Why the Tax Gap Means Hassle for Banks in 2013

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The Internal Revenue Service is focused on reducing the $450 billion tax gap. To do that, financial institutions are being asked to collect more data. This could lead to administrative hassles and customer relations headaches in 2013.

For the last 25 years, 1099 forms have been used predominantly in financial services industries to supply the IRS with a stream of information on non-payroll income. Now, regulation is being ramped up to focus on previously overlooked areas of economic income. Recent regulatory changes indicate that much of the administrative burden will fall on banks.

In light of all this, banks need to be aware of three large regulatory changes in various stages of coming into effect in 2013.

The 1099-B: Last year the 1099-B form was expanded to include cost-basis information for all share sales made after January 2011. Many bank systems struggled to collect correct data on those share trades and were forced into tricky customer service situations when trying to deliver correct 1099 forms. Many forms missed the February deadline and banks raced to get out correct information before the April income tax deadline.

For Fiscal Year 2012, the IRS is expanding the 1099-B to include cost-basis information on all mutual fund sales since January 2012. While some banks were able to put systems in place to handle reporting on stock trades, this new regulation will significantly increase the number of 1099-Bs to be filed. In fact, the IRS predicts it may collect more than 1 billion 1099-B forms in 2013, almost double what it collected in 2012.

The 1099-K: In 2011, the IRS asked for information on all merchant credit card action greater than $20,000 and 200 transactions. In its inaugural year, these forms initially carried no penalty or withholding risk. This year may be considerably more difficult as penalties and withholding requirements become effective. In 2013, the IRS will begin sending CP2100 forms (B-Notices) attached to incorrectly filed 1099-Ks. This will mean penalties and the start of a lengthy information collection process to amend any mistakes. A B-Notice is also the point at which the bank must begin withholding 28% of the customer's income.

Again, this is potentially a huge customer service issue. Online support forums for online merchants selling through the likes of eBay and Amazon are rife with confusion and anger about this new form. This anger could become even more evident if 28% of their income is withheld by their credit card processor for incorrect submission. The best thing a financial institution can do now is work with its merchant clients to get the correct 1099-K information to avoid withholding in 2013.

FATCA and the 1042-S: The most publicized and contentious tax information legislation that banks must begin to prepare for is the Foreign Account Tax Compliance Act. U.S. banks are facing increased documentation requirements for foreign accountholders that receive U.S.-source income. This information, reported on a 1042-S, will be shared with tax authorities throughout the world. In 2015, for reporting on FY2014, FATCA withholding will also be reported on the 1042-S.

While this regulation is a year away, it could lead to a significant amount of work for banks. It means examining the entire client base to determine who is a foreign national and how much income they are receiving from all sources, and then beginning to collect missing information before it is due in January 2014. Withholding on U.S income and clients is difficult enough, withholding internationally is much harder.

As 2013 progresses, banks must be considering a gold standard for 1099 information collection. It will mean collecting more tax information when a new client is signed up, and it will also require an audit of existing customer databases to find out much more in terms of business activity, investment trades and foreign transactions.

In 2013, the IRS is likely to report an uptick in the $450 billion tax gap, the amount of revenue it does not collect each year. This collection deficit may be attributed to the underreporting of income, and result in an even greater increase in tax information reporting. As fiscal crises show no sign of abating, the IRS and both federal and state governments will lean more heavily on banks' data filings to reduce the tax gap and improve government bottom lines.

Troy Thibodeau is executive vice president of Convey Compliance Systems, a provider of tax information reporting filing software and services.




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