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Treasury Explains Administration's Fiscal Year 2010 Revenue Proposals

On May 11, 2009, the U.S. Treasury Department released its explanation of the Obama Administration’s fiscal year 2010 revenue proposals. An abridged version of the Treasury Department’s explanation of each of the proposals that affect independent contractors is provided below, followed by commentary.

1.            Require Information Reporting on Payments to Corporations

A.   Current Law

Generally, a taxpayer making payments to a recipient of $600 or more for services or determinable gains in the course of a trade or business in a calendar year is required to report the payments on an information return (generally Form 1099). Treasury regulations contain certain exceptions for payments to corporations.

B.   Reasons for Change
Generally, compliance increases significantly for payments that a third party reports to the Internal Revenue Service (“IRS”). During the decades in which the regulatory exception for payments to corporations has existed, the number and complexity of corporate taxpayers have increased, which has created compliance issues.

C.  Proposal
A business would be required to file an information return for payments of $600 or more in a calendar year to a corporation (except a tax-exempt corporation).
The proposal would be effective for payments made to corporations after December 31, 2009.

D.  Commentary
A proposal to impose Form 1099 reporting duties with respect to payments made to corporate payees has been considered many times, and rejected.  While IRS data establish a powerful correlation between information reporting and tax compliance, this proposal is overly broad.

The proposal would inundate the IRS with Form 1099 information and the information most likely could not be meaningfully matched by the IRS, unless the corporate income tax return, Form 1120, were modified:

•    to separately report business-to-business income, since consumer payors would still have no Form 1099 reporting obligation, or

•    to separately list the Form 1099 amounts, as is the current practice for individuals who report interest and dividend income on Schedule B to their individual income tax return, Form 1040 (to enable the IRS to match each Form 1099 amount with a corresponding amount reported on the corporate payee’s Form 1120).   

While a more carefully targeted proposal might be more feasible, the principal difficulty with that type of proposal, e.g., targeting incorporated independent contractors, is that it would impose a different type of compliance burden on purchasing businesses, namely, to ascertain whether or not a prospective services vendor is subject to the new information-reporting duty.

2.             Require a Certified Taxpayer Identification Number from Contractors and Allow Certain Withholding

A.   Current Law
In the course of a trade or business, service recipients (“businesses”) making payments of $600 or more in a calendar year to any non-employee service provider (“contractor”) that is not a corporation are required to report the payments on a Form 1099, which includes the contractor’s taxpayer identification number (“TIN”). A contractor generally provides its TIN on a Form W-9.

Withholding is not required or permitted for payments to contractors. Since contractors are not subject to withholding, they may be required to make quarterly payments of estimated income taxes and self-employment (“SECA”) taxes near the end of each calendar quarter. The contractor is required to pay any balance due when the annual income tax return is subsequently filed.

B.   Reasons for Change
Without accurate TINs, information reporting requirements cannot reach their potential to improve compliance.

Estimated tax filing is burdensome for less sophisticated and lower-income taxpayers. Moreover, by the time estimated tax payments (or final tax payments) are due, some contractors will not have the necessary funds.

An optional withholding method for contractors would reduce the burdens of having to make quarterly payments and help increase compliance.

C.  Proposal
A contractor receiving payments of $600 or more in a calendar year from a particular business would be required to furnish to the business a Form W-9 with the contractor’s certified TIN. A business would be required to verify the contractor’s TIN with the IRS. If a contractor fails to furnish an accurate certified TIN, the business would be required to withhold a flat-rate percentage of gross payments.

Also, contractors receiving payments of $600 or more in a calendar year from a particular business could require the business to withhold a flat-rate percentage of their gross payments, with the flat-rate percentage of 15, 25, 30, or 35 percent being selected by the contractor.

The proposal would be effective for payments made to contractors after December 31, 2009.

D.  Commentary



i.    TIN Verification
Requiring a client company to verify the TIN provided by an independent contractor would be welcomed by some firms, but opposed by others and by independent contractors who do business with such other firms.

Services brokers that are in the business of conducting background screening and credential verification of self-employed service providers might welcome such a requirement, as such firms could simply add the verification requirement to its credentialing process. Such firms typically attach a high value to resolving all credentialing issues at the outset, and avoiding subsequent problems such as a TIN mismatch.

