An Ugly Side Effect of New 1099 Law: More Tax Evasion
By Elizabeth MacDonald

Published January 21, 2011


Tax pros now fear that tax evasion could go viral if the health-reform bill’s new 1099 requirement takes effect next year. They say more small businesses will likely opt to do all-cash transactions under the table to avoid the 1099 reporting requirement, and all of its onerous provisions, which are worse than small businesses may realize.

That's the direct opposite effect of what lawmakers had hoped for, and it would pose a bad development for the Internal Revenue Service, which for years has been under pressure from Congress to bring in more tax revenue. That revenue is needed now more than ever, as Social Security and Medicare teeter into the red, and as more states rely on federal revenue to fill their budget holes.

Indeed, three Senate Democrats wrote to House Speaker John Boehner on Thursday urging the House to vote to repeal the 1099 provision. "The [1099 provision] is particularly onerous for small businesses..who cannot afford to employ extra lawyers and accountants to comply with the new rules," Senators Ben Nelson, Maria Cantwell and Amy Klobuchar wrote.

Health-reform’s new 1099 requirement says small businesses, charities, even government entities must issue 1099 forms to all vendors from whom they purchased more than $600 worth of goods and services a year. Plus they must report to the IRS these transactions as well. The new law takes effect January 1, 2012. It was first proposed under the Bush Administration.

But the 1099 change under the Bush Administration did not require reporting of goods and services amounting to $600 or more. Instead, that change, the 1099-K form, covers reporting of payments small businesses receive via credit cards, debit cards, gift cards and PayPal.

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Tax pros, who asked to remain anonymous, fear taxpayers simply won’t comply with health reform's new onerous 1099 requirement because it requires small businesses to file even more, separate tax forms to be compliant; can trigger erroneous penalties from the IRS if the forms are missing information or are incorrect: can expose taxpayers’ personal identification information; and it can require expensive new computerized systems to comport with the letter of the tax law.

For years, the IRS has struggled to pare back what’s called the tax gap, the difference between tax amounts owed and paid. The IRS estimates that gap is around $290 billion, based on 2001 data, the latest estimate available.

The thinking behind the new 1099 requirement was that forcing smaller sums to be reported on a new 1099 paper trail would bring the underground economy into the light, and cut the tax gap.

However, the onerous impact of the law may outweigh the revenue brought in, tax officials note. Congress's Joint Committee on Taxation estimates that the new requirement will increase federal tax revenue, but by just $17 billion over 10 years.

That $1.7 billion a year would supposedly help offset provisions in the bill that increase IRS collection costs. But tax preparers and small business groups only see more paper jams, despite the president’s executive order to cut the red tape for small business. 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," Nina Olson, the IRS Taxpayer Advocate [TAO], the federal overseer at the IRS who protects taxpayers, said in a June report.

[b]Moreover, Olson says there is cause for concern about identity theft with the new 1099s, given the fact tens of millions of taxpayers will need to give out personal Social Security numbers or taxpayer identification numbers [TINs] to complete 1099 forms. “There could be identity theft concerns, especially if TINs essentially become public through routine printing on receipts,â€