The Government Accountability Office has produced a report looking at the tax compliance benefits and costs of 1099-MISC information reporting, which has been expanded under the health care reform bill.
The report was produced in conjunction with hearings by the Senate Committee on Small Business and Entrepreneurship on Thursday on the subject of regulatory and administrative burdens on small businesses.
Third parties, often businesses, reported more than $6 trillion in miscellaneous income payments to the Internal Revenue Service in tax year 2006 on Form 1099-MISC. Payees are to report this income on their tax returns. It has been long known that if these payments are not reported on 1099-MISCs, it is less likely that they will be reported on payee tax returns, the GAO noted. In 2010, the reporting requirements were expanded to cover payments for goods and payments to corporations, both previously exempt, beginning in 2012.
The report noted that information reporting may sometimes reduce taxpayers’ costs of preparing their tax returns, although by how much is not known. The IRS has estimated that $68 billion of the annual $345 billion gross tax gap for 2001, the most current available estimate, was caused by sole proprietors underreporting their net business income. A key reason for this noncompliance was that sole proprietors were not subject to tax withholding and only a portion of their net business income was reported to IRS by third parties.
The benefits from information reporting are affected by payers’ compliance with reporting requirements and the IRS’s ability to use the information in its process that matches third-party data with tax returns. However, the IRS does not have estimates of the number or characteristics of payers that fail to submit 1099-MISCs as required. To improve its use of 1099-MISC information, the IRS has collected data to help identify ways to refine its matching process and select the most productive cases for review, as GAO recommended in 2009.
Current 1099-MISC requirements impose costs on the third parties required to file them. The magnitude of these costs is not easily estimated because payers generally do not track these costs separate from other accounting costs. In nongeneralizable case studies conducted in 2007 with four payers and five vendors that file information returns on behalf of their clients, the GAO was told that existing information return costs were relatively low.
One small business employing under five people told the GAO of possibly spending three to five hours per year filing Form 1099 information returns manually, using an accounting package to gather the information. Two vendors reported prices for preparing and filing Forms 1099 of about $10 per form for five forms to about $2 per form for 100 forms, with one charging about $0.80 per form for 100,000 forms. However, these prices did not include clients’ recordkeeping costs.
Payers face a variety of impediments preparing and submitting 1099-MISC forms, including complex rules and an inconvenient submission process. For example, payers must determine whether payees are incorporated, must get the payees’ taxpayer identification number, and must use special forms if filing on paper.
A variety of options exist for mitigating the costs of filing Form 1099-MISC. Most have pros and cons. The IRS has already exempted payments, including those paid by credit card, which will be reported to IRS by other means. Other options include improving IRS guidance and education; adding a check-the-box question to business tax forms that would force return preparers to ask their clients whether they have complied with 1099-MISC reporting requirements; waiving late submission penalties for first-time payers; raising the payment reporting threshold; initially limiting the types of payments covered; having the IRS develop an online filing capability; and allowing paper filers to submit computer-generated black and white 1099-MISCs rather than the IRS’s printed forms.
“Information reporting by third parties is a proven approach for improving taxpayer compliance with the tax laws and for minimizing taxpayers’ costs of complying,” said GAO director of strategic issues James R. White in the report. “However, such reporting imposes a cost on the third parties. Consequently, there is a trade-off. Our tax system shifts some of the costs of tax administration to the third parties and gains improved compliance and reduced compliance costs for taxpayers.”
This trade-off is illustrated by the requirement for additional reporting of miscellaneous income in Section 9006 of the Patient Protection and Affordable Care Act, which requires expanded information reporting to include payments to corporations and payments of amounts in consideration of property and gross proceeds, he noted. For payments after Dec. 31, 2011, every person engaged in a trade or business would be required to file a Form 1099-MISC reporting aggregate annual payments of more than $600 to any individual or corporate payee for the purchase of goods or services. Currently, information reporting is only required for payments for services and only to payees who are not incorporated.
Concerns have been expressed about the costs that the additional reporting will impose on businesses. The Joint Committee on Taxation estimates that eliminating the new requirement would result in a revenue loss of approximately $19 billion from 2012 to 2020 from increased taxpayer noncompliance.
The American Institute of CPAs wrote to leaders in Congress this week urging them to repeal the expanded 1099 reporting requirements. A number of lawmakers have introduced bills to repeal or scale back the new requirements, including the chairman of the Senate Finance Committee, Max Baucus, D-Mont.
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