Healthcare Reform Legislation Increases Tax Reporting Burdens with New 1099 Mandate

Buried deep within the recently passed healthcare reform legislation lays a harmless looking piece of legislation titled Section 533, Expansion of Information Reporting Requirements.  Though it appears uncontroversial on the surface, Section 533 adds two new subsections to Section 6041 of the Internal Revenue (IRS) Code and has the potential to impact American businesses to a much higher degree than the proposed healthcare changes.

For business owners, Section 533 of the Patient Protection and Affordable Care Act as modified by the Health Care Education and Reconciliation Act of 2010 seems to be a solution in search of a problem.   Conceived to raise revenues to offset the costs of healthcare reform, Section 533 aims to close the “tax gap” caused by the underreporting and nonpayment of taxes by requiring businesses to submit a more complete picture of their annual spending.

Specifically, the legislation requires businesses making payments to a provider for services or property aggregating more than $600 over the course of a year to send a 1099 to the IRS and the vendor setting forth the amount.  The only exceptions are payments made to tax-exempt corporations.  Previously, this procedure was only required when payments totaling more than $600 annually were made to a service provider.

“The practical effect of the new reporting requirements will be that, beginning in 2012, companies must submit 1099s for nearly all business payments greater than $600.  These changes will generate a substantial increase in paperwork for businesses,” said Dean Zarafonetis, an associate with Warner Norcross & Judd LLP, a Michigan law firm.  “Although many large companies have sophisticated accounting departments that will be able to adapt to the new requirements with certain modifications, many still will face dramatic changes in addition to a deluge of paperwork, increased data collection, and more stringent record keeping,  and smaller companies will face these same issues with smaller staffs and fewer resources.”

Challenges to Business
 

Consider all of the payments businesses make in the course of a calendar year for services such as janitorial, coffee and package delivery.  Then add to that the payments made for property such as computers, software and office supplies.  If the business pays out more than $600 over the course of the tax year to any one of these vendors, they will be required to file a Form 1099. 

“For administration, this will be a paperwork tsunami,” said Jonathan Gassman, CPA, CFP, CAP, director of tax and wealth management for Gassman & Golodny, a New York City-based accounting and financial planning boutique.  “The paperwork and tracking are bound to be a nightmare and will require more staff or [more of the] current staff’s time devoted to this function alone.”

For office supply retailers, airlines and even cleaning product suppliers, the amount of incoming paperwork will drastically increase, which Gary S. Ruderman, CPA, vice president of tax at AlphaStaff, Inc., a human resource outsourcing company, predicts will result in much of it being discarded.

“What about ordering general office supplies from Office Depot?  Presumably they will receive a ridiculous number of 1099s, which they will likely just discard,” he adds.

Solutions to a Problem
 

Regardless of the headaches this legislation creates, businesses must be prepared to comply in 2012.   Early preparation is recommended to ease the transition and lighten the administrative burden.

This should begin with companies collecting from vendors the information needed to file 1099s.  This includes the Tax Payer Information Number, or TIN.  If vendors do not provide this number, businesses are legally obligated to withhold payments for property or service.

“Prior to paying any vendors I would suggest having them complete W-9 reporting forms so every business has a signed document with their employer identification number and correct name.  This way it can be entered into their accounting systems, making it easy to complete and process the 1099s,” said Gassman.  “If you wait to solicit this information after paying the vendor, they may be inclined to withhold their identification number so you cannot report the payment to the government.  This could lead to significant penalties, so you want to get a head start on compliance.”  Ruderman recommends that businesses “get policies in place now and start educating and training all employees.  Being proactive and starting this process will help with the implementation and minimize the last minute rush.”

Adds Jay A. Kennedy, senior counsel with Warner Norcross & Judd: “Companies that begin sooner rather than later should face a smoother transition than those who wait, but it remains possible that the new requirements could be delayed, repealed, or changed.  The IRS has not yet issued regulations regarding the new requirements, which could also reduce some of the burdens that companies may face under the new reporting requirements.  Unfortunately, these regulations will not likely be released until next year, and preparing for the new 1099 reporting requirements without knowing exactly what they entail presents some difficulties.”

Other difficulties may arise once final rules are issued.  These include increased expenses on businesses’ behalf and an avalanche of paperwork filed with the IRS.  Additionally, the mandate may trigger a higher volume of audits, as these forms are likely to be littered with inadvertent mistakes.

Affect on Operations
 

The overall affect this legislation will have on business operations will have much to do with the size and capacity of the organization.

“For small businesses and not-for-profits, compliance will be over the top—a real headache.  They are already overtaxed and bring in less revenue.  Increasing expenses runs the risk of businesses shutting down.  This may be the nail in the coffin, simply because of the additional compliance burden of time, needed professional advice and updated computer systems,” said Gassman.  “However, from the government perspective, it will be significantly harder to cheat the system since most payments will be reported, making underreporting of income less likely.”

However, Kennedy believes these reporting changes will have a positive effect on future taxes, as well as on certain types of businesses that can provide support services to customers impacted by the new rules.

“The changes should increase overall tax compliance, which could reduce the need for Congress to increase taxes with new legislation.  They may also increase the business of accountants, software developers, consultants and others who will assist companies with the implementation of the new reporting rules,” he said.  “However, I believe these changes will have little or no direct benefit to businesses subject to the new reporting requirements.”

Uncertainty still remains in regards to the affect these changes will have on business over the next five to 10 years. Some believe the new law may result in less intrusive audits and examinations since the IRS will receive a more accurate picture of a business’ income.  Others believe the greatest impact will be felt by the nation’s smallest companies. 
 
 

“There likely won't be much of an impact to larger companies,” said AlphaStaff’s Ruderman.  “And it should level the playing field with smaller ‘mom & pop’ companies, as they will be forced to report all income, and as a result the IRS should have better matching and audit info.  Hopefully, this will benefit the companies that are compliant with regards to their income tax reporting.”

Lightening the Load
 

While larger software programs should be able to handle the administrative changes easily, companies will need to evaluate their software capabilities before compliance is mandated.  Industry specific custom developed accounting systems may need to be swapped out or updated.  New software may also be in development, as the reporting rules do not apply to transactions until the beginning of 2012.

Outsourcing may also be a viable option, but only for certain aspects of the requirement such as gathering TINs and preparing the Forms 1099. General outsourcing is not likely, as the amount of information that must be prepared and distributed on a daily basis is lofty.  Too, outsourcing service providers will face the same battle to secure TIN and other required information from their client organization’s vendors as would the companies themselves.

Automation and outsourcing aside, it is the IRS that holds the key to streamlining the compliance process.  Until the agency issues final rules, financial and legal advisors and their corporation clients are left scratching their heads in terms of what this truly means for organizations.

Said Grassman: “If I eat out at a favorite local restaurant does that mean my business now has to report at the end of the year the total amount that I paid the restaurant for eating there?  Wow, that is a lot of work, or what happens if I attend a conference in San Diego and eat at a restaurant in a hotel, do I have to send a 1099 at the end of the year to the hotel?  It’s a huge amount of work to collect the data but we have roughly two years to get up to speed.”

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