Tax Season & Chargeback AccountingKey Practices to Optimize Chargeback Reporting for Tax Purposes

April 13, 2023 | 6 min read

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Tax Season Chargebacks

In a Nutshell

Do you know how to report chargebacks, and the resulting revenue losses and fees, to the Internal Revenue Service (IRS)? In this article, we'll explain a few key points to keep in mind to ensure that you're not overreporting income and paying taxes for revenue that doesn't actually exist.

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

Your customer service staff, as well as your accounting and legal departments, should be working to insulate you against the financial impact of chargebacks throughout the year. However, there’s one specific period — tax season — in which chargebacks take on a new dimension.

It’s true that chargebacks filed against your business in 2022 are in the rearview mirror. What you may not know, however, is the best way to report losses and the resulting fees to the Internal Revenue Service (IRS).

This can often be an area of contention, especially as the deadline for tax filing approaches. In this post, we’re going to help you and your accountants find the best method to report chargebacks to the IRS. We’ll also look at some preventative measures that you can take to eliminate this problem next year.

The Chargeback Cycle is a Long, Drawn-Out Process

Chargebacks are most commonly issued between 45-60 days after an initial transaction. Then, the chargeback process itself can carry on for several weeks — or even months — after the initial dispute is filed.

Cardholders generally have 120 days after the transaction (or order fulfillment, depending on the reason code) to file a chargeback. Once filed, you must respond and either accept the chargeback, or compile and present your evidence to the issuing bank, typically within 30 days. The bank will then make a ruling in the dispute.

Of course, if the bank rules in your favor, the cardholder may still be able to escalate to arbitration. They may even be able to file a second chargeback if there is new evidence to consider.

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In other words: if you’re dealing with a chargeback filed for in response to a purchase made during the 2022 holiday season, it could be early June before the issuing bank notifies you that you’ve ultimately lost that money. And, if the chargeback process for transactions made in 2022 carries on after the tax filing deadline, this could lead to a situation in which you end up reporting more revenue than you actually received.

“End-of-year purchases can cause new year's headaches for many merchants,” explains Chargebacks911® Founder Monica Eaton. “While businesses do everything in their power to prevent transaction disputes, many chargebacks — oftentimes fraudulent or invalid — make their way to the retailer. 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.”

Four Key Points for Chargeback Tax Accounting

Looking at chargebacks from a tax accounting perspective, there are four critically important points to keep in mind:

Chargebacks are NOT Refunds

First, you need to know that chargebacks are not the same as refunds, and should not be treated as such when reporting them to the IRS.

While fraudulent or otherwise illegitimate chargebacks cannot be reported as “cost of goods sold” (COGS) on tax returns, they can be logged as “accounts receivable.” You should do this in a separate account designated for funds owed to the business, which will eventually move into your 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 you lose a case, or choose not to challenge a chargeback in the first place, then the accounts receivable balance should be written off as a “bad debt expense.”

Treat Fees as Expenses

Second, because you will incur chargeback fees regardless whether you win or lose the case, these fees should be treated as operating expenses or bank fees.

If you’re dealing with a high volume of chargebacks, it may be best to allocate chargeback fees to a separate sub-account. This will make reporting and analysis an easier and more organized process.

Know Your Forms

Thirdly, all businesses are required to file an annual income tax return. However, if you receive payments through third-party platforms like PayPal, Zelle, or Venmo, you’re required to fill out an IRS Form 1099-K as part of this process.

Your Form 1099-K will be sent directly to you from the payment platform in question. This form 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 (for now; more on this later).

Payment transaction services report gross monthly and annual payments made through their platform. They do not account for refunds, chargebacks, or any associated fees, though. 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.

Look Ahead to Next Year

Finally, as the IRS recently announced, remember that the de minimis rule for third-party settlement entities will apply to any income earned in 2023. This means the threshold for reporting payments from third-party networks has been reduced from $20,000 and more than 200 transactions, down to $600 for any number of transactions on a given platform.

This means that, in 2024’s tax season, you will need to report any income in excess of $600 earned through an app like Venmo or CashApp. 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.

If you’re using any of these platforms, and you’re not already accounting for this change, you’ll need to act quickly, so as to avoid a lot of confusion next spring.

Collaborate First, but Fight When Necessary

The points outlined above are best practices for filing tax returns. However, there are two critical strategies that you can deploy throughout the year to help reduce the number of chargebacks levied against your business: collaboration and confrontation.

“Retailers can collaborate with financial institutions by using products offered by card schemes that alert merchants to a potential chargeback before it’s ever filed,” Monica elaborates. “This allows them to review the transaction and, if necessary, offer a refund rather than incur a chargeback. These products include both Order Insights and Rapid Dispute Resolution for Visa transactions, as well as Ethoca Alerts, to name just a few.”

Collaboration between merchants and financial institutions will be a vital component of any long-term solution for chargebacks. In the meantime, though, you need to take a hard line against chargeback abuse in order to protect your revenue.

“Merchants also need to confront and challenge any chargeback they see as possibly fraudulent or illegitimate,” Monica continues. “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.”

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