Latest Financial NewsStay tuned for the financial news from all over the World!

The new rules on 1099 forms, which were attached to the health care bill and are set to go into effect in 2012, call for all businesses, no matter how small, to file 1099 forms for goods as well as for services. That sounds like a technicality, but it’s got small business up in arms.

Here’s why it matters, and what you need to know.

What exactly is the rule, anyway?

The new rule requires all business to file 1099 forms for goods as well as services, if those goods cost over $600 annually (the current threshold). It also gets rid of the distinction between corporations, which previously did not need to receive 1099s, and unincorporated entities, which did. The rule is slated to go into effect in 2012.

Who will it affect?

It will affect all businesses, including sole proprietors, consultants, self-employed people and freelancers, who are considered businesses for tax purposes, but may not think of themselves that way. It also will apply to charities and other tax-exempt organizations. The National Taxpayer Advocate, based on Internal Revenue Service data, figures that it will affect 26 million sole proprietorships, 4 million S corporations, 2 million C corporations, 3 million partnerships, 2 million farms, 1 million charities and other tax-exempt organizations, and likely more than 100,000 federal, state and local government entities. All told, that’s more than 38 million taxpayers and taxpaying entities.

What does it mean?

It means that you’d better be ready to track your spending by vendor, and have an easy way of tallying up whether that spending totals more than $600 per year. A business that spends $20 a week on pizza for its employees, for example, would spend a total of $1,040 a yea r— and would need to file a 1099 form to that local pizzeria.

The recordkeeping complexities are mindboggling, and there are still a lot of unanswered questions about how this new rule might be implemented. Internal Revenue Service Commissioner Douglas Shulman has said that the agency will look to exempt transactions done with credit or debit cards. While a credit-card exemption would provide significant relief to many small businesses, it could create its own recordkeeping issues (businesses would then need to distinguish between payments made by card and those done by cash or check to the same vendor) and it could also wind up unintentionally hurting businesses that do not accept credit cards.

The National Taxpayer Advocate Nina Olson notes in her latest report to Congress that the new rules “could have distortionary effects on taxpayer behavior,” because large vendors can more easily track purchases on their computerized accounting systems, while small businesses cannot. “It’s a headache, there are increased costs, and I think there is also significant concern about how they will implement it,” says Dena Battle, director of tax policy at the National Association of Manufacturers, one of the business groups that has pushed for repeal.  “Any time you have these ‘tax gap’ provisions, there are gigantic unintended consequences.”

How did it come to pass?

Federal lawmakers have been looking for ways to close the “tax gap,” the more than $300 billion chasm between what Americans owe in taxes and what they actually pay. This provision was included in the health care legislation, one of more than a dozen revenue-raising measures in that bill. The Joint Committee on Taxation has estimated that it will bring in $17 billion in tax revenues over 10 years.

Will it actually go into effect, or might we see some relief?

The National Federation of Independent Business and a slew of other small-business groups have called for the provision’s repeal. But recent proposals in Congress to get the 1099 reporting requirements repealed or changed have thus far failed to pass. Republican Senator Mike Johanns of Nevada sponsored legislation that would have eliminated the 1099 requirement, while Democratic Senator Bill Nelson of Florida proposed legislation that would have exempted businesses with fewer than 25 workers and raised the reporting threshold to purchases over $5,000.

With all tax legislation now stalled until after the mid-term elections, and bigger tax questions to be dealt with before yearend, it’s unclear what might happen to this rule between now and when it’s slated to go into effect.

What are some of the potential complications?

As with most things tax, the complications are in the details, and the recordkeeping complexities. For example, how will you track that $600, if you spend it at multiple locations of the same business? What if some payments are made by check and others by credit card to the same vendor? What about returns? Will a business be required to send 1099 forms to its electricity provider or to its landlord? Get into the thorny details, and the questions — largely unanswered — seem endless. For sole proprietors, who use Social Security numbers for tax purposes, the new rule also raises the potential for identity theft, especially if that number becomes public through printing on receipts, according to the National Taxpayer Advocate. As Steve Henley, a national practice leader at financial consultancy CBIZ MHM, says: “It is a tremendous new administrative burden, and it is so senseless.”

Are there penalties for messing up?

Yes. A business can be fined $50 for every 1099 it fails to report, and that amount can rise to $100 if the failure to file was considered “intentional.” Also, businesses would be required to withhold taxes at a rate of 28% from vendors who fail to supply their taxpayer identification numbers.

What can I do to prepare?

If you’re running a start-up or one-person operation that doesn’t already have a separate business credit card, get one. To comply with the rule, you’ll need to be sure that you have the legal name, address and taxpayer identification of each of your vendors on file. If you don’t, you’ll want to take some time in 2011 to send Form W-9s out to all of them in order to gather this information. Keeping tabs of all this information will be much easier if you’ve got computerized accounting software that can track payments by vendor and tally them up — distinguishing between credit-card payments and cash or checks — so that come yearend you’ll know who needs to get a 1099. If you don’t have such software, you’ll need to come up with an alternate method to track this information.

Photo: April 15, 2009 at the IRS tax office in New York City. REUTERS/Lucas Jackson

Similar Posts:

• Small business bill passes, now what?
• Election Year Spurs Small Business Giveaways
• Tax Compliance Now Takes More Than 7 Billion Hours
• The Costs of Hiding From Vendors
• New Health Care Tax Credit Encourages Small Businesses to Provide Coverage