Three New Information Reporting Tools Being Added By the IRS
The IRS has long used information reporting as a tool to enforce compliance with the tax laws. This is done in a variety of ways. Information reporting provides the IRS with the ability to perform vast numbers of compliance checks using their computer system. For example, Bank A issues a Form 1099-INT to Customer X and the IRS that reports the $1,000 of interest it paid to Customer X during the year. The IRS then checks X’s tax return to see if the $1,000 of income has been reported. The most commonly encountered compliance checks include the following:
o Wages (W-2)
o Income as an Independent Contractor (1099-MISC)
o State tax refunds and unemployment compensation (1099-G)
o Certain gambling income (W-2G)
o Interest and dividend income (1099-INT and 1099-DIV)
o Pension income, IRA withdrawals, etc. (1099-R)
o Social Security benefits/Medicare premiums (SSA-1099)
o Dependent Exemptions (Match against all other returns filed)
o Filing status (Match against other returns filed)
o Alimony (Match recipient to payer)
o Gross proceeds from the sales of stock and property (1099-B and 1099-S)
o Home Mortgage Interest (1098)
There are more, but this gives you an idea of how information reporting can be used as a tool to uncover noncompliance, unreported or under-reported income, and underpayment of taxes. Beginning in 2011 and 2012, the IRS has added three additional tools to their toolbox which will significantly increase their ability to uncover noncompliance by security investors and business entities.
Here is an overview of the forthcoming new information reporting tools:
- Payment Card and Third-Party Payment Transactions - The “Housing Assistance Tax Act of 2008” added Code Sec. 6050W which adds one of the new compliance tools for the IRS. This new tool will affect businesses that accept credit or debit cards, or other electronic payments received during 2011. Beginning in 2012, payment processors will have to make an annual information report (for the year 2011) to the merchant and the IRS, stating the gross amount paid to the merchant during the previous calendar year.
This will allow the IRS to determine the business’s gross income from credit and debit card sales and make it easier to segregate the credit/debit card sales from cash sales. The IRS will then be in a position to see if the credit card dollar figure reported on the tax return matches the bank's information return and will also allow them to see if a business’s other sales from cash and check payments makes sense in the context of the firm's overall business.
We can probably expect IRS to develop statistics for various types of businesses related to the ratio of cash payments to credit payments as a means of imputing cash payments for merchants that do not report a reasonable amount of income over and above that reported by the payment processors.
The new reporting form is Form 1099-K. The draft version of this form includes a box for reporting the annual amount of merchant card/third party payments and also has a box for each month’s credit/debit card sales.
- Basis Reporting – For years, the IRS has had the ability to identify the gross sales received by taxpayers from broker transactions including security (1099-B) and property sales (1099-S). However, the profit or loss from those sales is the amount that is taxable, and the only way to determine the profit or loss is to know the basis in the property that was sold. The profit or loss is the difference between gross sales price and the taxpayer’s basis in the property. Without confirmation of the basis, which up to now is only obtainable from the taxpayer via an audit, the IRS has no way to verify the reported profit or loss from the sale, leaving the area open to abuse.
That will be changing beginning in 2011, at least for security sales. Under tax changes enacted as part of the Emergency Economic Stabilization Act of 2008, every broker that is required to file an information return reporting the gross proceeds of a covered security must include in the return the customer's adjusted basis in the security, and whether any gain or loss with respect to the security is short-term or long-term. Generally, this will apply to corporation stocks acquired after 2010 (2011 for regulated investment companies and dividend reinvestment plans and 2012 for other securities to be determined by the IRS).
The IRS estimates that more than one in three taxpayers who sold securities may have misreported capital gains and losses—in many cases because they misreported their basis—and expects the new basis reporting rules will go a long way towards correcting that problem.
- Payments to Corporations – For as long as most can remember, payments for services made by one business to an unincorporated business required the payee to report the payments on a 1099-MISC if the aggregate payments for the year to a single entity were $600 or more. Payments for merchandise (unless made in connection with services that were purchased) have been excluded from 1099-MISC reporting. As part of the Health Care Act passed in 2010, the exemption from reporting payments to incorporated businesses will end, as will the exclusion of payments for merchandise, beginning for transactions occurring in 2012. Thus, all business-related aggregate payments for the year to a single entity of $600 or more, including payments for merchandise, will need to be reported by all business entities.
This will place a significant burden on businesses not only to track and report payments but also to reconcile their income with their accounting method and their reporting year (if not a calendar year).
To ease the burden this requirement may impose on businesses, the IRS has indicated it plans to use its administrative authority to exempt from this new requirement business transactions conducted using payment cards (such as credit and debit cards). These transactions will already be covered by the new reporting requirements on payment card processors, so there will be no need for businesses to report them as well.
It is not too early to start thinking about the impact these new reporting requirements will have on your investment transactions or your business. You need to be prepared when 2011 rolls around. If you have questions, please give this office a call.