The Internal Revenue Service has provided special transitional relief to banks and other payment settlement entities required under a 2008 law to begin withholding 28 percent of payments if they are unable to verify a taxpayer identification number for a retailer.

Payment processors are supposed to begin reporting payment card and third-party network transactions to the IRS on a new information form known as the Form 1099-K and withhold 28 percent of the money from retailers and others for whom a taxpayer identification number could not be verified, starting next year. However, under transitional relief granted by the IRS last week, they will not need to begin the withholding until 2013.

According to the Housing Assistance Tax Act of 2008, payment-processing companies that handle credit and debit card transactions were scheduled to begin reporting in early 2012 payment card and third-party network transactions that occurred in 2011. The law added Section 6050W to the Tax Code for reporting of payment card and third party network transactions, in order to increase transparency in relation to electronic payments and transfers. It was expected to raise $9.5 billion in extra revenue over 10 years.

Under the law, payment processors were supposed to withhold 28 percent of the payments they made to retailers and other entities for which they lacked verified taxpayer identification numbers.

However, in Notice 2011-88, the IRS postponed for one year the effective date for potential backup withholding obligations for payments made in settlement of payment card and third party network transactions. All payments made in settlement of payment card transactions are required to be reported under Section 6050W of the Tax Code. Payments made in settlement of third party network transactions, however, are required to be reported only if the amount paid exceeds $20,000 and the aggregate number of transactions exceeds 200 with respect to any payee within a calendar year.

“Requests to postpone the effective date for backup withholding on Section 6050W payments have been made by a number of payors,” said the IRS. “Among the reasons cited in support of this postponement include the payors’ unfamiliarity with procedures for backup withholding because of no prior withholding obligations, the need for additional time to develop systems to enable withholding, unfamiliarity with the IRS’ TIN matching program and general difficulties in matching TINs already obtained with the correct taxpayers. After careful consideration of these comments, Treasury and the IRS are postponing the effective date for the application of backup withholding on Section 6050W payments for an additional year from the current effective date. Thus, backup withholding will be required on section 6050W payments made after Dec. 31, 2012.”

In addition, in Notice 2011-89 the IRS provided transitional relief from penalties for a Section 6050W filer reporting incorrect information on information returns (Form 1099-K) and payee statements filed under Section 6050W of the Tax Code. As long as the filer makes a "good faith effort to accurately file the appropriate information return and the accompanying payee statement," the company will not be subject to penalty for the information returns and payee statements filed in 2012 based on payments made in calendar yeat 2011, according to the IRS.

However, Convey, a provider of tax information reporting services and software, advised companies Monday not to interpret the IRS’s transitional relief for Form 1099-K reporting as a vacation from, or repeal of, the new tax law.

The 2008 law and its side effects, such as more frequent requests for tax information forms, led to confusion amongst merchant banks and acquirers as well as merchants themselves, Convey noted. As a result of pleas from several trade associations representing both merchants and acquirers, the IRS announced plans not to assess penalties to those who make good faith efforts in 2012, the first year of the reporting process.

“The new IRS transitional relief is a reasonable step to ease into a big change for the payment industry,” said Convey executive vice president Troy Thibodeau in a statement. “Businesses who treat this opportunity as a tax reporting holiday—or think that this is signaling 1099-K reporting being repealed—will risk penalties.”

More than just immediate penalties, how businesses handle the transition in the long run will determine if they are recognized as a purveyor of best practices or a cautionary tale. Those who efficiently manage the process will create competitive advantages such as not having to pass along related costs to their customers.

“This is as if the payment industry was at the starting line of a marathon that was delayed,” said Thibodeau. “The elite competitors will continue training and, once the race starts, will blow by contenders on the way to their prize.”

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