A friend of a friend admitted to me last week that he hadn’t filed taxes in more than 20 years. He’s self-employed as a cab driver on the East coast, and has created a flourishing underground business without catching Uncle Sam’s eye. That is until about a month when he received a Form 1099-K in the mail from the company who processes credit and debit card payments for his business.

The 1099-K reported his 2011 income for payments processed through his merchant account. Now the IRS knows about him, and if he doesn’t file an income tax return this year, the agency will hunt him down and squeeze tax dollars from him. On top of that, the IRS will likely go after him for the years he didn’t file. He could even face criminal and civil charges.  

Entrepreneurs in similar circumstances shouldn’t panic. An IRS agent once told me that it really doesn’t want to put anyone in jail—it just wants people voluntarily complying, making money and paying taxes. In fact, the IRS will most likely welcome any tax-escaping business with open arms if they pay what they owe, to help the agency put a dent in the tax gap.

The tax gap is the difference between taxes owed and taxes paid to the IRS. In order to shrink this gap and improve voluntary compliance, the IRS issued final regulations in August 2010 mandating the reporting of income to businesses from third-party settlement organizations if the aggregate payments to the payee are at least $20,000, or if the aggregate number of transactions is 200 within the calendar year. This applies only to the payments settled by third-party settlement organizations.

This reporting is done on a 1099-K form which breaks down a company’s sales by month in order to make reconciliation of the amounts easier.  For 2011, small businesses do not need to do anything different when filing their taxes, just make sure the total of the 1099-K plus the total of all other 1099s received do not exceed the income reported on the business tax return.

The amount reported on the 1099-K will not include charge backs or returns. Owners must track these items separately and report them under “Returns and Allowances” on their income tax return.

Beginning in 2012, small business owners will be required to break out sales by the amounts reported on the 1099-K separately from the payments received by other means such as cash, check, barter, etc.

This changes the way in which small firms must comply with 1099 reporting for a business. Owners paying for a tax pro, for example, by credit or debit card, the payment will be reported by the tax pro’s merchant account provider on Form 1099-K. Entrepreneurs, therefore, are not required to provide the tax pro with a 1099-MISC, otherwise the amount will be reported twice. So when owners compile their 2012 data for preparing 1099s next January, they must remember this new rule so they don’t subject a vendor to duplicated reporting and create a potential problem with the IRS.

And here’s where we have a problem. Not every business owner who is subject to filing 1099s knows the new rules.  I foresee some tax problems coming up.

Most business owner clients come into my office with a stack of 1099s they received still sealed into the envelopes in which they arrived. As the recipient of 1099s, you will want to tear open every envelope and check them for accuracy. Any 1099 showing an incorrect amount or showing a payment that was received via credit or debit card and therefore duplicated on a 1099-K should be dealt with. Request a corrected 1099 from the issuer so you don’t have needless tax troubles.

Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all fifty states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, CA and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebook

 

Bonnie Lee is an Enrolled Agent admitted to practice and representing taxpayers in all 50 states at all levels within the Internal Revenue Service. She is the owner of Taxpertise in Sonoma, Calif., and the author of Entrepreneur Press book, “Taxpertise, The Complete Book of Dirty Little Secrets and Hidden Deductions for Small Business that the IRS Doesn't Want You to Know.” Her new e-book Taxpertise for the Creative Mind Murder, Mayem, Romance, Comedy and Tax Tips for Artists of all Kinds is available at all major booksellers. Follow Bonnie Lee on Twitter at BLTaxpertise and at Facebookhttp://global.fncstatic.com/static/v/all/img/external-link.png