Acquiring: That Problematic New Tax Law

 

BY Linda Punch

 

New IRS reporting requirements for processors and merchants take effect soon. The extra work involved is one formidable obstacle for the acquiring business. Another one is the IRS itself.

 

 

 

When Congress passed a new law requiring merchant acquirers to report merchants’ electronic-payment transactions to the Internal Revenue Service, the industry knew it faced some challenges.

 

But as the January 2012 deadline for reporting approaches, processors and acquirers are finding that in addition to meeting the actual requirements, the IRS itself may be a major obstacle to compliance.

 

The new law originated with the deficit-ridden federal government’s concern about finding unreported or under-reported taxable business revenues. The law is designed to help the IRS match income from sales paid with payment 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, and final rules were issued at the end of last year.

 

The rules require so-called payment-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 the merchant’s monthly gross receipts from electronic-payment transactions. Acquirers and networks must list the receipts, along with the merchant’s taxpayer identification number (TIN) and legal name, on a new form, Form 1099-K.

 

‘A Little More Complicated’

 

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 is not resolved, it triggers back-up withholding of 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.

 

Compliance obviously will involve plenty of data gathering, cross checking, and computing power. In a September report based on interviews with 18 senior acquiring industry executives, research firm Aite Group LLC estimated the industry would spend a total of $125 million to implement the rule, or $17.80 on average for each of about 7 million U.S. card-accepting merchants.

 

Costs will vary by company and portfolio size, with some small independent sales organizations possibly paying up to $48 annually per merchant, Aite predicts.

 

Many acquirers and ISOs haven’t yet decided how they’ll recover their compliance costs, but some have already increased fees or are planning to, according to Boston-based Aite. Some might even boost fees enough to transform the new rule into a profit generator.

 

For now, however, acquirers and ISOs seem to be focused mostly on the nuts and bolts of compliance rather than the bottom line. To ensure they have the correct TIN, most acquirers have been voluntarily submitting the TINs and business names they have in their records to the IRS’s TIN business-name database in advance of filing the 1099-K. If the acquirer’s data don’t match the IRS information, the acquirer can then go back to the business to try to resolve the issue.

 

Any business without a valid TIN after the 1099-K is submitted to the IRS could be hit with the 28% withholding penalty. Businesses have a 30-day period in which to validate or obtain a valid TIN before the withholding penalty is actually imposed.

 

But many acquirers say they are running into roadblocks with the IRS, primarily because the agency’s system is out of date and not equipped to handle the volume and complexity of the filings. And they fear the 28% withholding penalty will be levied on merchants unfairly simply because of backlogs in the system.

 

“This is a mandate and [acquirers] are absolutely doing their best to comply,” says attorney Holli Hart Targan, partner at Jaffee Raitt Heuer & Weiss, a Southfield, Mich.-based law firm that represents ISOs. “It’s just a little more complicated than anyone bargained for.”

 

IRS Takes Issue

 

Acquirers are not alone in their concerns. Reports from two government agencies also detail deficiencies in the IRS’s administration of the law.

 

An audit released in July by the Treasury Inspector General for Tax Administration criticized the IRS’s handling of the program. The audit found that reporting forms created by the IRS included the cash-back portion—funds returned to customers—of card transactions, inflating merchant revenue.

 

The audit 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 inspector general suggested an alternative form that breaks out cash back on a separate line.

 

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

 

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 has not 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 such mismatches “may take significant resources for the IRS, payment-settlement entities, and taxpayers,” the audit says.

 

The inspector general also had other concerns. One was that computer programming for the merchant card reporting might not be completed in order to use the new data. Another was that the capacity of the IRS’s systems might not be adequate to match the TINs and names when the new documents are first received at the agency, requiring correspondence with the sender on any mismatches.

 

The report also said sensitive taxpayer data could be at risk of disclosure and that payment-settlement entities and merchants will require significant education.

 

The U.S. Government Accountability Office (GAO) in a May report leveled similar criticisms. That report noted that the IRS missed its targets for issuing regulations by about one year while trying to learn more about the acquiring industry. “Although IRS released drafts of the newly required or revised forms, they did not release draft instructions prior to the regulations’ effective dates,” the report said.

 

For its part, the IRS has said it is taking steps to correct identified deficiencies but disagreed with some conclusions in the two reports. In the IRS response to the Treasury audit, Faris R. Fink, commissioner of the small business/self-employed division, said the agency disagreed with the “characterization that implementation plans could result in burdens for taxpayers and problems” for the IRS.

 

An IRS spokesperson indicated the agency would try to comment for this story but hadn’t responded by press time.

 

Slow Response

 

What concerns acquirers most is the difficulty in verifying TINs and business names against the IRS database.

 

“The problem is the IRS systems are not brand new—they’re a little bit dated and they’re not fast,” says Mary Weaver Bennett, director of government and industry relations for the Electronic Transactions Association, the Washington, D.C.-based industry trade group for acquirers and ISOs.

 

Slow response time appears to be a problem primarily for acquirers using batch submission for TIN verification, says Jacob Young, manager of business development for SecurityMetrics Inc., an Orem, Utah-based data-protection and compliance firm.

 

“They’re having more issues,” Young says. “I’ve heard of people getting it back in four hours and some people are not getting it back in over 48 hours.”

 

SecurityMetrics typically uses a real-time TIN-submission process because it is tracking down TIN/business names on a small number of merchants that individual acquirers haven’t been able to validate through the batch-matching process. “We have a system that allows us to get a response from the IRS almost immediately, under 10 seconds,” he says.

 

The IRS, however, caps how many TINs and business names an acquirer can submit within set time periods, Bennett says. “For an acquirer that’s got thousands of merchants, that’s problematic,” she says.

