The New IRS Reporting Rule Could Have a Silver Lining for Acquirers

The new federal regulation requiring processors and acquirers to report merchant electronic payment transactions to the Internal Revenue Service is proving to be a major challenge for the industry, but at the same time could turn into a revenue generator for acquirers, according to a researcher.

The requirements originated with the government’s concern about finding unreported or under-reported taxable business revenues. Congress passed enabling legislation, which amended the Internal Revenue Code, in July 2008. The law is designed to help the IRS match income from sales paid with payment cards to income claimed on tax returns. The U.S. Department of the Treasury estimated the law could result in the collection of an additional $10 billion over 10 years.

While all for finding unreported income, merchant-acquiring executives are recoiling at the workload and regard the law as a “necessary evil,” says Adil Moussa, an analyst at Boston-based research firm Aite Group LLC and author of a new report about the industry’s response to it.

The rules require settlement entities such as bank card merchant acquirers or payment card networks such as American Express Co. and Discover Financial Services that have direct relationships with merchants to file annual reports for each merchant listing each merchant’s monthly gross receipts from electronic payment transactions. Acquirers must list the receipts, along with the merchant’s taxpayer identification number (TIN) and legal name, on a new form, Form 1099-K.

A card-accepting business encounters problems if the TIN and legal name on file with the acquirer do not match the ones in the IRS’s files. If the mismatch can’t be resolved, it triggers back-up withholding of up to 28% of a merchant’s payment card transactions. If acquirers don’t withhold the payment amount when required, they are then held responsible for the amount. The law is effective for tax returns with calendar years that began Dec. 31, 2010, with first reports due in early 2012.

Many acquirers are critical of the way the IRS has implemented the program so far and two government reports also have cited deficiencies in how the IRS is handling it.

In its report based on interviews with 18 senior acquiring industry executives, Aite estimates the industry would spend a total of $125 million to implement the rule, or $17.80 on average for each of about 7 million U.S. card-accepting merchants.

“A lot of them are struggling to actually get their compliance level up because it’s going to obviously have a huge impact on their merchants,” Moussa says. “Nobody wants to get to the point where they have to actually withhold the 28%,” creating friction with merchants and possibly driving them to the competition.

At the same time, acquirers are looking to recoup the costs of implementing the program, and in some cases make a profit, Moussa says. Although the IRS prohibits acquirers from directly charging fees related to form 1099-K, the acquirers surveyed by Aite said they plan to introduce a fee or increase existing fees or rates to recuperate the cost, giving the fee a generic name.

While 44% of Aite’s survey group said they were undecided about how to recoup the costs, 39% said they plan to increase pre-existing fees, 33% planned to charge an IRS reporting fee, and 17% planned to charge fees to their independent sales organizations and other partners. Others planned to incorporate the cost into their overall pricing model, increase discount rates, create value-added products and charge for them, or charge non-compliance fees. Only 22% said they plan to absorb the cost of compliance.

“It’s definitely going to be a huge revenue maker for a lot of these guys,” Moussa says. “There are very few acquirers that simply are not planning to charge. They’re going to make it part of their costs one way or another.”

Aite estimates that ISOs and acquirers will make a total $420 million from implementing 1099-K regulatory compliance, with merchants paying on average $60 annually for IRS reporting. Fees would be $24 per year on the low end and potentially would go as high as $129.

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