Hiding Income? Look Out, Here Comes the 1099-K

Starting this month, business owners will begin getting new tax forms issued by their credit-card and online-payment processors and intended to keep businesses from hiding income. The form, called 1099-K, will document all 2011 transactions processed for sellers with more than 200 transactions and $20,000 in annual gross receipts. The IRS estimates that 53 million forms will be issued by such processors as eBay, PayPal, and Amazon as well as credit-card companies, says Steven Aldrich, chief executive officer of Outright.com, which makes online bookkeeping applications for self-employed people and small business owners. Aldrich spoke with Smart Answers columnist Karen E. Klein about how small business owners should handle the new forms. Edited excerpts of their conversation follow.

The new 1099-K requirement was signed into law by President George W. Bush in 2008 but is just now taking effect. Why is the government mandating this?

Electronic payments are a growing part of our economy, but up to now they have not been officially reported to the IRS. People were on their scout’s honor to report this income. This new form is designed to help close the gap between what businesses and individuals owe the IRS and what they actually pay. It is expected to bring about $9.5 billion into the U.S. Treasury over 10 years by taxing revenue flowing through electronic networks.

It is a big number, but our concern is keeping the burden on small business low enough so they don’t lose their competitiveness and don’t have a big burden of extra time they have to put into dealing with this. All businesses will get these, not just small businesses, but larger businesses have got tax teams and people to handle these matters and small business people usually do not. Our concern is that small business owners could be distracted and worried when they get this form and not know what to do with it.

This is going out for the first time to individuals such as eBay and Etsy online sellers. Have they gotten any notice about the form?

The payment processors were required to obtain sellers’ tax identification numbers for these forms, so many of them sent out notices last year when they were verifying the information and making sure the right people got the right form.

What information will the form list?

It’s actually very simple. At the top is a box with your total gross revenue for the year, processed by PayPal or whichever payment processor you use. Beneath that box is a breakdown of revenue month by month.

How is that number going to be compared with what’s reported on an individual’s tax return?

The IRS will look at the gross sales amount reported on the 1099-K and compare it with the total gross receipts reported on an individual’s Schedule C. The amount on the tax return has to be at least as much as what’s reported on the 1099-K.

The interesting thing is that these amounts reported to the IRS are gross sales numbers. But businesses never actually make their gross sales because of refunds, frauds, exchanges, and returns. But none of those expenses are taken out of the gross sales amount.

And business owners don’t pay taxes on gross income, but on net income.

Exactly. So it will be incumbent on the business owner to take the gross amount reported on the 1099-K and capture all the transaction fees, charges, and returns, in addition to the other expenses of running their business, in their tax reporting.

Is that going to be a big burden for micro-businesses?

It’s not going to be a big deal if you have good record keeping. The problem is that most small business owners are still using paper and pencil and spreadsheets to track their business data. This reporting is really a clarion call to move those people into the digital age. Certainly, if you’re taking electronic payments, you need to move to a digital form of keeping your books.

Are there other pitfalls related to the 1099-K?

For service providers, like consultants, who are taking advantage of electronic payment systems, they might get a 1099-MISC for some part of their consulting revenue. But that income would also show up on the 1099-K if it was processed electronically. That could result in double counting that income, so that’s something to be very careful about, especially as more people in the service industry are starting to use services such as PayPal or mobile credit-card readers instead of taking cash or check payments.

This article was written by Karen E. Klein and was published in Bloomberg Businessweek magazine.