A new law will require payment card processors and third-party settlement organizations to report online merchants' transactions to the IRS beginning in 2011. David Montague, founder and President of The Fraud Practice, explains what merchants need to know about the Housing and Economic Recovery Act of 2008 and how it may effect their bottom line.
David's background includes an in-depth application of innovative solutions for preventing business to consumer ecommerce fraud. Prior to founding The Fraud Practice, he held positions as Director of Risk Solutions at CyberSource Inc and National Principal at IBM Global Services. He has a Master's Degree in Information Management and is author of "Fraud Prevention Techniques for Credit Card Fraud." He speaks regularly about ecommerce fraud and has been a featured speaker at such events as the Direct Response Forum, National Retail Federation Fraud and Loss Prevention Conference, Retail Week's Retail Solutions Show, Retail Week's United Kingdom Risk Management Conferences, CyberSABOTAGE Conferences, Nestor Fraud Symposiums, Microsoft Tech-Ed and a host of other seminars and workshops around the world.
EcommerceBytes Insider: What is the new IRS reporting requirement included in the Housing Economic Recovery Act of 2008?
David Montague: The Housing and Economic Recovery Act of 2008 contained a provision, H.R. 3221-6, TITLE III-REVENUE PROVISIONS, creating an IRS 1099 reporting requirement for all credit card payment providers (i.e., PayPal, Google Checkout, Amazon) to report individuals that receive deposits totaling more than $20,000 from over 200 debit/credit card transactions in one year. In short, for any person or entity that is selling goods or services online today and receiving payments through a payment processor, the money collected from sales will be reportable as income, if they exceed the reporting thresholds.
EcommerceBytes Insider: Is the new requirement expected to increase tax revenues, and if so, how?
David Montague: The belief in government is that many small businesses are either not reporting or are providing only partial reporting of their revenue from online sales. For example an eBay PowerSeller that has setup a side business but hasn't actually been reporting the revenue generated from the business in a Schedule C in their tax return. For these businesses, they would now be paying taxes on this income, creating more tax revenue for the US government. The proposed provision could deliver tax revenue in the amount of $9.529 billion over 10 years. This is not just related to the likes of PayPal, Google Checkout and Amazon - traditional payment processors are also affected by this, and there have been a couple of recent legal requests for these companies to disclose the deposits processed for certain merchants.
EcommerceBytes Insider: Will services like PayPal, Amazon Payments and Google Checkout be more attractive to online sellers or less so with these new reporting requirements?
David Montague: For valid businesses and sellers that have been reporting their income, this change should be seen as a neutral event. For the casual user of these payment processing services, the change should also have a neutral view, as they will not likely exceed the reporting thresholds. For the population of small businesses and power sellers that will meet the reporting threshold, and are not fully reporting, the change will be seen as a negative event. This population will most likely direct their displeasure of the 1099 reporting at the payment processers.
This change could put more pressure on companies like eBay to offer multiple payment methods over just PayPal.
EcommerceBytes Insider: How do you think sellers will try to avoid hitting the numbers that will trigger reporting by payment processors, and are there legitimate ways to do so?
David Montague: There are 2 ways sellers could attempt to get around exceeding the reporting threshold:
1) Account holders could set up multiple accounts (i.e. 1 personal, 1 business, 1 in my wife's name) to purposely spread out revenue; While this may seem obvious and trivial, this presents a problem for a number of payment processors who view the world as 1 person equals 1 account. Payment processors will have to adjust their velocity systems to pool accounts which can increase record keeping costs, customer service inquiries and maintenance costs.
2) Some sellers from auction sites such as eBay or Craigslist will attempt to avoid the reporting requirements by diversifying their payment strategy. This would entail utilizing several different payment processors to try and go "unnoticed" by staying under the reporting threshold with any single processor. Sellers on these portals can pretty much dictate payment terms to the buyer.
There is nothing illegal about setting up and offering multiple payment choices, but to do so with the intention of avoiding reporting is. There is the potential that this could spark a rise in the number of supported payment processors for small (less than $100k per year) businesses and sellers, as they attempt to avoid the reporting requirements.
EcommerceBytes Insider: It seems there are a number of reasons why there may be legitimate discrepancies between what merchants claim on their taxes and what processors will report to the IRS. How do you think the IRS will handle this, and will it result in an increase in the number of audits conducted by the tax agency?
David Montague: While I am not an accountant or lawyer, my opinion is the IRS will do little to "handle" this. From the IRS perspective, this is nothing different from any other business. For other businesses they are required to track all monies coming and going from the top level down. The concept of gross and net is essentially the same, what is different is that a lot of the smaller merchants are most likely not keeping the proper accounting on their sales, which means they will most likely report incorrectly, or be unable to write off the appropriate levels of the reported gross deposits to the IRS. I would expect this will cause a number of audits.
Sellers will really have to keep books, tracking cost of goods sold, eBay fees, PayPal fees, chargebacks, refunds, shipping fees and deposits. Sellers will have to estimate taxes and prepay those taxes.
EcommerceBytes Insider: Are there unintended consequences of the new IRS reporting requirements?
David Montague: For payment processors, this is not just a simple matter of developing an accounting and reporting system. Payment processors will need to integrate tax reporting into their customer facing applications; they will have to change the way they collect and authenticate account holder data; they will have to setup customer service support for tax related inquiries and they will likely have to change the fundamental way they look at account holders.
Payment processors will also have to deal with the potential for brand damage from "guilt by association." This association will come from account holders expressing their displeasure of the new requirements in the blogosphere and from the increased damage caused to victims of fraud. In terms of fraud, fraudsters that setup accounts using stolen identities will be causing 1099 income to be reported on the victims. In this case a 1099 would be generated and the consumer may not have any idea that it has occurred until they are contacted by the IRS for not reporting the income. The burden of proof will be with the taxpayer to prove their innocence to the IRS, and the burden of proof will be on the payment processor to prove to the victim they didn't do anything wrong. Needless to say, this scenario is likely to receive a lot of attention in the press and blogosphere that a payment processor doesn't want to have.
All of this could mean higher fees for merchants.
EcommerceBytes Insider: When do you believe the IRS will provide guidance to clear up some of the confusion in how the law will be enforced?
David Montague: I actually don't know, but I would expect any guidance from them will come in their 2010 tax regulations.
EcommerceBytes Insider: Are there resources where sellers can learn more about the Housing and Economic Recovery Act of 2008?
David Montague: Here are links to two such resources.
Information on The Fraud Practice website
A PDF File containing the fulltext of HR 3211