New Tax Reporting Rules Leave IRS to Mop Up Congress' Mess

NEW YORK - With a new mandate looming that will require business owners to file millions more tax forms, the Internal Revenue Service has begun the daunting process of figuring out how to turn the law's sweeping demands into actual rules for taxpayers, CNNMoney.com reported.

The new regulations, which kick in at the start of 2012, require any taxpayer with business income to issue 1099 forms to all vendors from whom they purchased more than $600 of goods and services that year. That promises to launch a fusillade of new paperwork: An estimated 40 million taxpayers will be subject to the requirement, including 26 million who run sole proprietorships, according to a report released this week by National Taxpayer Advocate Nina Olson.

Olson's office, which operates independently within the IRS, flagged the new reporting requirements as one of its priority issues for the next year. Like many who have delved into the details of the new rules, Olson is concerned about their far-reaching scope and potential unintended consequences.

"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," the Taxpayer Advocate Service wrote in a report released this week.

The new rules are aimed at reducing the "tax gap" between what individuals and businesses owe and what they actually pay. The federal government misses out on estimated $300 billion each year from tax underpayment. The expanded reporting requirements, which Congress slipped into the landmark health care reform bill passed in March, are an attempt to create a paper trail of 1099s exposing business-to-business payments that might otherwise stay off the radar.

But the cost of that paper trail could swamp the small companies, sole proprietors freelancers forced to generate it. Pennsylvania business networking organization SMC Business Councils surveyed its members and found that they currently average 10 filings a year of 1099 forms. The new rules would push that average to more than 200 filings per year for a typical small business, the industry group estimates.

The IRS will have broad leeway to interpret the rules -- and it's already showing signs that it will look for ways to staunch the paperwork flood.

In a late May speech before the two payroll industry trade group, IRS Commissioner Douglas Shulman announced a major exception to the new rules: The IRS plans to exempt transactions made through credit and debit cards. A separate reporting requirement kicks in next year that will cover card transactions and help the IRS spot unreported payments made through those channels, "so there is no need for businesses to report them as well," Shulman said. "Whenever a business uses a credit or debit card, there will be no new burden under the new law."

How much of a sigh of relief you should breathe depends on what kind of purchases your business makes. Some big-ticket consumer items that are typically paid by card -- airline tickets or hotel stays, for example -- will be 1099-free. But SMC Business Councils President Tom Henschke, a vocal critic of the new law, estimates that exempting credit-card transactions would affect less than 10% of his members' reporting requirements.

"Most of the small businesses out there that do small business [purchasing] don't do it by credit card," he said. "One of the reasons is the transaction cost is very high -- 2 percent to 3 percent."

Henschke thinks the main beneficiaries of the exemption are likely to be credit-card companies, which will gain an added hook to get small businesses to pay their fees. Nolan Newman, a Seattle CPA who specializes in small-business needs, says it's certainly possible that card usage will rise as a result: "If I'm a small business and I use my credit card moderately, would I try to increase my volume with which I pay vendors with it? Maybe."

Henschke foresees another unintended consequence of the new reporting provisions: that in order to cut down on tax forms to be filed, businesses will trim the number of vendors they do business with. "I've actually heard businesses talking about consolidating their purchases, going from 150, 200 vendors, down to less than 100," he said. "That will most certainly lead to some small businesses being swept under the door."