Don’t Ignore This IRS Notice

By Steve Barlotta, CPA

Recently the IRS has been sending notices to many small businesses  as a result of the information reported on Form 1099-K. This form is prepared annually by banks and other financial institutions that process credit and other electronic payments to merchants. If your company processed a minimum of 200 transactions that total at least $20,000 in gross sales in a particular year, you are supposed to receive a Form 1099-K from the bank or financial institution that processed the transactions. More importantly, the banks and financial institutions are also required to send a copy of each form Form 1099-K to our friends at the IRS.

If you receive this notice from the IRS inquiring about the information reported on Form 1099-K, your business is probably not under a current audit. But, failure to respond to this notice, or responding in an insufficient manner, can initiate an audit and result in an assessment for unpaid taxes.

The question is what prompts the IRS in sending these notices related to Form 1099-K and what can your company do to prevent this scrutiny. Well, I’m not sure there’s much you can do to avoid receiving these notices, as there seems to be no methodology in who the IRS seems to be targeting.The most likely reason why these notices are sent to a business is either a mismatch between the gross payment amount reported on Forms 1099-K and the gross income reported by the business on its federal tax return, or a disproportionate amount of reported gross income related to the payments reported on Form 1099-K. Because most companies have sales other than from processed credit and other electronic payments (e.g., checks, gift cards), there is almost always a mismatch between the gross payment on Forms 1099-K and the gross income reported on the federal income tax return. The IRS realizes this also, and one has to wonder if they are using this as a convenient pretext to go after “unreported income”.

But, there are measures a small business can take to ensure that if the IRS does come knocking, they can verify the income that gets reported on Form 1099-K. Most important, a company should have a system in place to make sure that all income reported on the Forms 1099-K is included on its tax return. The easiest way to accomplish this would be for the business to establish a separate bank account for credit card transactions and other electronic merchant payments like PayPal. This way if the IRS is looking to substantiate the income from these type of transactions, the company has a much better audit trail and is better prepared to respond to the 1099-K notice.

So, if you receive this notice don’t ignore it. Immediately contact your accountant and he or she will help you put a plan in place on how to collect the records for the period in question so an appropriate and timely response can be made to the IRS.