For years, the federal government has salivated over the thought of taxing Internet commerce. With a recent change in the tax laws, they may have taken one step closer to satisfying that hunger. Webmasters, affiliate program managers, payment processors, and any other businesses that generate money online should take notice of this change in the tax laws.
Beginning in 2011, a new tax statue (enacted as part of the Housing Assistance Tax Act of 2008) will require certain online businesses to file an annual report of their gross credit card and third party network transaction revenue by using the IRS Information Return called the 1099-K.
The regulations were presumably passed because the IRS believes that many online businesses fail to report all of the revenue from their transactions. According to the IRS, this new reporting regime will “help the tax system work better by ensuring that everyone pays what they owe.” The law also provides business taxpayers with revised documentation to compute and report their income and expenses.
How does this new information reporting form work? As with other IRS reporting forms, there are complex rules found in the proposed regulations, which can be viewed at www.IRS.gov.
Note that these proposed regulations have not yet been finalized as of the date of this article. Here are the two most significant aspects of the proposed rules as they pertain to a typical adult entertainment business:
- When Joe Customer buys a subscription to your site, and pays for it with a credit card, the bank that settles the transaction (i.e., that makes the payment to your business) would be considered a ‘merchant acquiring entity’ and as such, would file the new information return and report the gross amount paid to your business (in settlement of the transaction) to the IRS (unless certain exceptions and/or exemptions apply).
- If your business uses PayPal or another third-party payment processor or Internet service provider to facilitate payments from Joe Customer to you, the arrangement would be considered a third-party payment network. The processing company would be considered to be a third party settlement organization, and as such, would file the new information return and report the gross amount paid to you.
Obviously, to aid in digestion, this article simplifies these complex rules, as there are many more nuances and situations where they would apply (i.e.: debit cards, gift cards, campus cards, pre-paid telephone cards, and others), as well as exceptions and exemptions (such as the de minimis exception for certain payors and payees — where reporting exists only if aggregate payments to that payee exceed $20,000 and the aggregate number of those transactions with the payee exceeds 200) that would change the reporting obligation.
You are probably wondering if this new reporting regime applies if your payment settlement entity (i.e., merchant acquiring entity/bank or third party settlement organization) is foreign or located in another country. Unfortunately, that fact will not automatically eliminate the reporting obligations because the proposed regulations clarify that a “payment settlement entity” may be a domestic or foreign entity.
In conclusion, if, for whatever reason, the receipts from your online sales transactions were not properly reported to the IRS in the past, this new reporting regime will change that practice starting on Jan. 1, 2011. There may be situations where past U.S. tax returns will show a low amount of gross revenues and 2011 U..S tax returns (and forward) will show a higher amount of gross revenues. This may prompt the IRS to review such discrepancies and audit businesses whose tax ducks are not in a row.
The tax man’s bell has tolled somewhat softly for online businesses to date. These new regulations show a shift in priorities and make it clear that the IRS will be looking more carefully at online commerce in the future.
Jonathane Ricci and Marc Randazza are attorneys with The Randazza Legal Group, an international law firm that focuses on providing legal services to online and adult entertainment businesses, with offices in Boston, Miami, San Diego, San Francisco, and Toronto. The firm focuses on the legal issues faced by adult entertainment companies, including 1st Amendment law, Internet law, Tax Law, and Employment Law. The Randazza Legal Group can be reached at www.randazza.com. All statements made in this article are general and should not be considered to be legal advice.