Merchants, Chargebacks, and the IRS: Navigating the Complexities of False Profits
Article: Monica Eaton, Founder of Chargebacks911
Chargebacks take a toll on retailers year-round, and when tax season approaches, the IRS is ready to collect. The proliferation of friendly fraud has put merchants on defense and their profits in limbo. The best defense is a good offense; merchants need to create their own chargeback playbook.
Chargebacks and Friendly Fraud
In a quest for the quickest route from point A to point B, dissatisfied retail customers are bypassing merchants and airing their grievances with their banks to secure a refund, known as a chargeback. First-party misuse occurs when the consumer makes a legitimate charge but may not recognize it and mistakenly assumes it to be a merchant error or fraud.
And the simplicity of it all has led to the abuse of the chargeback system, with customers viewing the process as the same as requesting a refund from a merchant, along with a growing trend of consumers knowingly gaming the system, also referred to as “friendly fraud.” Merchant Fraud Journal predicts chargebacks will cost retailers over $100 billion in 2023.
While banks deposit chargebacks into their customer’s accounts almost instantly, the chargeback process to validate or invalidate the dispute can take months. Win or lose, merchants still contend with the quandary of how to report unpredictable chargebacks and their associated fees to the IRS.
Proactive Planning
Firstly, chargebacks should be treated differently than refunds. Chargebacks cannot be reported as “cost of goods sold” (COGS); however, they can be listed as “accounts receivable.” They should be logged in a separate account designated for chargebacks as funds owed to the business. If the retailer wins their dispute, the amount will be applied against that account. If they lose or elect not to challenge a chargeback, the accounts receivable balance should be written off as a “bad debt expense.”
Secondly, Chargeback fees should be considered operating expenses or bank fees; a subaccount is recommended for high-volume chargebacks.
Thirdly, retailers who receive payments through payment card processors, such as PayPal, Zelle, or Venmo, must fill out IRS Form 1099-K, which will be sent directly to the retailers from the payment networks. It is essential for merchants to note which chargebacks come from third-party networks. Payment transaction services do not account for refunds, chargebacks, or associated fees when reporting their gross monthly and annual payments. If not properly accounted for, this can lead to a higher income being reported to the IRS than was actually received.
In the 2024 tax season, the threshold to report payments and transactions from third-party payment platforms and apps will drop from $20,000 for more than 200 transactions to $600 for any number of transactions on a given platform.
Prevention Strategies
To prevent chargebacks before they happen, retailers can implement two key strategies throughout the year — collaboration and confrontation.
Collaborate with financial institutions and take advantage of the products they offer that alert retailers to a potential chargeback before it is filed. This allows merchants more time to review the transaction and take the appropriate action to avoid a chargeback.
Confront and challenge illegitimate or fraudulent chargebacks, not only to recover lost revenue, but to open up communication with issuing banks to help both sides recognize current patterns and the latest trends in friendly fraud and its abuse.
About Chargebacks911
Chargebacks911 is the global leader in chargeback management and remediation technology. As a provider or supplier to financial technology companies and financial institutions, Chargebacks911 safeguards more than 2.4 billion transactions per year on behalf of clients in 87 countries around the world. For details on Chargebacks911’s comprehensive dispute management solutions, visit https://chargebacks911.com.
