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									              National Small Business Network
    P O Box 639 Corvallis, Oregon 97339-0639                                Email Tax@
                                               NationalSmallBusiness.net




    Analysis of the Administrative Burden Problems From the
                            Increased
  Form 1099 Reporting Requirements in the Health Care Reform
                               Law



The adopted Patient Protection and Affordable Care Act (PPACA) included a revenue-
offset provision that dramatically increases Form 1099 information return reporting
requirements for all businesses and government agencies.       The new law requires
totaling and reporting, by vendor, ALL purchases of BOTH goods and services from ANY
taxpayer-vendor which total to more than $600 per year. A similar provision requiring
1099 reporting for rental property owner expenses was also included in the 2010 Jobs
Bill.    These provisions will have substantial unintended consequences including
unreasonably high administrative costs for both taxpayers and the government
including the IRS.

The expanded reporting requirement is bad for the businesses and government
agencies that will have to collect, process, and report the data; bad for true net federal
revenues; and particularly bad for small businesses who will also face unintended
economic impacts.      As IRS Taxpayer Advocate Nina Olson said in her 2011 Report to
Congress “… the new reporting burden, particularly as it falls on small businesses, may
turn out to be disproportionate as compared with any resulting improvement in tax
compliance.” Although the new requirements do not take effect until January 2012,
businesses trying to comply with that deadline will have to start making major
expenditures to modify accounting software and procedures by mid 2011.                The
Congress needs to quickly re-examine the real value of this change in relation to its very
high administrative costs and enact an alternative revenue offset for health care.

The provision grew out of a much more limited Treasury Department recommendation
to remove the the long standing "corporation" exemption to reporting most personal
service payments. There was a concern that a self employed contractor working for a
business could incorporate so the business would not be required to report the income
on a Form 1099. However no research was presented to show that this was really a
significant issue. To protect their ability to deduct the expense, and reduce the risk the
contractor will be reclassified as an employee, businesses usually send 1099s in personal
service situations.     The actual number of incorporated non-professional personal
service providers is also probably very small because of the offsetting burden and cost
of corporation tax returns and other administrative requirements.

The adopted requirements, however, were a massive overkill directed at the wrong
target. Business purchasers of goods or personal services are not the primary source of
unreported income.      Business purchases are usually tax deductible and businesses
have a self-interest in clearly documenting transactions in case they are audited
internally or by the IRS.   Business customers normally require printed proof of the
transaction such as invoices or paid receipts, which also assures that the revenue was
entered in the vendor’s accounting system records. Individual consumers are actually
the major source of unreported sales and personal service income. Individuals employ
far more personal service providers and also make more small cash purchases. Many
individuals may even offer a non-traceable cash payment in order to obtain a better
price. Because individuals generally cannot deduct the expenditure, they do not need a
receipt, and they are not required to file a Form 1099.     The new annual credit card
transaction reporting requirements for payment processors will more accurately and
efficiently capture income data on sales of goods. This reporting will include most
product sales transactions made over the internet or in non-conventional market places
as well as any charged personal services payments.

The potential cost burden on businesses and government agencies –

Business accounting systems are set up with accounts to record and total all
expenditures by type, such as "office supplies", rather than by specific vendors. The
only exception is normally payroll or independent contractor accounts, which are paid
by check. This is logical for business management purposes because a business often
buys the same product or service from many different companies during the year, or
different categories of products from the same supplier. Businesses want to track and
control expenditures by type, not by vendor. This category format is also required on
IRS tax forms and all standard business financial statements. Retail and wholesale
businesses may also track total purchases or sales by resale product vendors, as part of
their inventory management system, but these reports may differ from their accounting
records. Factors such as freight costs paid to other parties may be included in inventory
purchasing information, and transaction reporting periods may differ.            Accurate
matching becomes even more difficult in larger businesses operating under Uniform
Capitalization Rules.

