1099s — The Good, the Bad and the Ugly
Can broader use of 1099s effectively reduce the tax gap without diminishing effective tax compliance and administration?
November 11, 2010
One provision of the Patient Protection and Affordable Care Act (P.L. 111–148 (PDF); March 23, 2010) receiving widespread criticism and calls for repeal has nothing to do with health care. Section 9006 of the Act made significant changes to IRC §6041 on the issuance of Form 1099, effective for payments made after 2011. This change requires 1099s to be issued to corporations and for payments for goods rather than only services.
The Government Accountability Office (GAO) has been touting the favorable cost-benefit result of issuing 1099s to corporations since 1991. Presidents Bush and Obama included the idea as a revenue raiser in their budget proposals for fiscal years 2008, 2009 and 2010. (Treasury, General Explanations of the Administrations Fiscal Year 2010 Revenue Proposals, May 2009, page 90 (PDF); FY2009 report, page 63 (PDF); and page 63 (PDF) of the FY2008 report).
It is widely accepted that information reporting reduces the tax gap thereby generating revenue. In recent years, Congress has used this type of revenue raiser by expanding information reporting to pay for tax cuts. For example, information reporting now covers basis of securities (§ 6045(g)), credit card payments (§6050W), and a change enacted as part of the Small Business Jobs Act (P.L. 111–240 (PDF); September 27, 2010) expands 1099 reporting obligations to certain landlords effective for payments made after 2010.
This article notes the changes made to §6041 in 2010, the rationale, the concerns raised, and possible alternatives.
2010 Changes to IRC §6041
IRC §6041 as changed in 2010 is produced below. The (green) text indicates changes made by health care legislation. The italicized (blue) text indicates changes made by the Small Business Jobs Act.
IRC §6041, Information at Source
(a) Payments of $600 or more — All persons engaged in a trade or business and making payment in the course of such trade or business to another person, of rent, salaries, wages, amounts in consideration for property, premiums, annuities, compensations, remunerations, emoluments, or other gross proceeds, fixed or determinable gains, profits, and income (other than payments to which section 6042(a)(1), 6044(a)(1), 6047(e), 6049(a) or 6050N(a) applies, and other than payments with respect to which a statement is required under the authority of section 6042(a)(2), 6044(a)(2) or 6045), of $600 or more in any taxable year, or, in the case of such payments made by the United States, the officers or employees of the United States having information as to such payments and required to make returns in regard thereto by the regulations hereinafter provided for, shall render a true and accurate return to the Secretary, under such regulations and in such form and manner and to such extent as may be prescribed by the Secretary, setting forth the amount of such gross proceeds, gains, profits, and income, and the name and address of the recipient of such payment.
(h) Treatment of Rental Property Expense Payments . —
(1) In general. — Solely for purposes of subsection (a) and except as provided in paragraph (2), a person receiving rental income from real estate shall be considered to be engaged in a trade or business of renting property.
(2) Exceptions. — Paragraph (1) shall not apply to —
(A) Any individual, including any individual who is an active member of the uniformed services or an employee of the intelligence community (as defined in section 121(d)(9)(C)(iv)), if substantially all rental income is derived from renting the principal residence (within the meaning of section 121) of such individual on a temporary basis,
(B) any individual who receives rental income of not more than the minimal amount, as determined under regulations prescribed by the Secretary and
(C) any other individual for whom the requirements of this section would cause hardship, as determined under regulations prescribed by the Secretary.
(i) Application to corporations. — Notwithstanding any regulation prescribed by the Secretary before the date of the enactment of this subsection, for purposes of this section the term ‘person’ includes any corporation that is not an organization exempt from tax under section 501(a).
(j) Regulations. — The Secretary may prescribe such regulations and other guidance as may be appropriate or necessary to carry out the purposes of this section, including rules to prevent duplicative reporting of transactions.
The rationale for greater information reporting is to reduce the tax gap. The Joint Committee on Taxation estimated the revenue to be generated by the 2010 changes to §6041 as follows:
In testimony before Congress back in 1991, the U.S. GAO stated:
"Matching information returns to individual tax returns has proven to be a highly cost-effective way of bringing in billions of dollars in tax revenues to the Treasury while at the same time boosting voluntary compliance by individuals. GAO believes that similar results would occur if the law required information returns reporting on income earned by corporations and if the Internal Revenue Service (IRS) developed a program to match these documents to corporate tax returns. Recognizing start-up costs of $70 million plus annual operating costs of $70 million, GAO estimates that a limited corporate document matching program involving interest, dividends, rents, royalties, and capital gains would generate about $1 billion in additional revenue. An expanded program that included more types of unreported corporate income could generate even more revenue. Given IRS' experience with the growth of the individual document matching program, the ratio of revenues to costs should only improve." [GAO, Benefits of a Corporate Document Matching Program Exceed the Costs, GAO-/GGD-91-118 (PDF), September 1991, page 11]
In a 2009 report, GAO echoed its earlier suggestion of requiring that 1099s be issued to corporations. (GAO, IRS Could Do More to Promote Compliance by Third Parties with Miscellaneous Income Reporting Requirements, GAO-09-238 (PDF), January 2009, page 4.)
