Convincing taxpayers to notice newly enacted tax legislation that does not affect the current year is difficult. Getting them to address ministerial requirements that will not be effective for two to three years is next to impossible. One piece of legislation passed in mid-2008 that has not received a lot of attention could end up biting some that have placed it at the bottom of their to-do list or, worse, failed to notice it altogether.
A provision in the Housing and Economic Recovery Act of 2008, P.L. 110-289, which was signed by President Bush on July 30, 2008, contains new information return reporting requirements related to the settlement of reportable transactions involving payment card (e.g., credit and debit cards) and third-party network transactions, including the settlement of any credit or debit card sales and internet transactions through a third-party network (Sec. 6050W).
The provision is part of Congress’s latest attempts to close the tax gap. The new reporting requirements are expected to reduce noncompliance related to income underreporting by taxpayers with gross income from payment card and/ or third-party network transactions. In practice, settlement of these transactions involves many steps that are performed by different participants. The new requirements target two of them:
- Payment settlement entity (the payor): The merchant acquiring entity or acquirer (for payment card transactions) or the third-party settlement organization (for third-party network transactions). A merchant acquiring entity is the bank or other organization that is contractually obligated to make payment in settlement of payment card transactions.
- Participating payee: The party that accepts a payment card as payment or establishes an account with a third-party settlement organization in order to settle transactions. In a payment card transaction, the payee may also be referred to as the merchant or seller.
Beginning with calendar year 2011, payment settlement entities for traditional and online merchants will be required to report to a payee, as well as to the IRS, the gross amount of the payee’s reportable payment transactions within a calendar year. Failure-to-file penalties will apply. While a substantial majority of the new reporting burdens will fall on financial institutions and other large businesses that provide merchant acquiring bank services or offer online payment settlement, these services are not restricted to these types of companies. Entities that accept payment cards or payment from third-party network providers should also consider the impact of the new requirements. Starting in calendar year 2012, the backup withholding rules will apply to reportable payments when a participating payee fails to provide a taxpayer identification number in the manner prescribed (Sec. 3406(b)(3)(F)).
The statute provides some description of targeted transactions. The payment settlement entity must have a contractual obligation to make payment to the participating payee in order for the statute to apply, notwithstanding the type of transaction involved. The statutory language is also specific regarding what constitutes a payment card agreement or a third-party payment network agreement.
In general, both types of agreements should include standards and mechanisms for settling transactions between the payor and the participating payee. Each type also requires a material number of participants to meet the definition of an arrangement. Payment card agreements must provide for a “network of persons,” while third-party payment network agreements are among a “substantial number of persons” (Sec. 6050W(d)). Though it is not defined in the statute, the Joint Committee on Taxation’s technical explanation indicates that “substantial” means more than 50 (Joint Committee on Taxation, Technical Explanation of Division C of H.R. 3221, The “Housing Assistance Tax Act of 2008,” 61 (JCX-63-08) (July 23, 2008)).
Notwithstanding these similarities, relationships between the parties that appear to exclude certain arrangements from reporting requirements are not treated consistently between the transaction types. For a third-party payment network, the network of payees must be unrelated to the settlement entity, the central organization with which accounts are established (Sec. 6050W(d)(3)(A)). The same restriction does not exist for payment card agreements, but the payees must be unrelated to each other and to the card issuer(s) (Sec. 6050W(d)(2)(B)).
The application of the new rules may be unfavorable for some payees. The statute requires informational reporting of “the gross amount of the reportable payment transactions” for each participating payee (Sec. 6050W(a)(2); emphasis added). Neither the statute nor the technical explanation contemplates an adjusted amount that more properly reflects the taxpayer’s (payee’s) income. The Bush administration’s revenue proposals previously included this type of revenue offset provision, but they stated that “[reporting] would reflect appropriate adjustments for amounts that represent cash advances made by the merchant via the payment card or other amounts not included in the merchant’s gross income” (Department of the Treasury, General Explanations of the Administration’s Fiscal Year 2009 Revenue Proposals 65 (February 2008)).
Though a cash advance was the only example, it is reasonable to suggest that amounts debited from a merchant’s account, such as sales refunds or chargebacks due to improper acceptances, should be excluded from the reportable amount, or at least not subjected to 28% backup withholding (based on enacted rates). A settlement entity may process debits by netting them against the amount otherwise due to the payee. In these instances, the payee may be unable to verify the correctness of the reported amount without additional, and perhaps undue, burden.
It is unclear if all payments may be excluded from the rules if a contractual agreement is lacking. While the presumptive parties to such an agreement would be the payment settlement entity and the participating payee, the statute does not specify. Sec. 6050W(b)(4)(B) provides that in any case in which an electronic payment facilitator or other third party makes payment in settlement of reportable payment transactions on the settlement entity’s behalf, the third party will be required to make the return in lieu of the settlement entity.
One can infer from this language that a contractual obligation exists because, absent such an obligation, there would be no payment settlement entity as defined in the statute. Note here that the contractual obligation may not be between the party required to report and the payee. This would suggest that any contractual obligation to make payment in settlement of a transaction would suffice. However, the technical explanation would limit the scope to exclude mere processors of electronic payments (e.g., wire transfers, electronic checks, and direct deposit payments) where there are no contractual agreements with sellers (Technical Explanation of Division C of H.R. 3221, p. 61). While this may suggest that the existence of a contractual agreement establishes the payor’s reporting obligation, the statute does not explicitly address this scenario.
Sec. 6050W(e) does provide a de minimis exception for third-party network transactions. Reporting is required only if the amount otherwise reportable to a participating payee exceeds $20,000 and the aggregate number of transactions exceeds 200. No threshold exists for payment card transactions. The statutory language subjects a single payment card transaction to informational reporting.
Congress delegated the authority to prescribe regulations or other guidance to the IRS and explicitly included “rules to prevent the reporting of the same transaction more than once” (Sec. 6050W (g)). A single transaction can result in multiple reportable payments by more than one type of payment settlement entity. Similar to the rules for electronic facilitators, Sec. 6050W(b)(4) provides that when aggregated reportable payment transactions are settled through an intermediary, the intermediary shall be treated as the settlement entity with respect to the participating payees. In addition, the intermediary is treated as the participating payee with respect to the original payor. An example would include a franchise network that used an intermediary to process payment card transactions. In this situation, the settlement entity would report payments made to the intermediary, and the intermediary would be required to report the payments to each franchisee.
Taxpayers that may qualify as a payment settlement entity and/or participating payee under Sec. 6050W should take the opportunity to consider the adverse consequences and ambiguities that the IRS should address by future regulations or other guidance. Those businesses that may be subject to duplicate reporting under the current statutory language should be particularly sensitive and offer comments, if able, to ensure that further guidance is relevant and effective.
Jeff Kummer is director of tax policy at Deloitte Tax LLP in Washington, DC.
Unless otherwise noted, contributors are members of or associated with Deloitte Tax LLP.
For additional information about these items, contact Mr. Kummer at (202) 220-2148 or firstname.lastname@example.org.