Businesses have been receiving the 1099-K for credit card payments and 3rd party network transactions since 2013.  This form is used to report the gross amount of reportable transactions for a calendar year to the IRS.  If your business takes credit card payments, you are going to receive a 1099-K after the first of the year for transactions conducted during the prior year.

Taxpayers do not have to reconcile the 1099-K to their tax returns and the IRS has publicly stated that it will not use the 1099-K information to determine income understatements but they will use the info to determine if the reported sales of a business is reasonable (which seems like trying to find income understatements to me).  In other words, if you have $100,000 reported on a 1099-K but report only $80,000 in sales, you could be flagged for an audit.  It is important to remember that the IRS gets a copy of the 1099-K as well as the business owner.

The reason for the program was to catch unreported cash sales but it doesn’t allow for several valid reductions in reported sales, such as collecting sales tax or payments with a debit card or customer refunds.  The IRS has lots of historical data for percentage of sales that is cash and percentage which is credit card.  Debit card sales are now very popular and are really cash transactions but are being reported as credit card transactions on the 1099-K.  This tends to render IRS historical data invalid.

Here is a what can happen.  Assume you have net sales of $430,000.  The 1099-K shows $500,000.  The IRS, using old algorithms, says that they expect that 40% of your sales were in cash form and that your total sales was actually over $800,000.  The IRS may then send you Letter 5305 stating that you have a high percentage of credit card sales which, to them, means you have unreported cash transactions and are potentially trying to commit fraud.  You will be audited costing you time, money and lots of stress.

And, to make matters worse, there are now instances of state sales tax people receiving this bad data from the IRS who then send out letters to businesses demanding explanation!  More audits by people that are convinced that you are a crook.

Moral of the story is to be cognizant of this potential problem.  Make sure total receipts equal or exceed the 1099-K amount. Keep track of customer refunds, rebates, allowances, etc.  Keep really good records as you could find yourself in a situation where you have to defend yourself against erroneous conclusions based on bad data and inaccurate out-of-date algorithms.

Good luck!