This is the first year that the IRS requires payments made with a credit or debit card to be reported by merchants who processed more than $20,000 and 200 transactions.

The program, initiated by the Housing and Economic Recovery Act of 2008, aims to generate $10 billion in revenue over 10 years, although estimates have varied widely. The goal is to assist the IRS in matching income from sales to income reported on tax returns. The law requires backup withholding, in the case of merchants who do not provide a valid Taxpayer Identification Number and name that match IRS records.

There was initial consternation in the potential taxpayer burden caused by the fact that gross transactions are being reported while most small businesses just report net sales on their tax returns. To partly address the problem, the IRS instructs taxpayers to “enter -0- on line 1(a)” of Schedule C.

Some have interpreted this as a “kick the can down the road” measure, but that’s not the case, according to Steven Aldrich, chief executive of Outright.com, the online accounting software.

“There’s been a lot of chatter on message boards and tax prep blogs saying, ‘The IRS gave us another year not to have to report our online sales or merchant payment sales,’” he said. “But that’s not the case.”

“Form 1099-K is still being sent to both the taxpayers and the IRS,” he noted. “The instructions are pretty clear: anyone who has a merchant account will get a 1099-K. For 2011, the IRS has deferred the requirement to report these amounts, so they tell you to enter zero on line 1a. But they also say to report all gross receipts on line 1b, including any income reported on Form 1099-K.”

“Don’t ignore the requirement,” advised Aldrich. “The rumor that you don’t need to report the income this year is simply not true. It still needs to be reported as part of your gross income. Rebates, refunds, cash backs, and other adjustments can be entered on line 2.”

The IRS was making a nod toward people trying to figure out how much time they should spend only on getting the Form 1099-K number perfect, Aldrich suggested. “It lessens the stress levels because there’s an implicit understanding that the small business owners would have to reconcile their internal records with the tax form. By not making it explicit, the IRS tried to lessen those burdens on small business owners, but since it is income it still needs to show up on the Schedule C in the way you think it should best be represented.”

The challenge for small businesses comes when they take electronic payments as revenue in, but give cash or non-electronic value back to the consumer; for example, cash-back payments on a credit or debit card or refunds. 

“This needs to be tracked locally, with the adjustments made on line 2,” Aldrich said. “The result is that even though you’re not required to report anything on line 1a, the IRS expects you to report all receipts. There’s now a level of visibility available to the IRS that wasn’t there before.”

Aldrich recommends that Form 1099-K be tailored to resemble Form W-2 in the way it organizes and presents information. “Gross sales as reported on the Form 1099-K doesn’t have transparency on the form itself,” he said. “The small business owner doesn’t know how the figure was generated, and can’t verify that the number matches what was received during the year. Going forward, it would simplify matters for the small business if the form shows all the components of gross receipts.”