Expenditures for a particular product or service provider may also be paid for in
different ways. The transactions often enter the accounting process through different
processes and accounting journals. Large purchases may be paid by check, while
smaller purchases are often paid by cash, credit card or debit card. For credit card
purchases, the actual payment is made by check to a bank, which will show in most
checking account records as the payee, not the many actual product vendors.
 As a result, most business accounting software is not designed for, or easily capable of,
providing total purchases by specific vendors, unless paid only by checks directly to the
vendor. The new law will require most businesses and government agencies to replace,
or modify, their accounting software to attempt to meet vendor specific expenditure
totaling requirements. Every expenditure entry will have to include a unique sortable
identifier for each vendor taxpayer entity. The software will also have to be capable of
totaling transactions by both standard expense category and by vendor identifier.
Entries will also have to be subtotaled by method of payment to exclude duplicate
reporting of purchases by debit or credit card. This will cause a massive administrative
burden and expense, even larger than the Millennium date conversion issue, particularly
for businesses with old or complex software which is often integrated with their
operations software and not easily replaceable. Such large changes in accounting
structure or software will also damage the continuity, and period-to-period
comparability, of expenditures, which is a primary purpose of good financial reporting.

Businesses will face a huge administrative burden to try to sort out and determine
accurate total expenditures by individual providers. Even a small business with only $1
million in sales might buy $600 in products or services from 200 or more product and
service providers in a year, in thousands of individual transactions. A single $600 dollar
expenditure could be as little as a computer, an office desk, an airline ticket or 10 tanks
of gas. Retailers and distributors would probably need to file Form 1099s for all of their
suppliers. Although it has been announced that the final regulations will exempt
reporting of expenses paid by credit and debit card, this may actually complicate
accurate reporting. A partial exemption will require businesses to further separate and
record expenses by payment method to avoid duplicate “reporting” to the IRS of card
purchases.

A large percentage of businesses, as well as most government agencies, may now have
to file more than 250 information returns. Under current law, this would require that
the forms be filed electronically through the IRS “FIRE” system. This system requires
special transmission software, and was designed for large businesses and payroll
processors with professional IT departments. Smaller businesses will not be capable of
meeting the electronic filing requirement unless IRS develops a different reporting
system and provides simple software for them to use. Data processing companies who
can provide electronic filing typically charge $3 - $4 per form, even after the business
provides all the correct data.

To further complicate accurate reporting, the same “taxpayer” corporation may own
many businesses that appear to be different companies, and many businesses that
appear to be part of the same chain may have different franchise owners. Even if a
business could calculate the total amount of expenditures by actual taxpayer provider,
the burden does not end there. The business will then have to get every provider's
Taxpayer Identification Number (TIN), legal tax entity name, and the correct address to
which their 1099 copy must be mailed. Businesses will not be able to file accurate or
complete forms, unless Congress requires vendor TIN numbers and other data to be
printed on all business billings, receipts and bankcard statements. Alternatively
Congress will need to require, and fund, the IRS to provide a new and comprehensive
online database of business taxpayer data. This database will have to be easily
searchable by business “trade name”, legal taxpayer name, and approximate geographic
location and provide the taxpayer legal name, identification number, and tax entity
address. The current on-line TIN matching programs will not be adequate because
filers will not know one or both of the data fields required. Required release of this
taxpayer identification data will increase fraud and identity theft since it may include
the Social Security Numbers of un-incorporated business owners. Individual personal
service providers will have to obtain a federal EIN. Many issues are also unclear.
When an employer reimburses an employee for a business purchase, would they
include the amount in a 1099 return to the original product vendor, or in a separate
1099 to the employee? When a government agency reimburses employees on a “per
diem” basis, how are those purchases from vendors totaled and reported? How are
returns and allowances reported, particularly if received in a different way, or in
different tax years? Will bank to bank electronic fund transfer payments be reported or
exempted like debit card payments?

Businesses will then have a difficult time requirement to be able to prepare and mail
Form 1099 copies by January 31st every year, when they are also trying to meet Form
W2 payroll reporting, and March 15th corporate tax filing deadlines. Penalties for non-
filing or filing an incorrect information return may also be doubled by provisions which
passed the House, and are now being considered in the Senate, to $100 per individual
Form 1099, up to a $1.5 Million maximum. Most tax professional are estimating a very
high level or reporting errors, resulting in “B” notices requiring corrections by the
taxpayer and penalties. These penalties will fall hardest on small businesses who are
less able to properly comply with the new requirements.

