Housing and Economic Recovery Act of 2008

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Many small businesses and payment processors were surprised to learn the Housing and Economic Recovery Act of 2008 included a provision creating an IRS 1099 reporting requirement for all credit card payment providers (i.e. PayPal, Google Checkout, Amazon) to report individuals that receive deposits totaling more than $20,000 on over 200 transactions in one year.  The proposed provision could deliver tax revenue in the amount of $9.529 billion over 10 years but at what cost?

 

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Housing and Economic Recovery Act of 2008

Table of Contents:

• Who is Affected?
• Summary of Implications
• Potential Impact on Individuals, Sellers and Small Businesses
• Potential Impact on Payment Processors
• Potential Impact on Fraud Trends
• Excerpt of Housing and Economic Recovery Act 2008, H.R. 3221-6, TITLE III-REVENUE PROVISIONS, Subtitle B-Revenue Offsets, Section 3091. “Returns relating to payments made in settlement of payment card and third party network transactions.”

Who is Affected?

• Individuals and businesses using companies to process payments from credit cards. (sellers using services like PayPal, Google Checkout, Amazon Payments)
• Payment processors, aggregators, IPSP’s, master merchants, third party payment providers, acquirers.

Summary of Implications:

KEY POINT: Takes effect in 2011

For payment processors this is not just a simple matter of developing an accounting and reporting system. Payment processors will need to integrate tax reporting into their customer facing applications; they will have to change the way they collect and authenticate account holder data; they will have to setup customer service support for tax related inquiries and they will likely have to change the fundamental way they look at account holders.

It only makes sense that account holders will now want to setup 2 accounts, one for business and one for personal use. While this may seem obvious and trivial, this presents a problem for a number of payment processors who view the world as 1 person equals 1 account. Payment processors will have to adjust their velocity systems to pool accounts which can increase record keeping costs, customer service inquiries and maintenance costs.

Of course some sellers, not so honest ones, may also utilize multiple accounts (i.e. 1 personal, 1 business, 1 in my wife’s name) to purposely spread out revenue.  Some sellers from auction sites such as eBay or Craig’s List will attempt to avoid the reporting requirements by diversifying their payment strategy.  This would entail utilizing several different payment processors to try and go ‘unnoticed’ by staying under the reporting threshold with any single processor. 

Payment processors will also have to deal with the potential for brand damage from “guilt by association”. This association will come from account holders expressing their displeasure of the new requirements in the blogosphere and from the increased damage caused to victims of fraud. In terms of fraud, fraudsters that setup accounts using stolen identities will be causing 1099 income to be reported on the victims. In this case a 1099 would be generated and the consumer may not have any idea that it has occurred until they are contacted by the IRS for not reporting the income. The burden of proof will be with the taxpayer to prove their innocence to the IRS, and the burden of proof will be on the payment processor to prove to the victim they didn’t do anything wrong.  Needless to say, this is scenario likely to receive a lot of attention in the press and blogosphere that a payment processor doesn’t want to have.

As if increased costs, brand risk and new operational support requirements weren’t enough, processors may also suffer a temporary reduction in revenue processed as some account holders return to payment methods that are not covered by the mandatory reporting requirements.

 

Potential Impact on Individuals, Sellers & Small Businesses:

• Payment processors will have to conduct more authentication, increase customer service and improve record keeping control and maintenance.  To pay for this payment processors may have to charge higher fees. 
• In order for payment processors to report 1099 earnings to the IRS will require a greater amount of sensitive information such as Employer Identification Number (EIN) or SSN.  Merchants who fail to provide their taxpayer identification number (usually the EIN) could become subject to a large backup withholding rate of 28% on their payments. 
• For some account holders, the complexity of additional schedules, accounting for write offs and the requirement to pay additional social security and Medicare may be too complex requiring the use of a professional tax preparer. At the very least account holders will need to keep more detailed books because fraudulent payments, refunds and processing fees will all have to be accounted for as deposits which will be viewed as “gross sales” and taxable income.

