The
Coming 1099 Revolution: Are You and Your Clients Ready? By DAVID LIFSON,
CPA | 08/06/10
Health care reform act provision vastly
expands information reporting requirements.
Revenue-raising provisions in the Patient
Protection and Affordable Care Act, PL 111-148, and the
Health Care and Education Reconciliation Act of 2010, PL
111-152, like their health care provisions, have far-reaching
implications. One could even fundamentally change the way
we do business and keep records in the United States—by
dramatically increasing information reporting requirements
for business transactions.
Under IRC §§ 6041(a) and (h) as
amended by the Patient Protection Act, beginning Jan. 1,
2012, virtually all payments by a trade or business aggregating
$600 or more to any single vendor during any calendar year
will have to be reported at the end of each calendar year
to the vendor and to the IRS on Form 1099. Vendors include
almost anyone a trade or business pays in the course of
doing business, other than its employees whose compensation
is already reported on Forms W-2.
Implementing this change will require collaboration
among businesses and software vendors and likely the help
of CPAs to correctly identify, characterize and report these
transactions. Purchases affected could range from inventory
to payments for advertising services to the electricity
bill. IRS Commissioner Doug Shulman, however, said in a
speech in May that the Service plans to administratively
exempt business transactions conducted using payment cards
such as credit and debit cards, because those transactions
would already be reported by the payment processors.
WHAT’S NEW?
Reporting on Form 1099 currently applies
only generally to certain financial transactions (for example,
dividends, interest, sales of securities and loan transactions),
targeted transactions (for example, bartering, prizes and
qualified plan distributions) and amounts paid to unincorporated
businesses—generally understood to be independent
contractors—for services. Current law and regulation
(Treas. Reg. § 1.6041-3) excludes reporting of most
business payments to corporations and governments and for
purchases of goods. Payments to tax-exempt organizations
should also continue to be exempt from information reporting
under the new law. With so much to keep track of, however,
it may be easier for many businesses to simply accumulate
and report these payments with other vendor transactions
rather than identify and segregate them for nonreporting.
Depending on any relief granted through
yet-to-be-published regulations, the new provisions will,
as a practical matter, require businesses to track all payments
made directly or through their employees or owners. Presumably,
they could even include repeated business meals at the same
restaurant, office supplies and equipment, or inventory
for resale.
Now is not too soon to start thinking about
the massive increase in record-keeping that will be required.
Billions of transactions will have to be identified and
re-sorted by vendor, summarized, and reported to the IRS
by more than 30 million U.S. businesses. Unless the IRS
administratively sets exceptions or a de minimis payment
amount, businesses will be required to record the taxpayer
identification number (TIN) of the payee, or some other
unique identifier, for each transaction during the year.
Most businesses probably don’t now routinely obtain
a TIN for every party from which they make a purchase. The
IRS’ TIN matching program allows a payer to validate
a TIN against a name electronically, but it’s unclear
how much help that will be with vastly more names and TINs
to check.
CPAs can take the lead—both those
who serve businesses internally and those who act as outside
advisers on tax and accounting—in encouraging businesses
that don’t yet have them in place to develop or prepare
their systems and procedures for routinely obtaining and
recording this data for each transaction. Trying to do so
after the fact would be extremely challenging. CPAs can
suggest that their employer or clients plan for appropriate
modifications to their payment vouchers, expense recording
software, and systems for sorting and reporting on expense
transactions to capture this information. The information
can then be used to generate internal reports and will be
readily transferrable to 1099s. Their systems for issuing
1099s will also need to be ready for what could be a many-fold
increase in the number of forms issued.
And what about foreign vendors? It’s
unclear whether any relief will be granted with regard to
obtaining TINs from overseas vendors that are not as likely
as a U.S. vendor to have one. What happens when a traveling
executive makes a business trip to Europe or China? Or when
a clothing manufacturer imports goods from a dozen different
factories in China, after the marketing executives purchased
dozens of locally manufactured samples and brought them
back to the U.S. for inspection? What’s the most efficient
way to uniquely identify the vendors?
SMALL BUSINESSES
Increased recordkeeping could weigh particularly
heavily on small businesses. Users of small business software
do not normally record transactions in a way that would
include a re-sorting of all payments made during the year
by vendor rather than by expense category, even when this
capability is included in the software package. At a minimum,
significant amounts of training and extra time to input
additional data will be required to provide sift-and-sort
capabilities necessary to comply with the new rules. In
some cases, entirely new software will be required.
Ignoring the requirements could lead to
expensive penalties for failure to provide information returns.
