By Karen M. Kroll
Despite all the attention paid to the recently passed health care bill, one provision slipped by largely unnoticed. This one has nothing to do with health care and everything to do with taxes.
Section 9006, "Expansion of Information Reporting Requirements," greatly expands the circumstances under which companies will be required to issue Form 1099-MISC, for reporting miscellaneous income. Currently, businesses issue 1099s primarily to partnerships and individuals and for non-wage earnings, such as interest or dividends, or for work an independent contractor has done.
Under Section 9006, companies also will be required to issue 1099s to corporations, other than non-profits, with which they do business. Moreover, 1099s will be required for payments for purchases of goods, as well as services. "It's 1099s on steroids," says Marvin Michelman, tax director with Deloitte Tax LLC. "You're basically going to be reporting everything to everyone."
The catalyst for the provision is the IRS' desire to ferret out businesses, particularly smaller ones, which either aren't filing tax returns or are filing but may be under-reporting income. Only about 8 percent of the approximately 50 million small businesses that filed tax returns in 2005 also submitted 1099s, according to a 2009 report by the Government Accounting Office. The "IRS does not know how many of the other 92 percent were required to report payments but did not," the report stated.
The change is part of a larger trend within Congress and the IRS to increase the amount of tax information that's reported, Michelman notes. The goal? Reducing companies' ability to shelter income and evade taxes. With the public debt close to $13 trillion as of the end of April, Uncle Sam is looking for every penny he can find.
The shift imposes a number of challenges for businesses. For starters, it substantially increases the number of 1099s they have to issue. Moreover, before businesses can send 1099s, they have to gather and verify their vendors' employer identification numbers (EINs), as well as their corporate names and addresses, says Abe Schneier, tax senior technical manager with the American Institute of Certified Public Accountants.
It's also possible that the IRS will flag more returns once the provision goes into effect, Schneier notes. That's because some vendors operate on different reporting years than their customers, causing mismatches between the amounts of income that the firms report. Or a vendor may accrue the income it receives over time, while the customer records the payment immediately. These differences could prompt the IRS to investigate, even when both parties are operating honestly. "There can be so many mismatches based on the accounting basis," Schneier notes. "
If there's a bright spot from businesses' perspective, it's that the change actually simplifies one aspect of such reporting. For most payments, businesses no longer will need to distinguish between vendors that are corporations and those who are individuals, nor between payments for services and those for goods. "You just report it all," says Steve Friedman, director in KPMG's national tax practice.
The fact that 1099s may be blanketing the country come 2013 has prompted some to question whether the provision will be changed or repealed. Here, experts appear divided. In the IRS' view, the change largely adds to activities that already are occurring, and doesn't create a new reporting system, Michelman notes. As a result, they're less likely to be sympathetic to the argument that this change is going to be onerous.
However, given that the provision was buried within a bill that spanned thousands of pages, Congress may face intense pressure from businesses, says Mitch Franklin, assistant professor of accounting at Syracuse University.
That could lead the IRS in its final interpretation of the law, which has yet to be issued, to exempt some types of transactions or businesses from the reporting requirements. At minimum, the service is likely to waive the requirements for transactions to companies over a certain asset size, Friedman says. This would prevent situations in which, for instance, independent contractors have to issue 1099s to OfficeMax.
At least one company has taken steps to prepare for the change. For several years, Lufkin Industries, a $520 million manufacturer of oil field equipment, has required completed W-9s, which show the taxpayer identification number, from all its suppliers, says Christopher Boone, chief financial officer. This is "one of our internal control points for creating and paying vendors. At the same time, Boone figured it was only a matter of time until the IRS required it. "This kind of electronic matching (of income) is the cheapest tool the IRS has."
Because Lufkin already has tax information on its suppliers, complying with the act shouldn't be difficult, Boone says. One exception: transactions completed on credit cards. The name that appears on the statement often differs from the actual business name, making it difficult to obtain the correct taxpayer identification number or TIN.
Financial execs whose companies aren't as far along will need to get to work. As a starting point, they'll want to begin collecting TINs, as well as business names and addresses, for entities to which they're paying $600 or more each year. Once they have this information, they can use the IRS' TIN matching program to check that the information is accurate. Many companies also will need to change their payments systems so that they issue 1099s to both corporate and individual vendors.
Although the changes don't take effect until 2012, which means the 1099s actually won't go out until 2013, companies should "jump on this," Michelman advises. Now is the time to get the necessary systems and processes in place.