Editor’s note: Steven Aldrich is CEO of Outright, an online accounting application that serves more than 150,000 small businesses, including many eBay, Amazon, and Etsy merchants. Follow him on Twitter @spaldrich.
The small business economy is suffering considerable harm from new regulations being enforced by the IRS this year. There’s a new tax form that’s causing this trouble for small business owners who collect ePayments and conduct eCommerce. The IRS Form 1099-K requires merchant processors and third-party payment processors, such as PayPal and Square, to report the income that individuals and small businesses were paid through their services to the IRS in 2011. The IRS estimates that 53 million of these forms should have been sent for tax year 2011, making it the 10th highest volume tax form in it’s first year of existence.
That’s a lot of small businesses being hit by the implementation of Internal Revenue Code Section 6050W.
The intention of the reporting law was to close the tax gap — the estimated $385 billion that the government loses from the under-reporting of income. The regulation created a reporting requirement for payment processors as a “check and balance” system to provide transparency into electronic and credit card payment earnings for income tax purposes in the same way employers send out W-2’s to report employees’ earnings.
Unfortunately, the outcome unfortunately put a big reporting and reconciliation burden on law-abiding entrepreneurs using online and mobile payment solutions. The challenge is that the 1099-K form reports “gross sales” made, without adjusting for items like fees, refunds, returns, or fraudulent transactions. There are 10 million small businesses that sell on eCommerce platforms, such as eBay or Amazon, their own websites, or that take payments through ePayments providers like PayPal and Square. These business owners are saying that the gross sales number on the form is coming in much higher than they expected and is causing each business to spend significant time and money to get their taxes done correctly.
As one Outright customer, who wished to remain anonymous, stated, “The IRS is being told that we’re literally generating double the revenue that we actually are.”
Without taking this new law into account, $140 billion and 3.5 billion hours of time are spent on tax compliance each year. Outright’s calculations suggest that over $10 billion in additional costs (approximately $180-$200 per form received) are being incurred. Given that the IRS is only expecting to raise an additional $9.5 billion in extra revenues from this new law over the next 10 years, this implementation has created a net loss to society over the next decade.
And the impact on the solo entrepreneurs who are already working six days a week to find and serve customers is high, in contrast to the original intent. In the Federal Register discussion of the regulation, one paragraph states, “The Treasury Department and the IRS certify that the regulations in this document will not have a significant economic impact on a substantial number of small entities.” But the millions of businesses that take electronic payments and have high transaction volumes are spending additional money and investing time to comply.
Getting transparency into the eEconomy makes sense. The Commerce Department estimates that $194 billion in sales were made online in 2011, 16 percent higher than 2010 and growing twice as fast as retail sales in general. But the IRS needs to clarify this reporting requirement for ePayments merchant account and payment processors to lighten the load on small businesses across America. The reporting requirement needs to be amended to provide a standard definition of what constitutes gross sales, so that ePayments providers can be consistent.
Additionally, the third-party payments providers should be required to report on expenses they know of, including total fees, returns, sales tax collected, and fraudulent transactions. This would be consistent with tax forms like the W2, which reports personal income plus deductions and taxes paid. Providing this additional information would make it much easier for the small business to have the information they need for taxes.
This solution would allow for transparency of income generated within the digital economy and reduce the burden of figuring out the correct numbers for taxes. Small business owners would then be able to focus more of their energy on growing their businesses and lifting the economy as a whole.
[image via Flickr/Alan Cleaver]