For many years I have been hearing about the “federal tax gap”. The tax gap is the amount the federal government believes should be paid in taxes versus the amount that is actually paid in taxes. The tax gap is estimated to be approximately $350 billion annually. The tax gap comes primarily from three areas of noncompliance with the tax law: under reporting of taxable income (by under reporting revenue or over reporting expenses), underpayment of taxes, or non-filing of returns. A significant majority of the tax gap is created by those who under report their taxable income. Essentially, the tax gap is created by tax evaders.
The federal government is running a $1.6 trillion deficit in the current fiscal year. Additionally, the new healthcare entitlement program will create huge cash drains on the federal budget in future years. To help close the tax gap and fund this deficit spending, the federal government has expanded informational reporting requirements of businesses. Under current tax law, if a business makes payments in excess of $600 to a person or a business over the course of a year, it must file Form 1099 to report those payments. One copy of the form is sent to the IRS and another copy is sent to the person to whom the payment was made. Payments made to a corporation and payments made in exchange for merchandise are not required to be reported on a 1099.
Tucked away in just 23 lines of Section 9006 of the Healthcare reform bill will be a dramatic change in the 1099 reporting requirements. No longer will payments made to corporations or payments made in exchange for merchandise be exempt from 1099 reporting. This new law is effective January 1, 2012. A large majority of payments made by a business will now be reported on a 1099. This reporting requirement will have a two pronged effect on those who under report their taxable income. First, most of a business’ revenue will now be reported to the IRS, so understating large amounts of revenue will be more difficult. Secondly, a business will be less inclined to overstate its expenses as it will need to disclose via its 1099 reports where those expenses were paid.
There is no doubt this will be an administrative nightmare for many businesses in the first year or two. Taxpayer identification numbers need to be collected for all vendors. Have a large business related meal at a restaurant, this will need to be reported on a 1099. Spend a week in a hotel in Waco, Texas, you will need to send a 1099.
I do not believe the IRS will be able to match these payments dollar for dollar to a tax return as there are too many variables involved. However, it will prevent wholesale abuse from taxpayers and force more people into compliance knowing the IRS will have more information at its disposal.
If you have any questions regarding this article, please contact Jamie Downey at jmdowney@downeycocpa.com.
