September 11, 2017
How to Reconcile the Difference between Gross Receipts and Receipt Reported on Form 1099-K
How to Reconcile the Difference between Gross Receipts and Receipt Reported on Form 1099-K
Post 2011, Taxpayers will receive IRS Form 1099-Ks from most of the Payment Processors if more than $20,000 in sales and more than 200 transactions. A single transaction of more than $20,000, or more than 200 transactions totaling less than $20,000, may result in the business not receiving a Form 1099-K from the Payment Processor. The Form 1099-K reports the gross receipts from Payment Processors, over the course of the year, which includes credit card companies, PayPal, Square, and similar organizations.
What is considered gross receipts will include all items related to a sale transaction, including sales tax, cash out and gratuity, which may seem to constitute income and will need to be reconciled. As a result, business owners may be understandably conflicted by not only the need to accurately report gross receipts and sales information on the tax return, but also the desire to not raise any red flags with the IRS.
Form 1099-K
Box 1a of Form 1099-K reports total transactions in dollars; box 2 reports the taxpayer’s merchant category code (MCC) (though reporting an MCC is not required for TPSOs); boxes 5a– 5l report total transactions broken out by month, which helps fiscal year filers determine income without having to reference monthly statements.
Businesses often receive payments from PSEs, net of fees and other adjustments, a few days after the customer made payment. According to Reg. section 1.6050W (a)(1), Form 1099-K information returns are filed based on payments made in settlement of reportable payment transactions. Paragraph (a)(6) clarifies that “The dollar amount of each transaction is determined on the date of the transaction.”
While the dollar amounts reported are clear, cutoff is not. Consider taxpayer B, whose only transaction is to swipe a customer’s card on Dec. 31, 2017, for $1,000. B then receives net payment for the swipe on Jan. 2, 2018, for $990 ($1,000 less a $10 transaction fee charged by the PSE). Depending on how the PSE determines cutoff, B could expect to receive a Form 1099-K for two scenarios: (a) Form 1099-K reports $1,000 in box 1a for 2017 and no Form 1099-K is issued for 2017; or (b) No Form 1099-K is issued for 2017 and a Form 1099-K reports $1,000 in box 1a for 2017.
Best practices in reporting Form 1099-K income
- Accumulate all Forms 1099-K. All domestic taxpayers who accept credit cards, debit cards and any other payments from a payment settlement entity should receive one or more Forms 1099-K.
- Review merchant category code. The IRS analyzes gross receipts by comparing a taxpayer’s gross receipts and Form 1099-K receipts to other taxpayers based on a variety of variables, including MCC (box 2 on Form 1099-K). An MCC is a four-digit number used by the payment card industry to classify businesses by the goods or services they provide (see Rev Proc. 2004-43 for a comprehensive listing of MCCs). If a taxpayer’s code is incorrect, the IRS’s comparative analysis may trigger a notice or examination even though the taxpayer’s receipts are in line with its actual merchant category peers. Taxpayers can check their MCC by reviewing their prior year Form 1099-K or by contacting their PSE. For the same reasons, taxpayers should ensure their business activity code as reported on their tax return is appropriate.
- Carefully consider how to report Form 1099-K Income. It is tempting to disregard Form 1099-K because it does not agree to payments received from reporting entities. That is because the gross proceeds reported include processing and transaction fees, which are deducted before net payments are sent to taxpayers. According to the Internal Revenue Manual, Form 1099-K amounts should be included in amounts reported on the gross receipts line of taxpayers’ returns and transaction fees should be reported in other deductions.
- Consider whether Form 1099-K includes transactions for a separate business. Certain taxpayers, referred to as ‘aggregated payees,’ will have one account with a PSE that services multiple entities. This raises the issue of where to report remittance of funds received on behalf of other entities. Taxpayers may consider reporting Form 1099-K on line 1 net of amounts paid to other entities and then attaching a clearly labeled statement detailing the payments made. Current form instructions for business returns are generally silent on where and how Form 1099-K income should be reported, suggesting the IRS may be flexible in where it allows these amounts to be included. According to Reg. section 1.6050W-1, aggregated payees serve the role of PSEs, and are then required to issue one or more Forms 1099-K to payees.
- Reconcile Form 1099-K revenue to gross revenues reported on the return. As noted earlier, cutoff applied by the PSE may differ from cutoff as established by the taxpayer, which may make reconciling Form 1099-K income to a taxpayer’s records challenging. However, this important step will allow the preparer to identify where income is sourced and to judge whether non-Form 1099-K income appears reasonable. If it does not appear reasonable, additional measures and potentially additional documentation should be considered before filing the return. If reconciling amounts are large, attaching the reconciliation to the return may help prevent a notice or examination. To compound reconciling challenges, cash back amounts are included in gross proceeds as reported on Form 1099-K. According to the IRS’s Payment Card Transaction FAQs, cash back should be disregarded on the tax return, not reported as offsetting amounts in income and expense.
- Watch out for Form 1099-MISC and Form 1099-K crossover. The preamble to Reg. section 1.6050W-1 discusses instances where a single transaction may fall under the reporting requirements of not only section 6050W, but also section 6041A(a), which covers such items as Form 1099-MISC for payments of more than $600 to service providers. In most situations, the payor is relieved of filing Form 1099-MISC while the PSE’s requirement to file Form 1099-K remains. Consider a contractor who provides $10,000 in services and accepts a credit card payment. The contractor might expect to receive a Form 1099-MISC and a Form 1099-K from the PSE. In such a scenario, Reg. section 1.6050W-1 provides relief for the section 6041A(a) payor. In practice, however, confusion can occur on many levels. The accountant may prepare a Form 1099-MISC because the payment to the contractor was not tagged as a credit card payment in information system. Accordingly, the contractor may receive both a Form 1099-K and Form 1099-MISC, which could generate confusion for the preparer and potentially trigger an IRS notice or examination. In these situations, it is suggested that the taxpayer is responsible for informing all parties involved who should and should not issue Forms 1099.
Owners should not:
- Use only the amounts from the Form 1099-K as the gross receipts on the tax return, unless it accurately reflects sales.
- Hesitate to contact the issuing Payment Processor if there is a discrepancy. While the amounts and transaction dates may not tie exactly, the total should be within reasonable proximity to the total included in the restaurant owner’s books. There should be a telephone number listed on the Form 1099-K to contact the issuer.
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