Health Care Reform's Terrible, Tiny Tax
A friend who, like me, is in an industry where contract and freelance workers are prevalent, just shared his dismay over the new rules for income reporting that were passed as part of health care reform. For those who were not following along at home, starting in a few years, businesses will have to provide 1099s for goods as well as services.
I understand the logic: people will have an incentive to give 1099s so that they can deduct the expense. It's the same sort of justification often given for a VAT. But the VAT makes a lot more sense. This version is a reporting nightmare that has none of the elegant self-enforcing mechanisms that keep companies from inflating their Cost of Goods Sold.
It could mean that anyone who does freelance would have to issue a 1099 to Amazon--forms that Amazon would have to keep track of and submit. The IRS, meanwhile, would have to process all this extra data, demanding to know why stated income didn't match. And since businesses don't usually break out their revenue by customer on their taxes (imagine Amazon's filing!), odds are that it would never match, and that it would be hard to untangle why it didn't.
Moreover, as I understand it, this raises a fairly trivial sum--about $17 billion over 10 years, if memory serves. Every little bit adds up, of course, but it's hard to see how the benefits outweigh the cost. Don't take my word for it; listen to the National Taxpayer Advocate, the in-house watchdog of the IRS:
Under prior law, information reporting was required for the purchase of services but was
not required for the purchase of goods. A person who made payments in the course of a
trade or business to a vendor totaling $600 or more for services or determinable gains in any taxable year was required to furnish an information report to the IRS, with a copy to
the vendor. This report, generally a Form 1099-MISC, Miscellaneous Income, sets forth the total amount of the payments as well as the name, address, and taxpayer identifying number (TIN) of the vendor.49
Prior law generally did not require a person to report payments to purchase goods, presumably because the purchaser could not determine the amount that (less cost of goods sold) would have been income to the vendor. Under a longstanding regulatory regime, moreover, there was an exception for payments to corporations as well as to tax-exempt and government entities. In recent years, legislative proposals to eliminate the corporate exception and expand information reporting appeared as part of an effort to reduce the tax gap. Since 2004, the National Taxpayer Advocate has recommended legislation, in the context of reducing the tax gap or noncompliance in the cash economy, to require Forms 1099-MISC to be issued to incorporated service providers.50 Similarly, the Department of the Treasury, under both prior and current administrations, has proposed legislation to eliminate the corporate exception to information reporting for services. 51 Neither the National Taxpayer Advocate nor Treasury recommended legislation to extend information reports to vendors of goods. In any case, the new information reporting requirements are likely intended to detect unreported income or gross proceeds.
The PPACA provision would apply to businesses of all sizes, charities and other tax-exempt organizations, and government entities. These would include, as reflected in IRS data, 26 million non-farm sole proprietorships, four million S corporations, two million C corporations, three million partnerships, two million farming businesses, one million charities and other tax-exempt organizations, and probably more than 100,000 federal, state, and local government entities.52 This mass of persons making payments in the course of a trade or business will soon be required to issue information reports to sellers of goods as well as providers of services. They also will have to report payments to a for-profit corporate service provider. In addition, a business will soon be required to report payments for purchases of goods as well as property of any sort.53 This new requirement has generateda great deal of concern because of its potential to create administrative burdens for businesses, vendors, and the IRS.54
First, vendors will have to furnish, and businesses will have to collect, TINs. If the vendor
is a sole proprietor who uses his or her Social Security number (SSN) as the TIN, there
could be identity theft concerns, especially if TINs essentially become public through
routine printing on receipts. Alternatively, such a vendor could obtain an Employer Identification Number (EIN).55 TAS will monitor any guidance that the IRS may set forth on the use of EINs for this purpose. If a sole proprietor uses an EIN, the IRS systematically will have to be able to associate the corresponding information reports with the SSN under which the resulting income should have been reported.
If a vendor fails to furnish a correct TIN, the business is required by law to impose back-up
withholding at the rate of 28 percent of the purchase price.56 In this situation, the business must prepare and file Form 945, Annual Return of Withheld Federal Income Tax, and make federal tax deposits at an authorized institution on a prescribed schedule. Failure to withhold an amount generally results in liability for that amount.57 In the case of a purchase of goods, back-up withholding may be impracticable, because a business already may have paid the full price at the point of sale before learning that the TIN was incorrect. Alternatively, a vendor may simply refuse to sell goods to any purchaser that refuses to pay the full purchase price. Such an outcome could significantly impair the normal course of commerce. No business should have to choose between compliance with back-up withholding and losing access to vendors on the one hand, and noncompliance while keeping vendor access on the other hand.
Second, businesses will now have to keep records of all purchases sorted by TIN. Under
prior law, a business may have retained sufficient records to substantiate lump-sum ex-
pense deductions. Under the new law, the business will have to segregate its records by
vendor TIN to determine whether the $600 annual threshold is met for each vendor.
The report goes on to note that this is probably going to require expensive new compliance measures, including e-filing; produce a bunch of reports that the IRS is going to have trouble making use of; cause multiple errors because the amount of revenue will not match the income (revenue-COGS) reported by the business; cause enormous problems when goods are returned; and unfairly enhance the competitive position of large firms that can afford the massive compliance architecture this entails.
Indeed, this provision is so bad that I haven't blogged it largely in the belief that it would never be enforced as enacted. And so far I'm right; the IRS has already said that transactions done by credit and debt cards are exempt. This is a good thing for freelancers who take a home office deduction, but I think they're still going to have to issue a 1099 to the landlord. It's still plenty bad, especially for small businesses, which often don't like to use credit cards because of the high transaction fees.
Why not just repeal it? Well, because we'd have to pay for repeal. In order to get PPACA across the finish line, Democrats threw just about every financing mechanism they could think of into it (this is why the student loan bill got rolled in) in an effort to ensure that it would score as deficit reducing. Now we can't take any of them out--no matter how stupid or ill-thought-out--because we don't have any little budget tricks left to offset even trivial losses such as this one.