Any difference between taxes paid and taxes owed gives rise to ‘tax gap’ which gives rise to difference between income that is taxable and income that is too reported.
It has been estimated that more than $400 billion taxes/year go uncollected. Previous IRS study showed that business income from small businesses accounted for 25 percent to 30 percent of the tax gap due to under reporting of taxes.
1099 forms are used by to report all the income and informational returns about businesses and their transactions. Example – A form issues 1099 misc to an independent contractor to whom it has paid $2000 for his services to the company.
To overcome the tax gap, government had decided the issue a 1099 form to all businesses small or big, goods or services who does any business or transaction of $600 or more per year.
This 1099 provision was set to begin in 2012, but it was cancelled in April 2011 after a great hue and cry was raised about the burden it placed on small businesses.
However, there is a 1099 provision that has not been revoked. The Housing Assistance Tax Act of 2008 added a provision of the Internal Revenue Code that requires companies that process credit and debit card payments, such as PayPal, to send a new type of 1099 form called 1099-K
1099-K is a form for Merchant Card and Third Party Network Payments. The IRS believes that some small companies do not report all of their credit or debit card revenues or revenues from third-party payments like PayPal. The new 1099-K will be used by the IRS to make sure small businesses will not be able to hide receipts from the IRS.
Until the enactment of the legislation requiring 1099-Ks, the IRS had been taking the word of the business owner that he was reporting all of his income because they did not have access to the credit card revenues of small companies. The only way to check if a company was cheating on its taxes was to do an audit of a particular return which can be time consuming and costly.
The IRS knows that there are hundreds of millions of dollars getting exchanged every year that go unreported. Much of these unreported transactions happen electronically.
The IRS commissioner said, "Beginning in 2012, payment processors will be required to make an annual information report to the merchant and the IRS stating the gross amount paid to the merchant during a calendar year. This will help improve voluntary tax compliance by business taxpayers and help the IRS determine whether their tax returns are correct and complete."
To trigger the reporting requirement, merchants must execute at least 200 transactions in a year that add up to at least $20,000. Payment providers will submit 1099-K forms only for sellers that meet both thresholds.
Taxpayers who have a credit card merchant account, PayPal account or similar account and otherwise meet the criteria will receive form 1099-K from their service providers at the end of the year.
The form 1099-K will report the gross amount paid to the taxpayer without any adjustments to fees, returns or sales tax.
Reconciling the 1099-Ks with the tax returns is going to be a problem. If your company receives debit and credit card payments and is above the reporting threshold, you should prepare for the 1099-K.
However, the effectiveness of 1099-K in succeeding the closing of tax gap is yet to be seen. The group that will be most affected are those who deliberately under- report and receive most or all of their income from cards or online payment portals like paypal.
The 1099-K form might discourage people from selling items on eBay and being paid through PayPal, for example, because they now will receive a 1099-K reporting the payments received.
On the other hand, there are people who vote on behalf of 1099-K saying that it is an unfair advantage to those who are not selling their goods on e-bay and not reporting taxes on their revenue.
However, 1099-K form is not without any disadvantages. It certainly holds a disadvantage of carrying with it a huge amount of paper work and thus huge costs. But if the huge amount of paper work leads to people reporting their incomes correctly, then the trouble is definitely worth it. The aim of the government should be to successfully be able to close the tax gap before they consider any tax increase for the payers.
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