Potential Impact on Payment Processors:

• Sellers that are positioned on auction sites such as eBay and Craig’s List may attempt to stay under the proposed reporting limits by diversifying their payment strategy.  This would entail a seller utilizing several forms of payment to try and go ‘unnoticed’ and not cross the reporting threshold. 
• Individual sellers may utilize multiple accounts (i.e. 1 personal, 1 business, 1 in my wife’s name) to spread out the revenue.  Payment processors will then have to adjust their velocity systems to pool the accounts which can increase record keeping costs, customer service inquiries and maintenance costs. 
• In order for payment processors to report 1099 earnings to the IRS will require a greater amount of sensitive information such as Employer Identification Number (EIN) or SSN.  Payment processors that market themselves as not requiring sensitive information will have to inform consumers and ensure it is stored securely.  
• Payment processors will also have to deal with the potential for brand damage from “guilt by association”. This association will come from account holders expressing their displeasure of the new requirements in the blogosphere and from the increased damage caused to victims of fraud.
• Development: New systems to monitor and report individual accounts; requirement for stronger authentication tools.
• Operations: Additional customer service personnel to handle customer inquiries for collecting and disputing 1099 reports.
• Brand: Education of customers on new reporting requirements, and managing customer satisfaction in response to customer backlash to the new reporting requirements.

Potential Impact on Fraud Trends:

• Actual accounts held by fraudsters will be vigilant in staying under the 200 transaction limit.
• Fraudster will attempt to capture higher value sales per transaction to avoid reporting requirements for stronger authentication. 
• Fraudsters could phish for account information, sell goods, take the money and run.  In the end, the legitimate account holder is dealing with the IRS.  This type of fraud poses huge costs and brand risks to the payment processor. 
• Fraudsters’ setup accounts using stolen identities which will cause 1099 income to be reported on the victims. In this case a 1099 would be generated and the consumer may not have any idea that it has occurred until they are contacted by the IRS for not reporting the income. The burden of proof will be with the taxpayer to prove their innocence to the IRS, and the burden of proof will be on the payment processor to prove to the victim they didn’t do anything wrong.  Needless to say, this is scenario likely to receive a lot of attention in the press and blogosphere that a payment processor doesn’t want to have.

Housing and Economic Recovery Act 2008

The following is an excerpt from the Housing and Economic Recovery Act 2008.  For full text and more information please click here: Housing and Economic Recovery Act 2008.

H.R. 3221-6, TITLE III-REVENUE PROVISIONS, Subtitle B-Revenue Offsets, Section 3091. “Returns relating to payments made in settlement of payment card and third party network transactions.”
SEC. 3091. RETURNS RELATING TO PAYMENTS MADE IN SETTLEMENT OF PAYMENT CARD AND THIRD PARTY NETWORK TRANSACTIONS.
(a) IN GENERAL.—Subpart B of part III of subchapter A of chapter 61 is amended by adding at the end the following new section: ‘‘SEC. 6050W. RETURNS RELATING TO PAYMENTS MADE IN SETTLEMENT OF PAYMENT CARD AND THIRD PARTY NETWORK TRANSACTIONS.
‘‘(a) IN GENERAL.—Each payment settlement entity shall make a return for each calendar year setting forth—

‘‘(1) the name, address, and TIN of each participating payee to whom one or more payments in settlement of reportable payment transactions are made, and

‘‘(2) the gross amount of the reportable payment transactions
with respect to each such participating payee. Such return shall be made at such time and in such form and manner as the Secretary may require by regulations.‘‘

(b) PAYMENT SETTLEMENT ENTITY.—For purposes of this section—

‘‘(1) IN GENERAL.—The term ‘payment settlement entity’means—

‘‘(A) in the case of a payment card transaction, the merchant acquiring entity, and‘

‘(B) in the case of a third party network transaction, the third party settlement organization.

