Online merchants face many challenges running their business, and taxes and cash flow are top concerns. A new law will require payment card processors and third-party settlement organizations to report eBay sellers' and online merchants' transactions to the IRS beginning in 2011. Sellers have had many questions about the new law and have also wondered about certain PayPal practices around credit checks and holding payments. We checked in with PayPal and with an attorney in the payments field to learn more about these issues.
Reporting Payment Transactions to the IRS
The United States Congress passed the Housing and Economic Recovery Act of 2008 last summer. Included was a provision that requires payment processors and third-party settlement organizations to report gross transactions of payees to the IRS (Internal Revenue Service). At the time, PayPal said the new law would require it to report to the IRS the total payment volume received by PayPal customers in the U.S. who receive more than $20,000 in payment volume in a single year and receive more than 200 payments in a single year. The new reporting requirement takes effect in 2011.
PayPal spokesperson Michael Oldenburg said last week there was nothing new to report on the new legislation. "We are also anticipating further IRS guidance, plus, we're several years away from the law's actual implementation."
Zahara Alarakhia, an attorney at Munck Carter who works with financial services firms, has been following the new legislation and what it means to processors. "We're expecting regulations to be drafted by the IRS - the taxing authorities - to provide some guidance," Zahara said, "but right now, all we have is a little blurb as part of the housing and rescue bill that states it is now law that they need to do this. But who's going to enforce it, what kind of compliance issues are payment processors going to face - no one really knows."
Zahara confirmed that the law applies to merchants who make over $20,000 in gross transactions and more than 200 transactions. So, for example, an online seller who makes two transactions for a total of $30,000 in the tax year would not be reported, since the number of transactions did not exceed 200. She said the law is not retroactive and takes effect for tax-year 2011.
The law does not differentiate between online and offline merchants, according to Zahara. What about retailers who only take checks and money orders? The legislation does not apply to cash or money orders, but may affect checks because of ACH. If the bank keeps the processing in-house, they would have to disclose check transactions. "Most banks outsource the processing function to a payment processor, but not always. If your bank is actually one of those that don't, then yes, they'll be reporting that."
Zahara said it's going to take a lot of upgrading on the technology end for settlement agencies to comply with the reporting requirements, and it also raises privacy and regulatory issues. The IRS does not really understand the merchant acquiring business, she said, and what Congress has required under the law raises substantial issues in the marketplace, such as security issues regarding keeping track of social security and tax identification numbers that might conflict with other laws. "The process would have to tie all of the transactions of the merchant to the tax identification number and store those on their systems, which would increase potential hacking issues and privacy issues."
The cost of compliance is high, and she believes the costs will ultimately be passed on to consumers. She also believes the new reporting requirements will result in an increase in the number of audits by the IRS, increasing costs for both merchants and the tax agency itself.
Another issue stems from legitimate discrepancies between what merchants may claim on their taxes and what processors will report to the IRS."I can give you tons of examples that are going to skew the numbers between the settlement entity and the merchant. How the IRS is going to close that loop, I'm not quite sure." During an audit, a merchant can show the IRS the reason for discrepancies, but Zahara said preparing for an audit takes merchants time, money and resources. Zahara is hoping the IRS will come out with regulations by the summer.
PayPal Credit Checks and eBay's 21-Day Hold Policy
PayPal may hold a seller's funds as part of eBay's 21-day hold policy - usually affecting fewer than 5% of transactions, according to PayPal Director Monroe Labouisse. In an interview with eBay blogger Richard Brewer-Hay last week, Monroe said, "In a very small percentage of cases, eBay asks PayPal to hold a payment in a seller's PayPal account for up to 21 days. eBay asks PayPal to do this for a buyer's protection when eBay believes the transaction is significantly more likely than the average transaction to be fraudulent or to wind up in a dispute between the buyer and the seller. For example, a relatively new eBay seller who is selling an expensive electronics item may be flagged for an eBay item hold."
Monroe said eBay item holds are part of eBay's overall efforts to bring more buyers back to eBay, which ultimately will drive more sales for sellers.
PayPal also conducts credit checks on sellers in certain cases to manage any possible risk of loss from a seller's transactions. The review might result in PayPal imposing a rolling reserve. "If the seller's credit score is not as high as we'd like (and the score we look for depends on the industry the seller operates in), or if we determine there are other factors that may increase the risk of claims or chargebacks, we will ask for the seller to deposit a reserve in their account," Monroe said in the blog interview. "The reserve will be a certain % of the seller's past volume over a certain period of time." These rolling reserves differ from the 21-day holds.
PayPal spokesperson Michael Oldenburg told AuctionBytes, "In most instances, credit inquires are for authentication purposes only and will not impact customers' credit scores. In those instances where there is an increased level of risk (for example, high processing volumes similar to a traditional merchant or business account), then we may do more in-depth credit inquiries that could potentially impact the customer's credit score."
Oldenburg also said that PayPal does not restrict accounts as a result of credit checks. "As you may know, accounts are generally restricted when we suspect fraudulent activity. We do this to protect both buyers and sellers against fraud."
We asked attorney Zahara Alarakhia about PayPal's practice of running credit checks and its 21-day hold policy. "As long as it's in PayPal's terms and conditions, can they do it? Yes." It's not uncommon for a payment processor to require a background check on the merchant business and its principals, she said. Banks typically put holds on checks in certain circumstances - though not as long as 21 days, Zahara said.
"Right now, PayPal has been fortunate enough to escape all kinds of regulation. They're not under the purview of a bank, so they can escape banking regulations" and KYC (Know Your Customer) standards. She believes PayPal is trying to enforce these laws to curb possible regulation that might be coming down the line that fight money-laundering and anti-terrorism activities.
"This new legislation (Housing and Economic Recovery Act of 2008) is the first time that PayPal will actually be hit with legislation - any sort of legislation." She said that while nothing is on the radar screen, she thinks eventually there will be some regulation regarding third-party settlement organizations.
Update 1/20/09: PayPal supplied AuctionBytes with details about regulations with which it complies, see details on the AuctionBytes Blog
Links
PayPal blog post ("Proposed IRS Reporting Requirements Become Law," August 5, 2008)
AuctionBytes Blog post ("PayPal to Report eBay and Merchant Payments to IRS," August 7, 2008)
eBay Ink blog post ("eBay Item Holds Explained," January 16, 2009)
Fulltext of the Housing and Economic Recovery Act of 2008 (PDF format)
Comment on the AuctionBytes Blog
