The Increasing Importance of Information Reporting in Today's Economy; U.S. Information Reporting to U.S. Persons – Payments Subject to Backup Withholding

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By Carol Kassem, Esq.
Fletcher, NC

In today's current economic environment, information reporting is becoming significantly more relevant as Congress scrambles to fund spending programs and stimulus packages. When the issue of increasing tax revenues is raised, most taxpayers assume that the intent of Congress is to increase the personal income tax rates. However, significant revenues can be generated through information reporting, a process that requires payers to report certain payments to recipients on Forms 1099. This same information is also filed with the IRS who will match the information filed on Forms 1099 with personal tax returns filed by payees and recipients. Payers are quickly becoming aware that information reporting has never been more important than it is today.

As budget deficits rise at the national level, Congress continues its efforts to close the tax gap by enacting legislation to bring errant taxpayers into compliance and reduce the issue of taxpayer underreporting. Typically, an increase in information reporting results in greater compliance within the taxpayer community, thereby generating additional tax revenues that can be used to offset additional government spending. A general misconception among taxpayers is that any payments not reported on a Form 1099 are not includible in their tax returns. Thus, significant revenues comprised of payments not required to be reported on Forms 1099 coupled with payments that cannot be easily tracked, i.e., cash payments, do not get reported to the IRS and ultimately escape taxation. In an effort to capture these unreported transactions, Congress and the IRS are consistently focused on identifying payments that should be reported and potentially included in gross income. Under the current information reporting regime, the payer's burden to report a multitude of transactions is already significant. The challenge for the payer or filer going forward is to stay current with respect to new changes so as to make appropriate modifications to internal systems and procedures to ensure compliance.

Of special interest relative to information reporting are two provisions that could ultimately have a dramatic impact on certain payers or filers. The first provision was attached to H.R. 3962, The Affordable Health Care for America Act, as passed by the House of Representatives that would have required payers to report payments of gross receipts (goods and services) made to corporations who have historically been exempt from this reporting requirement. This provision was originally introduced as part of H.R. 3408, Taxpayer Responsibility, Accountability, and Consistency Act of 2009, to require reporting payments to corporations for services only. Currently, a payer is only required to report payments for services made to nonexempt persons which excludes corporations. Support for this change suggests that corporations who receive Forms 1099 would be more inclined to report certain income transactions in their returns that may have otherwise been excluded. In addition to the added burden of reporting, a payer may be required to impose backup withholding when making payments to a corporation who has not provided a valid taxpayer identification number. This 28% withholding is particularly onerous given that the payments subject to this tax would be gross receipts, not just payments for services.

Another provision of H.R. 3408 that has been introduced in the last two Congressional sessions is a proposal to materially increase the current amount of penalties that may be assessed for failures to file correct information returns with recipients and the IRS. Failures may include providing incorrect Forms 1099 to recipients, filing incorrect information with the IRS, or filing information returns past the due dates for timely filing. For example, a payer may currently be assessed a $50 penalty for failing to file a correct information return. Under the new proposed legislation, this same penalty would be $250 for each failure. These requirements include a variety of penalties which means that a payer may be subject to multiple penalties. This proposed change is so significant that the passage of this legislation could potentially bankrupt a filer who has not complied with the appropriate filing requirements and becomes subject to one or more of the penalties covered by this provision.

Although neither provision has been passed by Congress, the potential revenue that could result from passage of either of these bills is too significant for the provisions not to be re-introduced in the near future. However, the requirements of these provisions could be rewritten before they are introduced again. Irrespective of the final form that these provisions take, the underlying premise in both cases will remain the same — information reporting for corporations should be required, and an increase in penalties for incorrect reporting is long overdue.

The significance of information reporting cannot be overly emphasized. There is no doubt that the number and types of payment transactions required to be reported will only increase in the future as Congress and the IRS strive to improve taxpayer compliance and close the tax gap. Filers and payers should make every effort to stay abreast of the most recent reporting requirements in an effort to be compliant and avoid potential penalties.

For more information, in the Tax Management Portfolios, see Tarr and Drucker, 634 T.M., Civil Tax Penalties, and in Tax Practice Series, see ¶3820, Tax Returns and Information Returns.