The GAO observed that eliminating the distinction that 1099s do not have to be issued to corporate payees, would remove an "impediment" for filers that should improve 1099 compliance (2009 report, page 36).
Many individuals, groups and even government agencies have either called for repeal of the new 1099 requirement added by the health care legislation or pointed out the burdens the new rules place on small businesses and the IRS. Some of these comments were directed to the IRS in response to its request for comments on §6041 guidance (Notice 2010-51 (PDF)). For example, in its comment letter to the IRS, the New York State Society of CPAs noted their "strong belief that a repeal of these changes by Congress is the best course of action at this time for all parties" (letter (PDF) dated September 28, 2010).
Other groups that have called for repeal of either the new requirement to issue 1099s to corporations or for purchase of goods or both, include the following:
Concern over the compliance burden of the new reporting requirements, particularly for small businesses, have been expressed by government groups including:
The key concerns raised by those calling for repeal or reconsideration include:
The IRS Information Reporting Program Advisory Committee (IRPAC) is concerned over the administrative burden placed upon the IRS by the broadened 1099 reporting requirements. In the committee's comment letter in response to Notice 2010-51, many concerns regarding the ability of the IRS to implement and effectively use the information were noted (see pages Appendix M of the 2010 report). A sampling of these concerns is listed below:
A few bills were introduced to repeal the 1099 changes made by the health care legislation. H.R. 5982 (111th Congress) was defeated by a vote of 241 –154 (July 23, 2010). Other proposals calling for repeal include H.R. 5141 and S. 3578. A challenge to repeal is that the revenue loss must be offset by a revenue raiser.
The President and legislators have a challenge before them. They are eager to reduce the tax gap, yet they are now aware of various aspects of the new 1099 reporting requirements that indicate that the hoped for revenue might not be generated. In addition, significant costs will be borne by taxpayers and the IRS to comply with the new rules.
When the GAO suggested expanding 1099 requirements in 1991, they also suggested some implementation approaches. These included phasing the change in over more than one year, limiting the types of payors and payees subject to filing, greater taxpayer education, and additional funding for the IRS to administer the new rules. GAO also suggested that 1099 compliance could be improved by not requiring use of the red ink forms that can be scanned, but finding alternatives more conducive to easier filing.
Congress and President Obama could review the concerns raised on the new rules and identify alternatives to outright repeal. For example, an exception could be added that 1099s need not need to be issued to publicly-traded corporations. In addition, retailers who primarily receive payments from customers not required to issue 1099s could be carved out since the few 1099s they would receive would be of little value to them or the IRS.
Funding could be provided to the IRS to enable them to improve their system of receiving 1099 data that would also reduce the compliance burden for filers.
The concern about disclosure of SSNs by some sole proprietor issuers could be addressed by requiring them to use an Employer Identification Number (EIN). Alternatively, the IRS could broaden its pilot program of allowing issuers of information returns to use truncated identification numbers for payees by allowing issuers to do the same (Notice 2009-93 (PDF)).
Lawmakers could also consider other approaches to reducing the tax gap such as tax law simplification, Another approach suggested by President Bush's Tax Advisory Panel would require small to medium size businesses to use "designated bank accounts" for all receipts and expenditures, with the bank reporting the "annual summary of account inflows and outflows" (Final Report (PDF), December 2005, page 128).
While there appears to be no support for the 1099 expansion approach Congress undertook in 2010, change will be difficult due to the need to find revenue offsets. In addition, Congress may be reluctant to send any message that it is not concerned about the tax gap.
It should not be overlooked that Congress is often in need of revenue raising provisions and expanded information return reporting helps fill that need. For example, despite legislative and public calls for repeal of the new 1099 changes, Congress further broadened them in the Small Business Jobs Act enacted September 27, 2010.
As we wait to see if Congress will repeal any of the 2010 changes to §6041, businesses and tax practitioners might better help their call for repeal by suggesting revenue offsets and better tax gap remedies.
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Annette Nellen, CPA, Esq., is a tax professor and director of the MST Program at San José State University. Nellen is an active member of the tax sections of the ABA and AICPA. She serves on the AICPA’s Individual Income Taxation Technical Resource Panel. She has several reports on tax reform and a blog.