Most companies are familiar with the IRS rules that require reporting certain payments on annual IRS Form 1099 information returns. A little-noticed provision of the recent Health Care Reform Law is substantially changing the IRS information reporting regime and will cause businesses new administrative burdens and produce a flood of new tax paperwork. While the new rules do not apply to payments made before 2012, it is not too early to start focusing on how to deal with them.

For many businesses, the new rules will require issuing Form 1099s for all sorts of business payments that they never had to worry about before. In addition, the IRS will receive Form 1099s detailing how companies spend money on a whole new range of business expenses. However, the Health Care Legislation did not require IRS Form 1099 reporting of payments that are made for non-business reasons.

Three principal changes are made in the IRS information reporting program:

  • Payments to corporations are now required to be reported.
  • Payments for purchases of property are now required to be reported.
  • Payments of "gross proceeds" will now be required to be reported.

Present IRS Information Reporting Rules

Background: For many years, businesses have been required to report various payments on different versions of Form 1099. For instance, when a business pays $600 or more during a calendar year to an independent contractor for services, the business must issue the contractor a Form 1099-MISC that reports the amount paid that year. The business must also furnish a copy of the Form 1099-MISC to the IRS. This reporting procedure helps independent contractors remember to include the payments on their tax returns, and it helps the IRS ensure that income is reported.

Other types of payments that businesses must report on IRS Forms 1099 include:

  1. Commissions, fees or other compensation paid to a single recipient when the total amount paid in a calendar year is $600 or more.
  2. Interest, rents, royalties, annuities and income items paid to a single recipient when the total amount paid in a calendar year is $600 or more.

When an IRS Form 1099 is required, it must contain:

  • The total amount for the calendar year;
  • The name and address of the payee;
  • The tax ID number ("TIN") of the payee;
  • Contact information for the payor; and
  • The payor's TIN.

If the particular company does not have a payee's TIN, the business may be required to institute back-up federal income tax withholding at a 28% rate on payments under the Internal Revenue Code.

Since they are generally considered to be businesses for IRS Form 1099 reporting purposes, the rules summarized also apply to payments made by non-profit entities.

If a business–payor fails to issue a proper IRS Form 1099, the IRS will assess a $50 penalty. The penalty for any intentional failure can be $100 or more.

Reporting Payments to Corporations

Under the rules that currently apply, most payments to corporations are exempt from Form 1099 reporting requirements. However, there are a few exceptions. For instance, payments of $600 or more in a calendar year to an incorporated law firm must be reported on Form 1099-MISC.

Reporting Payments for Property

Under current rules, there also is generally no requirement to issue 1099s to report payments for purchases of property (such as merchandise, raw materials and equipment).

2012 Changes on IRS Information Reporting

The Health Care Law made two big changes to the existing Form 1099 reporting rules and a third change that is hard to evaluate until the IRS provides further guidance.

First Change: Payments to Corporations Must Be Reported. Starting in 2012, if your business pays a corporation $600 or more for tangible property or services in a calendar year, you must report the total amount on an information return. Presumably, Form 1099-MISC will be used for this purpose, or the IRS will develop a new form. (Payments to corporations that are tax-exempt organizations will be exempt from this new requirement.)

Second Change: Payments for Property Must Be Reported. Starting in 2012, if your business pays $600 or more in a calendar year to any party (including an individual) as "amounts in consideration for property," you must report the total payments on an information return for that year. The term "property" means computer equipment, office supplies, raw materials and just about anything else you can put your hands on. Again, Form 1099-MISC might be used to report the payments, or a new IRS form might be created.

Third Change: Payments of "Gross Proceeds" Must Be Reported. Under a third new rule that will also take effect in 2012, payments of $600 or more in "gross proceeds" to a payee in a calendar year must be reported on an information return. At this point, it is unclear what this new reporting requirement is meant to cover. The definition of gross proceeds should not include any costs that would not be included as income to the recipient of the proceeds. An example would be state and local taxes, which would be in the purchase transaction, but the recipient of the payment is merely a collector and remitter of such taxes. Like non-income payments also should be excluded as “gross payments” in the new IRS information reporting. More IRS clarification on the "gross proceeds" question needs to be forthcoming.

Key Points

The Health Care Bill made key changes in how IRS 1099s are used. First, it expanded the scope by using them to track payments not only for services but also for tangible goods. Second, it requires that IRS Form 1099s be issued not just to individuals but also to corporations.

These seemingly small changes will generate millions of additional IRS information forms to be received and sent out. It creates a heavy administrative burden.

Companies need to do four things:

1. The final impact of the law will be "flushed out" by IRS rulings and regulations on the new law. Businesses should carefully track IRS developments such as the recently issued IRS Notice 2010-51, requesting comments on open issues for the new IRS information reporting rules. Some of these unanswered questions include:

  • The appropriate scope of the statutory terms "gross proceeds" and "amounts in consideration for property," and how to interpret these terms to minimize duplicate reporting;
  • Whether or how the expanded IRS reporting requirements should apply to payments between related corporations, such as payments related to intercompany transactions within the same consolidated group;
  • The appropriate time and manner of reporting to the IRS (cash or accrual accounting and fiscal or calendar year), and what, if any, changes are needed to existing practices for the new IRS Form 1099 information reporting;
  • Changes that might be needed to Form W-9, Request for Taxpayer Identification Number and Certification, and the existing rules for soliciting TINs to minimize the burden for business-payors to get TINs from payees, as well as privacy concerns with TINs; and
  • How the back-up withholding requirements for missing TINs under the expanded new IRS reporting requirements should be administered in order to minimize the burden on payors.

2. Companies need to be evaluating how their existing computer software will accommodate the new IRS reporting regime.

3. Review your business's procedures for obtaining a TIN from each payee to avoid the requirement for back-up withholding of federal income tax.

4. Since this is a new federal information program, most, if not all, states have not enacted similar programs. However, with the economic downturn and shrinking budgets, many states will enact similar or “piggyback” proposals and these must be monitored to ensure compliance.