Retailers who notice a significant discrepancy between gross sales and available revenue can often trace the issue to one specific challenge: chargebacks. Customer disputes represent a growing threat that can negatively impact reputation, cash flow, and long-term sustainability.
To counter this, customer service, legal departments, and others work throughout the year to mitigate chargeback claims. But when it comes to reporting chargebacks — and the associated fees and other losses — to the Internal Revenue Service, the responsibility typically falls directly on the accounting department. The process can be confusing, to say the least.
Chargebacks — forced payment reversals conducted at the bank level — were created as a consumer protection mechanism. They enable cardholders to obtain refunds in the event of fraud or merchant error.
Unfortunately, the chargeback cycle can be a long, drawn-out process: cardholders typically have 120 days from the transaction date (or order completion, in some cases) to initiate a chargeback. Merchants then have a window of time to respond, either accepting or challenging the claim. The bank also needs time to examine evidence before judging the case.
All told, this process can take months. That potentially means it could be June before a merchant resolves a chargeback on a purchase made during the previous holiday season, when overzealous holiday gifting can result in an unexpected wave of chargebacks. Even if the settlement period is shorter, retailers still find themselves losing fourth quarter sales for months afterwards.
If all this wasn't bad enough, chargeback challenges are exacerbated by customer misuse. Either intentionally or by accident, a growing number of cardholders are committing first-party fraud by filing invalid or unwarranted disputes.
This ultimately creates a nightmare for accountants, who must keep altering records they thought were closed. And holiday chargebacks are the worst, since the resolution of any of last year's transactions can extend beyond the tax filing deadline. That requires more than just bookkeeping updates: multiple adjustments to tax statements may also have to be filed with the IRS.
5 chargeback tax tips
Accurate reporting and recordkeeping is the best way to minimize chargeback losses. Here are five tips to help accountants navigate chargebacks and maintain IRS compliance:
1. Distinguish chargebacks from refunds. Chargebacks are not the same as refunds; when it comes to tax returns, the two should be reported differently.
While it may seem to fall under "cost of goods sold," fraudulent or illegitimate chargebacks should actually be logged as "accounts receivable." Try creating a separate account for funds owed to the business, which will eventually transfer into your main account.
2. "Accounts receivable" versus "bad debt." Merchants have the right to contest invalid chargebacks through representment. If they win a reversal, the funds should be applied to the amount previously earmarked as "accounts receivable."
If the merchant loses the claim or decides not to challenge it, the accounts receivable balance should be written off as a "bad debt expense."
3. Chargeback fees are expenses. Chargeback fees are incurred even if a case is reversed, so accountants should treat them as operating expenses or bank fees. Retailers with a high volume of disputes may want to create a separate "chargeback fees" sub-account to simplify reporting and analysis.
4. Leverage tax forms in third-party platforms. Third-party platforms like PayPal, Zelle or Venmo are required to
These forms come directly from the payment platform, but they typically don't incorporate refunds, chargebacks or associated fees. Carefully log chargebacks from each third-party platform separately to prevent over-reporting income to the IRS.
5. Get ready for next year. At the start of the year,
In simple terms, this means that for the 2024 tax season, merchants will need to report any income exceeding $600 received through apps like Venmo or Cash App. That change will significantly impact IRS reporting next year, so merchants are advised to update their bookkeeping procedures now to avoid confusion.
Two keys to chargeback reduction
Obviously, merchants must make accurate tax reports to the IRS, but that can be a complex process — particularly when it comes to chargebacks. That makes it essential to adopt best practices for preventing IRS penalties and other losses.
The tips outlined above are specifically designed to help accountants get through tax season. At the same time, reducing chargebacks throughout the year can be aided by implementing two key strategies: collaboration and confrontation.
Retailers can collaborate with financial institutions by leveraging tools for proactive notification of potential chargebacks. This enables sellers to review disputed transactions and, if necessary, offer refunds instead of incurring chargebacks. Available products include
While collaboration is a critical component of any long-term solution, it's also important to confront chargeback abuse by cardholders. Simply put, retailers must develop a reputation for challenging any chargeback they perceive as potentially fraudulent or illegitimate.
Doing so not only
Complacency is not an option here. As the tax landscape continues to evolve, keeping informed and adapting to new regulations remains a crucial element for merchants wishing to maintain compliance and achieve long-term success.
