IRS Under Reporting

Casual “Merchants” Likely to Get IRS Under Reporting Notices

Small business taxpayers whose gross receipts, as reported by credit card companies and third-party networks, appear to exceed the income stated on their tax returns may soon be receiving notices from the IRS inquiring about the discrepancy. Specifically included in this category are individuals who sell items on E-bay and other online auction sites as well as food cart operators, mom-and-pop shops, or swap meet participants.

In various forums and meetings, IRS officials have said the agency would begin sending “soft letters” of inquiry to taxpayers whose Form(s) 1099-K, Merchant Card and Third Party Network Payments, show an unusually high portion of receipts from credit card payments and other reportable transactions but whose tax returns do not show commensurate levels of income. The letters would ask these taxpayers to provide additional information about the apparent over- or under reporting of their gross credit card and other receipts, the IRS said.

The letters are an outgrowth of a provision in the Housing Assistance Tax Act of 2008, which required reporting of income from merchant payment cards beginning in 2011— including credit, debit, and certain electronic transactions—to provide the IRS a tool to help increase voluntary compliance and improve collections.

The IRS has acknowledged it is aware that the amounts reported by various third-parties, such as PayPal, may not match a merchant’s monthly reported income for legitimate reasons, including accounting discrepancies such as the use of an accrual system or a difference between parties calendar year versus fiscal year accounting systems. Furthermore, discrepancies can arise because Form 1099-K is a report of gross receipts and does not take into account a refund of a merchant’s cost of goods, or other deductions from gross income.

The IRS plans to begin with the soft letters and to request taxpayers to amend their returns if they agree with IRS’s assessment of under reporting.