The legislation also did not provide any exemption to the backup withholding
requirements that generally apply to IRC section 6014 reporting when a business does
not have the payee’s TIN.      How could a business possibly “withhold” on normal
purchases of products or common services such as transportation or restaurants, which
must normally be paid for at the time of purchase? If they cannot identify the correct
business entity, or obtain a valid TIN and fail to withhold, will they be subject to
penalties? If a business could and did withhold 28% from their payment for billed
purchases because they did not have correct taxpayer address or TIN information, how
would the seller ever receive credit for that “withholding”? If a business tried to
“withhold” 28% of the payment for goods, what would happen to the business’s credit
rating and relationship with its suppliers? As Taxpayer Advocate Olson said “No
business should have to choose between compliance with backup withholding and
loosing access to vendors…”

Almost all businesses who would receive these 1099 forms have accounting systems to
accurately establish their taxable income in the event of an IRS audit, and will probably
just recycle the forms, unopened. Most businesses would actually have no way to
reconcile customer reported 1099 amounts with their sales records, or to challenge
them in the event of an IRS audit, unless they keep taxpayer identified sale records for
every transaction, which most businesses do not. As Taxpayer Advocate Olson noted,
"At this point the taxpayer may have to prove a negative", which is often impossible.


It will cost businesses, and the IRS, at least 100 times more to administer this new
requirement than the average $1.7 billion annual JCT estimate predicts it might collect.
The IRS estimates the provision will impact 26 million non-farm sole proprietorships, 4
million S corporations, 2 million C corporations, 3 million partnerships, 2 million farming
businesses, 1 million charities and tax exempt organizations, and probably more than
100,000 federal, state and local government entities.       Total accounting, information
research, and reporting costs could easily exceed $50 per information return. If each
reporting entity had to file only 100 returns for a $5,000 average annual total
compliance expense, the total administrative expense would be $190,500,000,000 every
year. Of course the cost to larger businesses or government agencies would be much
higher.     The only potential benefactor of this legislation might be the Postal Service,
because of the volume of forms that will need to be mailed. Some states, such as
California previously decided to use the same reporting and withholding rules as the
federal government which now will further multiply the new administrative burdens.

Because of the significantly different administrative cost burdens for this new type of
Form 1099 reporting, this changed use should also receive a complete OMB re-
evaluation under the Paperwork Reduction Act of 1995.


The Potential Cost Burden for the IRS and other government agencies –

The JCT revenue estimates are limited to estimated tax revenue changes, and do not
include the initial and ongoing costs to the federal government. The IRS will be required
to process potentially 100 or more paper Form 1099s, or electronic filings, from 38
million business and government entities. This will probably be well over 100 times the
current Form 1099 processing load and will result in significant extra IRS expense.
The JCT scoring does not include all of the system change and ongoing processing and
examination costs for the IRS, or the added administrative costs on all government
purchasing by Federal, State, and local government agencies who will also be required
to comply with the same reporting burdens.           The revenue estimate is also not the
result of an actual change in tax rates or tax base, but is simply speculation that
purchase reporting will result in more accurate tax compliance. The JCT revenue
estimate for the much more limited Green Book proposal to just eliminate the corporate
exemption on personal service providers was $915 Millon per year. The adopted
expansion to cover all goods and services purchases is only projected to raise about
$800 Million more per year. When all of the additional governmental costs are added
in, we believe the total net fiscal impact on the government may actually be negative.
Even if the data on all filed 1099s is correct, which it probably unlikely, the IRS will not
be able to accurately match it against revenue reported on tax returns for effective
auditing.      Most businesses sell primarily to individual consumers or to a mix of
businesses and individuals.        Since purchases by individuals are not reported, the
collected data would only cover part of most business' sales. Form 1099s are also filed
on a calendar year basis, while many C corporations have a different “fiscal” tax year
that may include significantly different monthly income amounts.               Most large
businesses report sales on an accrual basis, while most information returns will be on a
cash basis.       The 2009 report of the IRS Information Reporting Program Advisory
Committee (IRPAC) identified many of these problems and concluded that “Reporting of
unusable information serves no purpose and should be avoided.” The 2010 IRS
Electronic Tax Administration Advisory Committee (ETAAC) report also questioned the
ability of the IRS to properly process and use the data. Tax Payer Advocate Olson said,
“In our view it is highly likely that the IRS will improperly assess penalties that it must
abate later, after great expenditure of taxpayer and IRS time and effort.” As repeated
GAO reports have shown, misdirected audits, based on poor data, often cost the IRS far
more than it collects. The combined administrative burden on governmental agencies
that will now have to issue Form 1099s for their purchases, and the added processing
and error correction costs for the IRS, alone will probably exceed the $1.7Billion
estimated annual revenue.

