The New 1099-K Adds New Level of Confusion

This year, there's one more 1099 form to add to the mix: the 1099-K. If your business takes payments via credit cards or services like PayPal, you may find one in your mail box later this month.

The forms will be sent by payment settlement entities -- typically, banks or other institutions that pay merchants and other businesses as settlement for payment card transactions -- and could include payments made via credit, debit or even gift cards. They'll also be sent by third-party settlement organizations -- organizations like PayPal that are contractually obligated to make payments to participating payees or merchants, in a third-party payment network -- if the gross payments to a payee exceed $20,000 and consist of more than 200 transactions.

The upshot? Many small businesses that accept credit card or PayPal payments soon will be receiving 1099-Ks; they are due to merchants by January 31, 2012. The payment settlement entities and organizations also separately report this information to the IRS.

The new forms and reporting requirements come courtesy of a provision in the Housing Assistance Tax Act of 2008. According to this summary of the bill by the House Ways and Means Committee, "some merchants fail to report accurately their gross income, including income derived from payment card transactions. Generally, compliance increases significantly for amounts that a third party reports to the IRS." The provision was expected to raise more than $9.5 billion over 10 years.

So, this reporting requirement doesn't actually impose any new taxes. Instead, "the bulk of the revenue is estimated to come simply from improved compliance among those accepting a payment card as payment and/or accepting payment from a third-party settlement organization," according to this brief by Grant Thornton.

The forms themselves look similar to other 1099 forms. They'll contain contact information on both the entity filing the tax return, and the payee. In addition, boxes 5a-5l on the form will show the gross amount of merchant card/third-party network payments the payee received during the year, broken out by month. The amounts reported will not be adjusted for any credits, discounts, or refunds, Grant Thornton says.

If your business receives a 1099-K, you have to report the amounts. For 2011, however, the reporting requirements are a bit confusing, to say the least. While Schedule C now includes Line 1A, which is where you normally would report the amounts shown on a 1099-K, the instructions read: "Merchant card and third-party payments. For 2011, enter 0." Huh?

The more detailed IRS instructions explain this: "We added new lines 1a and 1b to implement reporting of gross receipts received via merchant card (credit and debit trade or business cards) and third-party network payments. However, for 2011, the IRS has deferred the requirement to report these amounts. Therefore, enter zero on line 1a and report all gross receipts on line 1b, including any income reported to you on Form 1099-K Merchant Card and Third Party Network Payments (but excluding any W-2 income reportable on line 1c).

That's not the only part that's confusing. As Barbara Weltman writes in EcommerceBytes, businesses that sell both goods and services may receive both a 1099-K and a 1099-MISC for the sale of the same service. If that happens, they'll need to contact the entity that issued the duplicate 1099s, and ask for a correction. Otherwise, the income will be reported twice.

More info on the 1099-K can be found here on the IRS website.