What is Form 1099-K?: online payment tax tracking paperwork

As a CPA, my job can be boiled down to one task, “Worry about everything.” And as co-founder of a tech startup, there is no shortage of things to worry about. One thing that has been bugging at me for over a year now is the new Form 1099-K.
As Forbes and others have been writing recently. What is Form 1099-K you ask? It is the IRS’ realization that much of our economy is now online. (Find the actual form on the IRS website here)

To borrow a line from President Reagan, “If it moves, tax it. If it keeps moving regulate it…” And our sector of the economy is certainly moving, which is a great thing! But as our little slice of GDP matures, we’ll have to get used to more regulations. The one constant regarding regulations – particularly tax regulations – is that they always change.
I’ve known about Form 1099-K for a while, but it wasn’t until my partner and I got deeper into our business model development that this innocent looking form began to weigh on me. Every time I’d mention it at design meetings, everyone’s eyes would roll: “Not again with the tax talk!”
Then something happened. Yesterday, my partner got an email from PayPal informing us that we needed to submit our EIN so that they could comply with the IRC Section 6050W and thus send us a Form 1099-K if we meet the two tests. Wakeup call. This thing is coming, and it is coming fast. This provision went into effect as of 1/1/2011, meaning that the first 1099-K’s will be delivered in January of 2012.
As entrepreneurs, you are likely to encounter this form in two ways; as a recipient and as a sender. You will receive this form if you have a merchant account (to process credit card payments from your customers) and/or a PayPal account. If you’ve applied for a merchant account, you’ll have noticed the merchant bank application has a section requesting your EIN and notifying you why they need it – to comply with IRC 6050W and send you a 1099-K. PayPal has a very good FAQ on the subject at: http://www.paypal.com/irs.
Big deal you say, you’ve received many Form 1099-MISC’s for your contract work; what’s the big deal? Well, the difference with this new form is that the sender has to separate out the money you have received by month. This will have ramifications to all of those pass-through entities whose owners have to pay quarterly tax estimates. No more waiting until the end of the year to play “catch up.” I suspect that there will be a dramatic increase in underpayment penalties with these new Form 1099-K’s.
Now think about this from a sender’s point of view. If you host auctions on your site and/or let other people use your site to conduct their own transactions – listen up! IRC 6050W describes two requirements that a person needs to meet in order for you to have to send them a Form 1099-K: they must have 200 transactions AND $20,000 in gross receipts during the calendar year. Admittedly, this won’t snare too many people in the first year, but you can bet that as the years progress, more people will trigger the tests.
From a technology point of view, the logic is simple enough. If a user on your site gets close to having 200 transactions and $20,000 in gross receipts, you can put a “logic-gate” down on their account until such time as they provide you with their SSN, EIN, or ITIN (the government sure loves acronyms). You can also configure your database to track payments made by month.
Consider the security needs. You’ll need to request and receive the user’s name, address, and SSN, EIN, or ITIN. You’ll need to store that information. At the end of the year, you’ll need to send out a Form 1099-K. Mercifully, the IRS will let us send out the forms electronically – but consider that at every stage of this process is an opportunity for a hacking.
Then there is the marketing side to consider. In order to encourage wide adoption of your services, you need to make the profile application process as smooth as possible. What is going to happen to our user adoption and retention rates when we now have to ask for such detailed and sensitive information?
Then consider the administrative side. If a user of your site refuses to give you their SSN, IRC 3406(b)(3) requires you to perform backup withholding. Basically, you have to hold back 28% of whatever money you’d be paying out to your users if they don’t comply – and fork that over to the IRS. PayPal’s response to this section was to simply freeze your account until you give them the info. If the user gives a faulty SSN, EIN, and/or ITIN, then the backup withholding rules apply and so do potential penalties for non-compliance on your part.
As annoying as complying with these new provisions are, ultimately it’s not a bad thing. Mark this increase in regulation as a sign that the technology and ecommerce sectors are maturing and becoming a larger, more vibrant part of the overall economy. I personally hope that my own site sends out a ton of these bothersome little forms – because that would mean that my site is doing a ton of business.