It has been indicated that purchases made by credit or debit card would be exempt from
the reporting requirements, but this might actually increase the amount of overall tax
avoidance.     If credit card transactions are exempted, the high administrative cost of
trying to produce 1099s would cause businesses to do as much of their purchasing as
possible by business credit card. Credit card transaction statements provide a poorer
audit record to identify and separate valid business purchases from personal
expenditures, compared to most cash receipts or check payments for specific invoices.
This is an important issue both for businesses who want to prevent employee misuse,
and fraudulent credit card transactions, as well as for the IRS in preventing intentional
or accidental deduction of non-deductible expenses.

Expenses paid by debit or credit card are usually entered into business accounting
systems at primary business offices from monthly statements, which have little
transaction detail. In many cases, the vendors legal name on the statement is even
different from the vendor’s trade name for the business, or is a third party payment
processor like PayPal, making matching with paper receipts difficult. Though backup
receipts are required, good auditing does not always occur and payment is often made
directly from these non-detailed statements. Because a credit card statement may
include dozens, or even hundreds, of transactions for different vendors, most current
software provides little ability to enter specific vendor or business purpose references
into searchable electronic accounting records. To reduce errors and avoid duplicate
reporting of transactions by both the business and the credit card company, banks will
need to be required to provide Taxpayer ID numbers for each transaction on credit card
statements.


ADDITIONAL NEGATIVE ECONOMIC CONSEQUENCES FOR SMALL BUSINESSES:

If credit card payments are excluded from reporting requirements, businesses will try to
make all possible purchases by credit card to avoid the reporting burden. Increased use
of credit cards benefits large national businesses that have the power to negotiate
lower processing fees or issue their own credit cards. Many new or small businesses
may not have the necessary credit rating to obtain a higher limit business credit card.
Even large well established businesses that purchase significant supplies or inventory
will not be able to get credit card limits high enough for all these large purchases. It
has been reported that banks are now restricting business credit cards and increasing
interest rates as a result of new legal requirements. This means that smaller businesses,
which are least able to comply, will face the greatest burden from the new reporting
requirements. Consumers, including business consumers, also pay a hidden cost of 2%
to 4% of their purchases for the bank processing fees retailers pay to accept credit
cards.       Manufacturers, raw material suppliers, and wholesalers will also now be
pressured to take credit card payments, and they will then need to increase their prices
to cover the added discount cost. With this second or third layer of card fees, the
hidden cost in final consumer prices could double to 6% or more of all retail sales, which
would be about $260 Billion in processing fees per year based on current retail sales.

The other likely way businesses would try to avoid the reporting burden is by
consolidating all their purchases with a few large diverse vendors like Sam’s Club,
Costco, or Amazon.com who have “membership” systems in place that could record
member’s purchases.       These firms could then send each business a total of their
purchases at the end of the year, which they could then put on a Form 1099 to send
back. Although this “game” would simplify the accounting burden for purchasers, it
would have a devastating competitive impact on small local independent businesses
who now sell the same services or products to other businesses.

All of the proposed methods to ”simplify” the reporting requirements through
administrative rule, would just add other complexity or have potential negative
economic effects. If Congress or the IRS tries to reduce the administrative burden by
excluding purchases from larger or publicly traded companies, it would have a deadly
economic impact on small business. After having discussions with Treasury officials, IRS
legal staff, and Congressional tax counsels, it appears that there is no way to
administratively correct most of the negative consequences of this legislation.
Congress should repeal the provision requiring reporting for purchases of property and
general consumer services and replace it with the original more limited Treasury
proposal. The legislation will also need to include a more logical and efficient revenue
alternative to offset the $800Million estimated annual revenue difference.
Prepared for the National Small Business Network by – Eric Blackledge, SBA Region 10
Tax Issue Chair and Thala Taperman Rolnick CPA, SBA Region 9 Tax Issue Chair.




          National Small Business Network PO Box 639 Corvallis, OR 97339-0639

                        Email Tax@NationalSmallBusiness.net

								
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