Many businesses receive Form 1099-K, Payment Card and Third Party Network Transactions, every year. This is an information return required by IRS to report certain payment transactions in order to improve tax compliance. Your business should receive Form 1099-K from a card processing company by January 31 if in the prior calendar year you receive payments from card transactions (e.g. debit, credit cards).
A copy of Form 1099-K is also submitted to IRS by the card processing company. If your business had significant amounts of card transactions or revenue in prior year, IRS will compare the gross receipts on Form 1099-K with those on your annual income tax return (Form 1120, 1120S, or 1065). The purpose of this comparison is to detect any potential understatement of income on your tax return. If the gross receipts on the tax return are less than those on Form 1099-K, you are likely to receive a notice from IRS, in which you are required to pay additional tax, plus penalty and interest, for the difference in gross receipts between the two forms mentioned above.
If you receive this notice, you should contact your CPA immediately. Your CPA will reconcile the difference and prepare a letter to IRS, along with supporting documents explaining the difference. If the reconciliation is done properly and the letter to IRS is sent timely, IRS will accept your explanation and close your case, i.e. you are not required to pay additional tax.
There are many reasons for the gross receipts on Form 1099-K being greater than the gross receipts on your tax return. Sales tax is included in gross receipts on Form 1099-K but is excluded in gross receipts on tax return. If you allow customers to receive cash back when they use debit cards for purchases, Form 1099-K will include those cash back amounts in gross receipts, but you will not include the cash back amounts as part of your business’s gross receipts on the tax return. Therefore, it is important that you maintain records of transactions and activities during the tax year to support the reconciliation.
It is a good practice if you request your CPA to reconcile the gross receipts on Form 1099-K when the CPA prepares your year-end financial statements or your annual tax return. By doing this, any difference will be well explained and supporting documents will be well prepared. Therefore, if you receive a notice from IRS later, you are not caught surprised and all documents explaining for the difference are ready then.
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