‘‘(2) MERCHANT ACQUIRING ENTITY.—The term ‘merchant acquiring entity’ means the bank or other organization whichhas the contractual obligation to make payment to participating payees in settlement of payment card transactions.‘‘

(3) THIRD PARTY SETTLEMENT ORGANIZATION.—The term ‘third party settlement organization’ means the centralorganization which has the contractual obligation to make payment to participating payees of third party network transactions. ‘‘

(4) SPECIAL RULES RELATED TO INTERMEDIARIES.—For purposes of this section—

‘‘(A) AGGREGATED PAYEES.—In any case where reportable payment transactions of more than one participating payee are settled through an intermediary— ‘‘

(i) such intermediary shall be treated as the participating payee for purposes of determining the reporting obligations of the payment settlement entity with respect to such transactions, and H. R. 3221—256 ‘‘

(ii) such intermediary shall be treated as the payment settlement entity with respect to the settlement of such transactions with the participating payees. ‘‘

(B) ELECTRONIC PAYMENT FACILITATORS.—In any case where an electronic payment facilitator or other third party makes payments in settlement of reportable payment transactions on behalf of the payment settlement entity, the return under subsection

(a) shall be made by such electronic payment facilitator or other third party in lieu of the payment settlement entity. ‘

‘(c) REPORTABLE PAYMENT TRANSACTION.—For purposes of this section— ‘‘

(1) IN GENERAL.—The term ‘reportable payment transaction’ means any payment card transaction and any third party network transaction. ‘‘

(2) PAYMENT CARD TRANSACTION.—The term ‘payment card transaction’ means any transaction in which a payment card is accepted as payment. ‘‘

(3) THIRD PARTY NETWORK TRANSACTION.—The term ‘third party network transaction’ means any transaction which is settled through a third party payment network. ‘‘

(d) OTHER DEFINITIONS.—For purposes of this section— ‘‘

(1) PARTICIPATING PAYEE.— ‘‘

(A) IN GENERAL.—The term ‘participating payee’ means— ‘‘

(i) in the case of a payment card transaction, any person who accepts a payment card as payment, and ‘‘

(ii) in the case of a third party network transaction, any person who accepts payment from a third party settlement organization in settlement of such transaction. ‘‘

(B) EXCLUSION OF FOREIGN PERSONS.—Except as provided by the Secretary in regulations or other guidance, such term shall not include any person with a foreign address. ‘‘

(C) INCLUSION OF GOVERNMENTAL UNITS.—The term ‘person’ includes any governmental unit (and any agency or instrumentality thereof). ‘‘

(2) PAYMENT CARD.—The term ‘payment card’ means any card which is issued pursuant to an agreement or arrangement which provides for— ‘‘

(A) one or more issuers of such cards, ‘‘

(B) a network of persons unrelated to each other, and to the issuer, who agree to accept such cards as payment, and ‘‘

(C) standards and mechanisms for settling the transactions between the merchant acquiring entities and the persons who agree to accept such cards as payment. The acceptance as payment of any account number or other indicia associated with a payment card shall be treated for purposes of this section in the same manner as accepting such payment card as payment. ‘‘

(3) THIRD PARTY PAYMENT NETWORK.—The term ‘third party payment network’ means any agreement or arrangement— H. R. 3221—257 ‘‘

(A) which involves the establishment of accounts with a central organization by a substantial number of persons who— ‘‘

(i) are unrelated to such organization,‘‘

(ii) provide goods or services, and ‘‘

(iii) have agreed to settle transactions for the provision of such goods or services pursuant to such agreement or arrangement, ‘‘

(B) which provides for standards and mechanisms for settling such transactions, and ‘‘

(C) which guarantees persons providing goods or services pursuant to such agreement or arrangement that such persons will be paid for providing such goods or services. Such term shall not include any agreement or arrangement which provides for the issuance of payment cards. ‘‘