 

That’s the case for Atlanta-based processor First Data Corp., the nation’s biggest merchant processor. Acquirers submitting TINs for a real-time matching can enter only 25 names and TINs per submission and are limited to 999 transmissions in a 24-hour period, says Joe Chen, director of the tax-planning group for First Data. Acquirers using bulk matching in which TINs and business names are submitted in a text file with results returned within a few days are limited to 100,000 in the file.

 

“We have over 5 million merchant accounts,” Chen says.

 

‘A Death Knell’

 

The problems don’t end when acquirers receive the results. That’s because the IRS doesn’t specify the cause of any mismatches, according to Bennett.

 

“You submit a batch file to the IRS and wait a few days or a week or two and then you get the batch back and the IRS says, ‘match, no match, match, no match,’” she says. “You don’t know if it’s a transposed number, you don’t know if it’s the name that’s wrong. So you have to go back to square one again.”

 

Simply using the ampersand symbol in place of an “and” in a business name can trigger a mismatch, Bennett says, adding “that’s a huge system challenge.”

 

What’s more, a business owner often doesn’t know how the IRS has the business name listed, since owners often are inconsistent in how they list the name of their company on tax forms from year to year. For example, Joe & Sons Drycleaners could also be listed as Joe and Sons Drycleaners, Bennett says.

 

“That’s what caused big headaches for just about every business I’ve talked to in the acquiring role because they’re getting mismatches and it’s a lot of time and effort to track down,” Bennett says. “To a certain extent, you may be playing a guessing game, submitting different iterations of a name with the right number and trying to get a match.”

 

But problems with matching TIN and business name are more than just an aggravation for acquirers, Bennett adds. Any business that doesn’t have a valid TIN could ultimately face the 28% withholding penalty until the issue is clarified.

 

“Twenty-eight percent is a very high number and to even withhold that for a week from a small business could be a death knell, particularly in this economy,” she says. “It’s a very drastic penalty, and given the difficulty with the TIN-matching system, the potential is there for someone to have withholding triggered for a reason that might not be their fault.”

 

A Massive Undertaking

 

Acquirers have no other options other than the IRS for matching TINs and business names, Bennett adds.

 

“We’re all sort of held hostage by the IRS TIN-matching system because there’s nobody else that has the data,” she says. “Only the IRS holds the taxpayer ID number matched with the business, and no one else has access to that data.”

 

The ETA asked that the IRS delay the penalty-withholding phase until issues with the TIN-matching systems can be resolved, she says.

 

While TIN matching may be the largest problem encountered by many acquirers, the 1099-K form used by the acquirer to report a merchant’s electronic-payment transactions also has created some difficulties. Initially, the IRS released a draft form without instructions detailing what information went into which boxes.

 

“It’s very difficult to comment on a form when you don’t have the instructions to tell you what they want in the boxes,” Bennett says.

 

The form also didn’t take into account the peculiarities of payment processing, for example, the fact that “there is a whole chain of relationships and different companies that handle transactions,” she says. “One company has this piece of information, another company has another piece of information … the form does not really allow for all of those parties to be reported.”

 

The form also didn’t account for cash back, as noted, or the value of merchandise returns, which would need to be subtracted from gross transaction volume.

 

While the IRS is making some accommodations for acquirers’ concerns, sometimes changes create even more difficulties. Ongoing revisions of rules complicate acquirers’ ability to meet deadlines set by the law, says Joe Samuel, First Data’s senior vice president of global public affairs.

 

“Overall, we anticipate being in compliance but the caveat is we have to know what the final regulations are,” Samuel says. “We got the final regulations in late 2010 but we still continue to receive revisions from the IRS—that’s the caveat that can change things for everyone in the industry. If the IRS continues to revise stuff up until the last minute, then it’s going to be problematic.”

 

Any new data element requires reprogramming of all First Data’s different platforms, a massive undertaking, Chen adds.

 

Merchant Disputes

 

Despite the problems, the IRS has made some helpful changes. One involves the documentation required to identify foreign businesses, which are exempt from the law.

 

Originally, the law required acquirers to obtain a W-8 form, an official document verifying a company is incorporated or exists in a foreign country.

 

“This was perceived as a tremendous hurdle,” the ETA’s Bennett says, noting that acquirers would have to track down W-8 forms for every foreign merchant. “It’s a problem because we don’t currently have it, and it would likely cause all those foreign merchants to jump to another acquirer, one in their home country.”

 

The ETA asked whether the IRS could use the same verification standards for foreign merchants as are required under the Anti-Money Laundering Rule, documents already held by acquirers, she says. As a result, the IRS agreed to add other documentation options in addition to the W-8, Bennett says.

 

Once the annual deadline for filing 1099-Ks is past, acquirers will face another challenge: resolving disputes with merchants who disagree with the transaction volume submitted to the IRS.

 

“It’s unknown how many merchants are going to want to dispute what’s on their 1099-K and how many 1099-K corrected forms are going to need to be filed,” SecurityMetrics’ Young says.

 

A certainty is that come January, there is going to be plenty more paper and electronic documents moving around.

 

 

 

Some Problems with the Tax-Reporting Regs

 

1099-K reporting forms at first didn’t account for cash-back, inflating the amount of revenue to merchants.

 

The capacity of Internal Revenue Service computer systems may not be adequate to match taxpayer identification numbers (TINs) and business names when new documents are first received.

 

Sensitive taxpayer data could be at risk of disclosure.

 

Computer programming for merchant card reporting may not be completed in order to use the new data submitted.

 

The IRS caps TIN/business name matching submissions in a 24-hour period, making it difficult for large acquirers to verify merchant TINs in a timely manner.

 

The IRS continues to issue revised regulations, forcing acquirers to continually change complex systems.

 

Source: Treasury Inspector General for Tax Administration,  Government Accountability Office, Digital Transactions