Remember those pesky 1099-K forms you received earlier this year? Well, even though IRS gave up on “matching” the income reported on those forms into your business or personal tax returns, they have undertaken something much worse: a fishing expedition with your name on the bait.
IRS is now sending out four different types of 1099-K notices called “Letters”:
Letter 5035 – a letter hinting that you “may have” underreported your income with no response required. A shot across the bow.
Letter 5036 – a letter that does more than hint that you have underreported your income – it provides dollar amounts showing that an unusually high percent of your income came from credit cards and 3rd party payers, and demanding a written response in 30 days explaining why you should not file an amended return and which describes your internal controls and cash receipts procedures and other reasons why a high percentage of total gross receipts comes from credit card transactions.
Letter 5039 – a letter which makes the same assertions as Letter 5036 and requires the taxpayer to complete Form 14420 within 30 days to explain why your income reflects an unusually high percentage of credit card and other 3rd party transactions reported on 1099-K.
Letter 5043 – a letter which alleges that compared to others in your industry, you have underreported your income, citing specific percentages and dollar amounts, and demanding a written response within 30 days explaining why you should not file an amended return and which describes your internal controls and cash receipts procedures and other reasons why a high percentage of total gross receipts comes from credit card transactions.
The response-required letters go to the Tax Examiner section of the IRS, so that should give you a clue that if your response is unsatisfactory it is highly likely that an audit will be initiated.
I have a number of concerns about these notices, but my primary one has to do with the fact that the taxpayer is not being notified of an audit. These 1099-K Letters are an end run around IRS’ obligations to properly inform taxpayers of their rights and duties during an examination, which includes the right to representation. Taxpayers may blithely respond, or perhaps even ignore these notices without realizing the implications.
Secondly, IRS makes bald-faced assertions in Letter 5043 which allege specific amounts of unreported income, using statistics which are not cited, and which are supposedly based on the industry code used on the tax return. As we know, these codes are very broad and somewhat outdated, so that your business may be nothing at all like another business using the same catch-all code. And, where do their statistics come from? Are they 10 years old or 1 year old? Knowing how understaffed IRS is, I am going to guess that the statistics used are not recent.
Finally, the whole idea of 1099-K reporting was to tap the underground economy. That is a very good goal and one that I fully support. Unfortunately, these 1099-K letters do no such thing. Instead of matching 1099-K’s into tax returns, the IRS is going after legitimate businesses whose cash receipts model may not fit their idea of the norm. This approach will have no impact whatsoever on the multitude of eBay sellers, construction contractors, and others who make up a chunk of the underground economy in the U.S. We need IRS to go back to the drawing board to re-think the 1099-K matching process and come up with a solution that meets the public policy objective from which this requirement originated.