The Hidden Tax Change in Health Care Bill

May 8th, 2010 by Lee Eldridge

Congress and the Tax Code

This is what happens when politicians with little understanding of business are in charge of tax policy. According to a recent article on CNN.com:

Section 9006 of the health care bill — just a few lines buried in the 2,409-page document — mandates that beginning in 2012 all companies will have to issue 1099 tax forms not just to contract workers but to any individual or corporation from which they buy more than $600 in goods or services in a tax year.

The stealth change radically alters the nature of 1099s and means businesses will have to issue millions of new tax documents each year.

Before we get into this, let me tell you a little about my dad. My dad thought he was good with money. And to his credit, he had a few periods in his life where he made quite a bit of money. But he also had a couple periods of his life where he lost virtually everything. He had a gambler mentality. But not the smart gambler mentality that told him when to walk away. He was the gambler that never knew when to stop. And he refused to learn from his mistakes.

Dad understood that it took spending money to make money. But he had no concept of diminishing returns. This is an over-simplified explanation of diminishing returns.

Let’s say as a business owner you can spend $100 on materials and labor, make a product, and sell it for $200. That’s a $100 profit. That’s good.

Then you discover you can build a better product for $130, and sell it for $300. That’s $170 profit. You not only increased your profit by $70, you increased your cost by only $30. That’s even better.

There becomes a point where diminishing returns kick in. Let’s continue with the example and build an even better product. Your cost is now $250. And you can sell this product for $500. On first glance this looks good. You’ve now made a $250 profit. But it’s not as good as it sounds. You’ve spent an additional $120 to increase your profit by $80.

That’s diminishing returns.

My dad never understood diminishing returns.

Neither does the federal government.

So let’s get back to this new tax policy where every business must generate 1099s for every individual AND every corporation from which they buy more than $600 in goods or services in a tax year.

The Burden of Creating the 1099s
I own a very small business, and I may have one hundred vendors which I will pay $600 or more every year. I will have to contact every one of my vendors to obtain their EIN numbers and enter their information into QuickBooks. At the end of the year I will have to print 1099s for these vendors, stuff them into envelopes, stamp them, and mail them. How much time will this take? That will largely depend on how easy and responsive my vendors are in providing the information I need. I will guestimate that I’ll have a good 50-60 hours into this project in the first year, plus expenses.

That’s 50-60 hours I can’t spend growing my business. And I’m a very small business. Multiply that out across the country for EVERY business, big and small. How many businesses are there in our country? How many hours of time to gather the required information and process it? How many millions of documents will be printed? How much postage will be used to mail millions of documents? What about the resources used to do all of this? I don’t know. I guarantee that it will be substantial.

The Burden of Receiving the 1099s
Now this also means that most of my customers will be issuing me 1099s. I will have to provide them with my EIN number upon their request. And every year I’ll receive a few dozen 1099s from my customers that I’ll include with all of my tax information to my accountant. This won’t be much of a burden for me personally. As I said, I’m a very small business.

But what about larger companies? What about Dell? Office Depot? Holiday Inn? They will receive tens of thousands of 1099s in the mail every year. If not more. They will have costs involved both in sending 1099s to their vendors, as well as processing the 1099s they receive from their business customers.

Who pays for this? Oh yeah, the customer. Dell doesn’t just absorb these new costs and move along. Their are repercussions. And the repercussions will either be in increased prices for their products, or financial cuts elsewhere to compensate for the new expenses.

Diminishing Returns
Now you’ve probably been wondering why I started this post talking about my dad and explaining diminishing returns. The question becomes, what is the net result of this tax policy change?

According to the same CNN article, the IRS estimates that the federal government loses more than $300 billion each year in tax revenue on income that goes unreported. This is the government’s attempt to collect a portion of this tax revenue.

But how much can they truly expect to increase in their tax collections with this policy change? Who will pay more in taxes and have to declare money that had previously gone unreported? Or under-reported?

Not Dell. They report their income. Receiving potentially hundreds of thousands of 1099s will not change the amount of income they report. What about Holiday Inn? What about Office Depot? What about IHOP? What about me? Nope. I already report all of my income. And I suspect that most of these other companies do as well. But even if a large company is purposefully under-reporting their income, would we really expect a change in their behavior resulting from receiving these 1099s? I wouldn’t think so. They would still find a way to under-report their income.

I don’t have a problem believing that the IRS fails to collect a lot of money due to unreported income. But which businesses will actually feel compelled to declare more, or all, of their income who aren’t doing so already? Whose behavior will this tax policy change?

One, it would have to be a business who does most of their work for companies, not individuals, as they would only be receiving 1099s from companies. And two, a company who is actively under-reporting their income who would feel at risk if they continued this behavior. I can only imagine that this scenario fits a very small set of very small businesses. Large companies currently cheating on their taxes will continue to find ways to cheat on their taxes. And that’s probably true for most small companies as well. I don’t expect this tax policy change to net the IRS a significant increase in tax revenues. And we haven’t even discussed the new burden on the IRS of receiving millions of new 1099s to process.

So once again, what’s the net result? I couldn’t find anything online that discussed this in detail, or broke down increased costs versus increased tax revenues. Though I didn’t really expect to find anything. Common sense tells me that it will cost business significantly more than it will net the IRS in increased tax revenues.

But our politicians don’t care about diminishing returns. They don’t care if it costs business $100 for them to increase tax revenues by $10. After all, it wasn’t their $100 that was spent for them to receive the $10. It was ours.

Cartoon from Stus.com.

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2 Responses to “The Hidden Tax Change in Health Care Bill”

  1. Bobby Says:

    Yowza. Do they ever think through their actions? Our tax policy needs a complete overhaul, and they just keep making it worse.

  2. Lee Eldridge Says:

    Yes it does. But I think this is what happens (at least in this case):

    The politicians are sitting around trying to figure out how to pay for health care. They talk about the fact that there are people and businesses who do not report all of their income, and therefore, don’t pay all of the taxes they should pay. And so their solution is to make all businesses process 1099s for everybody and every company they pay more than $600 to in a tax year. (We already do this for individuals such as freelancers and contractors.)

    So in their eyes, the IRS will collect more in tax revenues. And this helps to pay for health care. To them it’s that simple. These are not business people. They’re politicians. They certainly haven’t thought out the ramifications for businesses and the economy.

    I had one friend tell me yesterday this will be good for small business. How? I just cannot picture a scenario where the IRS will collect more in tax revenues than what this will cost business. Maybe I’m wrong. It’s happened before. But I’d like to see someone describe a credible scenario where the IRS will collect billions in new revenue, because that’s what it will take to offset the burden they’ve put on business.