A Form 1099-K, Payment Card and Third-Party Network Transactions, is an IRS information return that is used to report payment card transactions. The IRS first began requiring payers to report annual gross payment transactions on a 1099-K in 2012, following the enactment of the Housing and Economic Recovery Act of 2008, Pub. L. No. 110-289, 122 Stat. 2654, which added Section 6050W to the Internal Revenue Code. Section 6050W requires payment settlement entities (payers) to report payment transactions made to merchants (payees). Since introducing the 1099-K, the IRS has utilized this reporting information to identify discrepancies between a taxpayer’s gross receipts from payment card sales and the gross receipts reported on the taxpayer’s tax return in order to select audit targets. Expect to see this IRS 1099-K audit initiative increase in coming years.
A Form 1099-K is required to include the gross amount of all “reportable payment transactions.” A reportable payment transaction is defined as a payment card transaction or a third-party network transaction.
- A “payment card transaction” is any transaction in which a payment card, or any account number or other identifying data associated with a payment card, is accepted as payment.
- A “third-party network transaction” means any transaction that is settled through a third-party payment network, but only after the total amount of such transactions exceeds $20,000 and the aggregate number of such transactions exceeds 200.
A reportable payment card transaction involves a bank or other entity with a contractual obligation to make a payment to a merchant in settlement of reportable payment card transactions, including credit cards, debit cards, and stored-value cards. An example of a third-party settlement organization is an online auction payment facilitator, such as PayPal, which operates as an intermediary between a buyer and seller by transferring funds between accounts in settlement of an auction or purchase.
IRS Form 1099-K Matching and Audits
The IRS established the Payment Card Program in 2012 as part of an effort to identify and combat underreporting of business income. As part of the Payment Card Program, the Service developed the Payment Mix Methodology (“PMM”) algorithm, which was designed to compare Form 1099-K data against tax return data and identify audit targets based on the assumption that similar businesses will have a comparable blend of cash and payment card purchases. That is, the PMM algorithm looks for reporting anomalies and identifies taxpayers as potential audit targets based upon their 1099-K’s.
TIGTA reports in recent years have indicated that “[t]he Internal Revenue Service (IRS) appears to have missed opportunities to audit tax returns with large discrepancies between payments reported on Forms 1099-K and income reported on taxpayers’ tax returns.” In light of this criticism, the IRS has increased its focus on 1099-K audits even more in recent years. Thus, many business taxpayers are finding themselves subject to audits due to 1099-K discrepancies.
As it turns out, however, many normal business practices can lead to inevitable 1099-K discrepancies. For example, credits, cash equivalents, discount amounts, fees, cash-back transactions, and refunds can all create 1099-K discrepancies, as these items are not reflected in the gross amounts that are reportable on a 1099-K. Business taxpayers facing audits that may involve 1099-K’s should seek a qualified tax professional, as identifying 1099-K issues early and taking proper steps to address these common discrepancies can often limit the scope and extent of an audit.