The Internal Revenue Service is hoping to keep merchants honest by checking up on their transaction volume. That’s fine, but the fallout is affecting independent sales organizations, their acquirer partners and their merchant clients

The 1099-K IRS reporting changes that went into effect Jan. 31 were instituted as a response to the 2008 Housing and Economic Recovery Act’s provision for more accurate reporting of electronic transactions.

As of the end of January, ISOs and acquirers are legally required to report merchants’ gross card receipts.

The authorities granted merchants a year’s relief to reconcile their gross receipts with net income entered on their tax returns.

However, they did not ease the requirement for ISOs.

Some ISOs will pay $48 per year, per merchant, according to Boston-based Aite Group’s research, to ensure tax identification numbers sync with merchant accounts, and gross receipts minus fees, fraudulent transactions, refunds made in cash and other charge-backs match net income.

For the past 18 months, ISOs and merchant processors spent big money on technology to comply with 1099-K reporting requirements, says Mary Bennett, director of government and industry relations at the Electronic Transactions Association. As a result, many changed the services they provide merchants, adding consulting and call centers to help answer merchant questions and ensure accuracy in merchant account records and reporting, she says.

“Ultimately, 1099 is a prime opportunity for ISOs to solidify merchant-ISO relations and make tax filings easy, simple and clear,” Bennett notes. “For 1099 reporting, the ultimate unintentional consequence is a small merchant being put out of business because they don’t have a valid” tax ID number.

This will cause some small merchants to stop accepting payment cards, contends Eric Grover, principal at Carson Valley, Nev.-based Intrepid Ventures, a payments consultancy. “It is a powerful tool. Every small merchant doesn’t pay 100% of taxes” today, he says.

Starting in 2013, ISOs will assess a required daily withholding of 28% on merchants with incorrect or missing tax ID numbers.

This is “a royal headache for ISOs,” says Grover, “They’ll get merchants calling up and saying, ‘Is this right?’ It is going to cause work and fines for ISOs.”

ISOs are not supposed to charge merchants for IRS reporting, he says, but they may recoup their spending on technology upgrades or implementations and 1099 error resolution through fee-based consulting.

The advisory relationship that can grow between merchants and ISOs as a result is not all about an economic upside for ISOs, though.

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