A webinar sponsored by the Electronic Transactions Association and conducted by representatives of the IRS outlined the requirements of banks and processors when they receive notice of levies for the collection of funds the IRS believes merchants owe to the federal government.
The IRS said it has the authority to attach levies to processors' reserve accounts as part of that collection process.
During the webinar's question and answer period, several call-in participants voiced concern about the potential damage caused to processors if they are forced to remit proceeds from those reserve accounts, which are set up to safeguard processors when problems with merchants arise, such as chargeback issues or fines levied upon merchants by Visa Inc. and MasterCard Worldwide.
One caller who represented a small ISO said the ISO underwrites 100 percent of its merchant accounts and therefore takes on 100 percent of the liability and risk from those accounts.
To minimize its exposure to losses if merchants encounter financial difficulties, the ISO holds back merchant funds in reserve accounts that can be tapped in case of precipitous revenue shortfalls, the caller said.
According to the caller, the money from reserve accounts can then be used by the ISO to fulfill its financial obligations to the card brands, but if reserve account money is seized as a way to pay off a merchant's debt to the IRS, the ISO itself is going to experience "a huge loss." The caller added, "So if you're saying that you guys can just come in and take our reserves for our liability, we could go out of business."
Payment attorney Paul Rianda agrees that attaching levies to reserve accounts could be devastating for processors. "You've got a processor that's determined that they're willing to take on risk given that they're holding these funds, and the IRS can swoop in and basically completely skew their risk analysis by taking that money," he said.
Rianda said reserve accounts can be funded by a merchant upfront, as a condition that must be fulfilled before the processor agrees to process the merchant's card payments; or the account can be built up over time, with a processor adding to the reserve by transferring a small percentage of ongoing card payments to the account.
If the IRS takes the reserve account money, the processor is then "left in a situation where they're going to try and get that money again out of the merchant," Rianda said. "And the merchant may not be immediately able to replenish that reserve.
"And it puts you [the processor] in a situation where now you've got to start collecting money from that merchant out of their processing revenue and not put them out of business at the same time."
Frederick Schindler, SB/SE Collection Policy Director at the IRS and webinar presenter, said the IRS' ability to attach reserve accounts to levies is contained in section 6332, subsection a, of the Internal Revenue Code.
Paraphrasing the language: all of a merchant's "property" (monetary funds) is subject to a levy, even if that property is in the possession of a processor via a reserve account.
Schindler said the funds in a reserve account are "the property of the taxpayer [merchant], but they don't have complete control over it."
But payment attorney Theodore Monroe said funds in a given merchant account are not always legally considered the property of that merchant. "Reserve accounts are governed by the contracts between the ISO, the bank and the merchant," he said. "In a properly written contract, the reserve does not become the merchant's property until all contingencies are finalized.
"For instance ... until all chargebacks have run their course - all possible Visa fines, etc. Until then it's not the merchant's property; title doesn't pass. A lot of contracts aren't written that way. And it's a major deficiency in those contracts."
Monroe recognizes that the IRS and other government agencies have an opposing viewpoint. "I've seen this with the Federal Trade Commission," he said. "And in context with lawsuits with the FTC, they've taken a different view. This issue is an open issue, and I've not yet seen it definitively decided by a court."
Rianda said that to protect themselves from levies attached to reserve accounts, processors should investigate the financial soundness of the merchants in their portfolios - especially the larger merchants since the larger the processing volume from a given merchant, the greater chance of trouble for the processor if the IRS issues a levy.
According to Rianda, investigations should include searching public records to discover if merchants have had levies issued against them.
"The fact that people owe money to the IRS is usually something that you could find out," he said. "So it would probably be something you'd want to do ... during the initial underwriting and, as time goes on, continue to monitor to see if any levies are coming up so you can either scale back processing with the merchant or shut them down entirely if it seems prudent to do that."
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