False Profits: The Chargeback Lessons Learned by Businesses This Tax Season

Throughout the year, many merchants and their accounting, customer service and legal departments work to prevent and mitigate unnecessary chargebacks from negatively impacting their business and its bottom line. While chargebacks from 2022 may be in the rearview mirror for merchants, how to best report chargebacks and their associated fees to the Internal Revenue Service (IRS) can often be an area of contention, especially starting off the new year. Monica Eaton, founder of the global transaction dispute company Chargebacks911, is informing retailers and their accountants of the best method to report their chargebacks to the IRS, as well as preventative measures merchant’s can take for next year’s tax season.

For transactions made in 2022, the chargeback process can carry on months after the tax filing deadline, potentially leading merchants to report more revenue than they actually received should they lose or choose not to fight some chargeback cases. Cardholders generally have 120 days after the transaction or order delivery to file a chargeback. Once filed, merchants must compile and present their evidence to the issuing bank typically within 30 days or less. If the bank rules in favor of the merchant, the cardholder can even file a second chargeback if there is new evidence to consider.

This means that if you’re a merchant dealing with a chargeback filed for a purchase made during the 2022 holiday shopping season, it could be early June before the issuing bank notifies you that you’ve lost that chargeback case.

“End-of-year purchases can cause new-year headaches for many merchants. While many businesses do everything in their power to prevent transaction disputes, many chargebacks—oftentimes fraudulent or invalid—make their way to the retailer,” said Eaton, whose company Chargebacks911 was the first in the world to specialize in chargeback management. “It’s important to know how to report chargebacks to the IRS to keep your company’s books accurate, as well as best practices to prevent these chargebacks from being filed in the first place.”

Firstly, Eaton says the most important thing for retailers to know is that chargebacks are not the same as refunds, and should not be treated as such when reporting them to the IRS. While fraudulent or illegitimate chargebacks cannot be reported as “cost of goods sold” (COGS) on tax returns, they can be logged as “accounts receivable.” Eaton says merchants should do this in a separate account designated for funds owed to the business, which will eventually move into the retailer’s main account.

If you contest an invalid chargeback and win in representment, the transaction amount would be applied against your accounts receivable that were set up specifically for chargebacks. If a business loses its chargeback representment, or chooses not to challenge a chargeback in the first place, the accounts receivable balance should be written off as a “bad debt expense.”

Secondly, because a merchant will incur chargeback fees whether they win or lose their case, these fees should be treated as operating expenses or bank fees. If a retailer is dealing with a high volume of chargebacks, it may be best to allocate chargeback fees to a separate sub-account to make reporting and analysis easier and more organized.

Thirdly, while all businesses are required to file an annual income tax return, retailers who receive payments through payment card processors or third-party networks like PayPal, Zelle and Venmo are required to fill out an IRS Form 1099-K. This form will be sent directly to merchants from the payment network themselves, and is used to report payments and transactions from online platforms and apps that exceed $20,000 on more than 200 transactions, just like merchant acquirers.

Eaton warns that while payment transaction services report gross monthly and annual payments made through their platform, they do not account for refunds, chargebacks or any associated fees, so it’s important to make note of which chargebacks come from which third-party network. If not accounted for properly, this can lead to a higher income being reported to the IRS than was actually received.

The IRS recently announced that for income earned in 2023, the de minimis rule for third-party settlement entities will see the threshold for reporting payments from third-party networks reduced from $20,000 for more than 200 transactions to $600 for any number of transactions on a given platform.

This means that in 2024’s tax season, merchants who receive more than $600 through an app like Venmo or CashApp will need to report that income on their tax return. This is expected to have a significant impact on the amount of income that will need to be reported to the IRS not just by businesses, but all taxpayers in general.

Lastly, Eaton notes that while these are best practices for filing tax returns, there are two critical strategies that merchants can deploy throughout the year to help reduce the number of chargebacks levied against their business: collaboration and confrontation.

“Retailers can collaborate with financial institutions by using products offered by card networks that alert merchants to a potential chargeback before it’s ever filed, allowing them to review the transaction and, if necessary, offer a refund rather than incur a chargeback. These products include Order Insights, Chargeback Dispute Resolution Network and Rapid Dispute Resolution (RDR), both offered by Visa Verifi, as well as Ethoca, Collaboration and Consumer Clarity from Mastercard,” explains Eaton. “Merchants also need to confront and challenge any chargeback they see as possibly fraudulent or illegitimate. Not only does this recover revenue lost in the chargeback process, but it shares valuable information with issuing banks to help both sides see emerging trends when it comes to friendly fraud and misuse.”

For more information on chargebacks and different management solutions available to retailers, visit https://chargebacks911.com.

ENDS

About Chargebacks911

Chargebacks911^® drives profitability for online merchants by decreasing payment disputes and recovering revenue lost to chargeback fraud. Through a proprietary suite of software and service offerings, the company delivers transparent, end-to-end chargeback management solutions backed by the industry’s only performance-based ROI guarantee.

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