the IRS to task for several shortcomings in its implementation plans. For example, it pointed out that the new Form 1099-K requests gross card receipts, an amount that for many can include cash-back amounts that do not constitute revenues.
From the perspective of acquirers and other third-party settlement agents covered by the new rules, collecting and verifying the information for the reports and then distributing 1099-K forms to clients and the IRS is a process fraught with complications and added costs.
Aite puts the average cost of compliance at $17.60 per merchant per year. Smaller ISOs will be hit particularly hard, Aite said in an Impact Note, U.S. Merchant Acquiring and 1099-K Regulation: Christmas Comes Early. In some cases, small business compliance could end up costing twice the per-merchant average.
Fortney called it a huge financial hit for Clearent. He said only the cost of a new processing platform, implemented four years ago, exceeded what Clearent spent developing a system to ensure compliance with IRS Section 6050W; in terms of time and effort spent in preparation, IRS reporting rivals what Clearent spends on PCI DSS compliance.
Aite surveyed leading stakeholders in the acquiring sector this summer to get a handle on implementation issues. The biggest challenges cited were:
Some banks and acquirers have said they don't intend to deal with backup withholding - opting to cut clients loose rather than deal with the hassles of the mandate. Others have said they may threaten to freeze the accounts of merchants with incorrect/missing information.
"It's much easier from a logistical standpoint," said Greg Cohen, President of Moneris Solutions USA. Most merchants that haven't responded to queries for correct TINs and related information either did not receive notices, or they did and just haven't gotten around to the task, Cohen said. But he added, "If you threaten to hold all their money, they're going to get around to it."
Section 6050W requires that the IRS reject any 1099-K with erroneous or missing TINs or other information, and penalize the bank/acquirer/processor $100 for each rejected form.
And the hoops don't stop there: there are strict requirements and deadlines for correcting and resubmitting rejected 1099-Ks, as well as a backup withholding mandate (28 percent withholding) that kicks in for any business with incorrect or missing TINs. Going forward, several acquirers and ISOs said they intend to integrate IRS 6050W requirements into the initial underwriting processes.
In an effort to get out in front of anticipated rejections in the first go-around of reporting, however, ISOs and their partners reported they are spending countless hours accessing an online registry for validating TINs. Apparently, the number of people trying to access the IRS-run registry has overloaded the system; ISOs report spending up to three hours a day trying to access it.
Other sources of frustration include IRS-established merchant category codes (MCCs) that differ from the MCCs Visa Inc. and MasterCard Worldwide use and a system quirk that doesn't recognize apostrophes. In other words, a business legally named "Joe's Pub" has to be registered with the IRS as "Joes Pub," and the required MCC is probably not the same one used on its processing contract.
As the Treasury Department's Inspector General's office noted, the sheer volume of new reporting documents will make it difficult to resolve information mismatches before mandatory withholding requirements kick in. That was one of the reasons the IRS gave for delaying startup of mandatory withholding until 2013.
While the delay was welcomed, experts agree time is a wasting for those not focused on complying with the new reporting requirements. "We really need to remain diligent," Fortney said. Some companies might also use the time to determine how best to recoup some of the money spent preparing for the new reporting requirements. Although IRS rules specifically prohibit charging fees for the distribution of 1099-Ks to clients, many have adopted what are being labeled "regulatory compliance fees" to cover costs associated with new reporting and other requirements.
"There are going to be real costs incurred with this," Fortney said. He thinks fees in the range of $30 a year are fair; recent posts to The Green Sheet's MLS Online Forum suggested some acquirers are assessing compliance fees that exceed $100 a year.
Troy Thibodeau, Executive Vice President at Convey Compliance Systems Inc., a Minnesota firm that specializes in 1099 reporting solutions, doesn't believe these fees will hold up over time, however. He pointed to the recent backtrack by many large banks regarding debit card fees. Convey's experience suggests companies that make new 1099 reporting compliance customer friendly will fare better over the long term. "This can be a point of competitive differentiation; it doesn't have to be just another cost," Thibodeau said of the reporting process.
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