Unless a waiver or other relief is granted, a business could
face a $50 penalty under section 6721 for each required
information return it fails to file, or that it files with
incomplete or incorrect information. For an intentional
disregard of the requirement, the penalty could increase
to $100 per return or more. Meeting these requirements will,
nevertheless, be a far less daunting task for those who
plan ahead and who maintain a good expense database from
which they can aggregate purchases by vendor and retrieve
full vendor information.
Senate Finance Committee staff who drafted
this legislation are reported as characterizing the requirement
as a “pay for” to provide $35 billion in tax
cuts for small businesses (the Joint Committee on Taxation
estimates it will raise $17.1 billion in additional revenue
through 2019), but how much will it cost to keep these records?
Will the information be worth the cost of gathering it,
and just what will the IRS do with it?
If called upon to identify all revenues
by customer, small businesses might lack the resources to
prove they did not receive income from customers that used
the wrong identification number. The IRS has historically
presumed that information reporting is correct and left
the burden of proof to the identified recipient. Continuing
that presumption in the face of 1099 proliferation could
present quite a challenge for smaller businesses with fewer
resources to identify all of their revenues by customer.
CPAs with small business clients have to
be proactive to help those clients adapt to these requirements.
They can check to make sure clients’ business software
has all the tools necessary—or will by 2012—to
start accumulating this data and organizing it in real time.
And CPAs are going to have to work with software designers
to make sure that the required information will easily produce
or at least populate government forms.
In fact, it may be helpful to think of this
new reporting regime as similar to payroll accounting. In
a sense, the whole world is going on a payroll system starting
in 2012. Historically, CPAs have been at the forefront of
helping businesses perform payroll processing and tax-related
functions, and here is an opportunity for them to lead in
providing a valuable service.
LARGE BUSINESSES
Large businesses generally maintain so-called
vendor or accounts payable ledgers, so they often already
track such payments. For them, information reporting could
simply involve transferring this information to a Form 1099.
Depending on any relief granted, payments to employees as
vendors for expense reimbursements could minimize the added
burden of accumulating this data for the vendors used by
each employee.
For example, an employee on a business trip
might purchase an airline ticket, stay in a hotel, and eat
at several restaurants. Technically, the employee is simply
a paying agent for the employer, and under the tax law the
expenses reimbursed to the employee are expenses of the
employer.
Assume that other employees also use the
same airlines, the same hotel and the same restaurant. Literal
interpretation of these laws would require the employer
to keep track of each vendor used by each employee, aggregate
all the payments made by all of its employees, and then
report to that airline, hotel or restaurant the sum of all
payments made by the company’s employees. Imagine
trying to reconcile that Form 1099 with the business records
of the vendor, which presumably would also want to make
sure the payments reported to the IRS as being made to that
business are correct and correspond with gross income reported
by the vendor on its income tax return. Business entities
with fiscal years will have the added challenge of having
to reconcile fiscal year data to calendar-year 1099 reporting.
On the receiving end, for the vendor receiving its annual
flurry of transaction-related Forms 1099, matching them
to its records is another task that could require a CPA’s
help.
RELIEF ON
THE HORIZON?
The trend toward enhanced business information
reporting is not new and has drawn increasing attention
in Congress over the past few years. Other recent legislation
is scheduled to go into effect in 2011 (Housing Assistance
Tax Act of 2008) requiring reporting of annual aggregate
payment card and third-party network payments to merchants
using the proposed Form 1099-K (see IRC § 6050W and
REG-139255-08). The regulation writers could provide relief
from reporting under section 6041 for transactions reported
under the credit card payments provisions of section 6050W,
as Shulman indicated in his May 27 speech the IRS plans
to do.
“These transactions will already be
covered by reporting requirements on payment card processors,
so there is no need for businesses to report them as well,”
Shulman said. “So, whenever a business uses a credit
or debit card, there will be no new burden under the new
law.”
While exempting all credit or debit card
payments is well intended, the relief provision could have
a chilling, unintended impact on some small business owners,
as also noted by the National Small Business Association.
Many small businesses could see their customers vanish as
those customers attempt to streamline and minimize the number
of vendors requiring additional reporting. Furthermore,
there are myriad small businesses that either do not accept
credit or debit card payments, or are unable to do so on
a competitive basis with larger companies. Balancing the
interests of efficiency and all parties within the economy
will be a challenging task for the regulation writers.
While the IRS is expected to provide guidance
on the section 6041 requirements, the drafting, exposure
and finalization of any regulation of this magnitude typically
can take a year or more to complete. We can only hope there
will be enough time for the business community to react.
Businesses will certainly have a greater chance of making
a timely transition if CPAs call their business clients’
attention to the reporting requirements and recommend an
immediate assessment of their readiness. Then CPAs also
have an opportunity to help business clients implement compliance
measures. This new transaction reporting regime looms as
a new hurdle for business accounting. It’s a real
business-to-business challenge, but who does business better
than CPAs?