(e) EXCEPTION FOR DE MINIMIS PAYMENTS BY THIRD PARTY SETTLEMENT ORGANIZATIONS.—A third party settlement organization shall be required to report any information under subsection

(a) with respect to third party network transactions of any participating payee only if— ‘‘

(1) the amount which would otherwise be reported under subsection (a)

(2) with respect to such transactions exceeds $20,000, and ‘‘

(2) the aggregate number of such transactions exceeds 200. ‘‘

(f) STATEMENTS TO BE FURNISHED TO PERSONS WITH RESPECT TO WHOM INFORMATION IS REQUIRED.—Every person required to make a return under subsection

(a) shall furnish to each person with respect to whom such a return is required a written statement showing— ‘

‘(1) the name, address, and phone number of the information contact of the person required to make such return, and ‘‘

(2) the gross amount of the reportable payment transactions with respect to the person required to be shown on the return. The written statement required under the preceding sentence shall be furnished to the person on or before January 31 of the year following the calendar year for which the return under subsection (a) was required to be made. Such statement may be furnished electronically, and if so, the email address of the person required to make such return may be shown in lieu of the phone number. ‘‘

(g) REGULATIONS.—The Secretary may prescribe such regulations or other guidance as may be necessary or appropriate to carry out this section, including rules to prevent the reporting of the same transaction more than once.’’.

(b) PENALTY FOR FAILURE TO FILE.—

(1) RETURN.—Subparagraph (B) of section 6724(d)(1) is amended—

(A) by striking ‘‘or’’ at the end of clause (xx),

(B) by redesignating the clause (xix) that follows clause (xx) as clause (xxi),

(C) by striking ‘‘and’’ at the end of clause (xxi), as redesignated by subparagraph (B) and inserting ‘‘or’’, and

(D) by adding at the end the following: ‘‘(xxii) section 6050W (relating to returns to payments made in settlement of payment card transactions), and’’. H. R. 3221—258

(2) STATEMENT.—Paragraph (2) of section 6724(d) is amended by striking ‘‘or’’ at the end of subparagraph (BB), by striking the period at the end of the subparagraph (CC) and inserting ‘‘, or’’, and by inserting after subparagraph (CC) the following: ‘‘(DD) section 6050W(c) (relating to returns relating to payments made in settlement of payment card transactions).’’.

(c) APPLICATION OF BACKUP WITHHOLDING.—Paragraph (3) of section 3406(b) is amended by striking ‘‘or’’ at the end of subparagraph

(D), by striking the period at the end of subparagraph

(E) and inserting ‘‘, or’’, and by adding at the end the following new subparagraph: ‘‘

(F) section 6050W (relating to returns relating to payments made in settlement of payment card transactions).’’.

(d) CLERICAL AMENDMENT.—The table of sections for subpart B of part III of subchapter A of chapter 61 is amended by inserting after the item relating to section 6050V the following: ‘‘Sec. 6050W. Returns relating to payments made in settlement of payment card transactions.’’.

(e) EFFECTIVE DATE.—

(1) IN GENERAL.—Except as otherwise provided in this subsection,
the amendments made by this section shall apply to returns for calendar years beginning after December 31, 2010.

(2) APPLICATION OF BACKUP WITHHOLDING.—

(A) IN GENERAL.—The amendment made by subsection (c) shall apply to amounts paid after December 31, 2011.

(B) ELIGIBILITY FOR TIN MATCHING PROGRAM.—Solely for purposes of carrying out any TIN matching program established by the Secretary under section 3406(i) of the Internal Revenue Code of 1986— (i) the amendments made this section shall be treated as taking effect on the date of the enactment of this Act, and (ii) each person responsible for setting the standards and mechanisms referred to in section 6050W(d)(2)(C) of such Code, as added by this section, for settling transactions involving payment cards shall be treated in the same manner as a payment settlement entity.

 

 

 

 

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