A Treasury Audit Criticizes the IRS About New Merchant-Reporting Requirements

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An audit of the Internal Revenue Service’s administration of a new law requiring processors and merchant acquirers to report merchants’ electronic payment transactions to the government criticizes the agency’s handling of the program, saying it could create burdens for taxpayers and problems for the IRS.

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The audit, conducted by the Treasury Department’s Office of Treasury Inspector General for Tax Administration, found that reporting forms created by the IRS included the cash-back portion—funds returned to customers—of card transactions, inflating the revenue to the merchants. The audit, released in July, noted that the “mismatched amounts may cause the IRS to contact the taxpayer for an explanation, increasing the burden on both the taxpayer and the IRS.” The audit suggested an alternative form that breaks out cash back on a separate line.

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The IRS says it will alter the form to address the problem and review other forms to prevent similar mismatches.

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The new reporting rules originated with the federal government’s concern about finding unreported or under-reported taxable business revenues. The law was designed to help the IRS match income from sales paid with credit and debit cards to income claimed on tax returns. The U.S. Department of the Treasury estimated the law would result in the collection of an additional $10 billion over 10 years. Congress passed the enabling legislation, which amended the Internal Revenue Code, in July 2008.

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The rules require settlement entities such as bank card merchant acquirers or payment card networks such as American Express Co. and Discover Financial Services that have direct relationships with merchants to file annual reports for each merchant listing that merchant’s monthly gross receipts from electronic payment transactions. Acquirers must list the receipts, along with the merchant’s taxpayer identification number (TIN) and legal name, on a new form, Form 1099-K.

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A card-accepting business encounters problems if the TIN and legal name on file with the acquirer do not match the ones in the IRS’s files. If the mismatch can’t be resolved, it triggers back-up withholding of up to 28% of a merchant’s payment card transactions. If acquirers don’t withhold the payment amount when required, they are then held responsible for the amount. The law is effective for tax returns with calendar years that began Dec. 31, 2010, with first reports due in early 2012.

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Although the IRS indicated it planned to validate the TINs and names of taxpayers shown on the 1099-K form as the documents are received, the audit found that the IRS hasn’t adequately addressed the risk that funds might be withheld from merchants because the agency wasn’t able to resolve mismatches in a timely manner. Resolving the mismatches “may take significant resources for the IRS, payment settlement entities, and taxpayers,” the audit says.

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The inspector general’s office also said it was concerned that computer programming for the merchant card reporting may not be completed to use the new data; the capacity of IRS systems may not be adequate to match the TINs and names when the new documents are first received at the IRS requiring correspondence with the sender on any mismatches; sensitive taxpayer data could be at risk of disclosure; and payment settlement entities and merchants will require significant education.

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In the IRS response to the audit, Faris R. Fink, commissioner of the small business/self-employed division, said the bureau disagreed with the “characterization that implementation plans could result in burdens for taxpayers and problems” for the IRS. He said, however, that the IRS agreed with recommendations in the report and is taking steps to correct forms and procedures.