Companies that simply seek to purchase services from a vendor, and can choose to purchase the services from either a corporate vendor or an independent contractor, might react to such a new requirement by eschewing the self-employed vendors in favor of corporate vendors, in order to avoid the TIN verification requirement. The independent contractors who do business with such firms could lose those clients and, accordingly, would likely oppose such a requirement.

Another type of firm that would likely oppose this proposal is a firm that does business with a very large number of independent contractors, where each independent-contractor transaction involves a relatively modest payment amount. For these firms, the cost associated with TIN verification could be excessive relative to the payment amount involved, and the firms would likely discontinue their relationships with the individuals who produce minimal payment amounts. This could lead to many individuals who want to participate in such an industry, albeit on a limited basis, being denied access to the opportunity. 

Also joining the opposition to such a proposal would be a firm that requires very rapid ramping up of independent contractors for specific client projects, and the verification requirement could slow the process. 

One possible approach would be to make the TIN verification process available, but voluntary.

ii.   Elective Tax Withholding
The withholding proposal is fundamentally misdirected. IRS data indicate that the tax compliance rate for Form 1099 recipients is 97%: only 2 percentage points lower than for recipients of Forms W-2, which is 99%. The compliance rate drops significantly in the absence of information reporting.  Thus, to impose tax withholding on Form 1099 recipients is to increase the burden on a segment that is already 97% compliant, and completely miss payees who have a lower compliance rate.

Permitting independent contractors who are unable or unwilling to comply with their own tax obligations to shift those burdens onto their clients is inequitable, rewards irresponsibility and diminishes any sense of individual responsibility.

Creating an independent-contractor tax withholding infrastructure would set a dangerous precedent, as such an infrastructure would facilitate a subsequent iteration that could transform a voluntary withholding program into a mandatory withholding program. Mandatory tax withholding on independent contractors can be the beginning of the end of the tax-law distinctions that separate independent contractors from employees.

If independent contractors are not complying with their estimated tax obligations, it is the responsibility of the IRS to follow-up with those independent contractors and to take appropriate enforcement action. For the IRS to further outsource this function to the business community is unfair to the client companies and legitimate independent contractors who do business with those companies.

This new burden will effectively penalize firms for doing business with independent contractors, and cause many affected firms to cease doing business with independent contractors, in order to avoid that penalty. The ultimate victims would be the legitimate independent contractors who end up losing clients who refuse to continue doing business with independent contractors in order to avoid exposure to the new withholding duty.


3.             Require Increased Information Reporting for Certain Government Payments for Property and Services

A.   Current Law
Generally, a taxpayer making payments of $600 or more for services in the course of a trade or business in a calendar year is required to report such payments (generally on Form 1099), unless the recipient is a corporation.  This requirement specifically applies to government agencies, even if the service provider is a corporation. Moreover, Federal agencies must file information returns with respect to contractors, generally on Form 8596 and Form 8596A. Under recently enacted legislation that will take effect in 2012, Federal, State and local government agencies generally must withhold 3 percent of payments for goods or services. Exceptions apply to certain payments such as those actually subjected to backup withholding, wages and public assistance.

B.   Reasons for Change
Generally, compliance increases significantly for payments that a third party reports to the IRS. Some government vendors fail to meet their tax filing and payment obligations.

C.  Proposal
The IRS and Treasury Department would be authorized to promulgate regulations requiring information reporting on all non-wage payments by Federal, State and local governments to procure property or services. It is expected that certain categories of payments would be excluded from the new information reporting requirements.

The proposal would be effective for payments made after December 31, 2009.

D.  Commentary
The commentary concerning this proposal is similar to that concerning the proposed imposition of Form 1099 reporting for payments to corporate payees. While in concept the proposal is constructive, it is arguably overly broad.

Also, in light of Internal Revenue Code (the “Code”) section 3402(t), which, effective January 1, 2012, will require tax withholding at the initial rate of 3% from payments made by federal, state and local government agencies for purchases of goods and services, this information-reporting proposal will be redundant once the tax-withholding provision becomes effective.

A better proposal would be for the proposed new information-reporting duty to replace the tax withholding provision contained in Code section 3402(t).

4.             Increase Information Return Penalties

A.   Current Law
There are a number of information reporting requirements under the Code. If a person subject to the information reporting requirements files a correct information return after the prescribed filing date, but on or before the date that is thirty days after the prescribed filing date, the amount of the penalty is $15 per return (the “first-tier penalty”), not to exceed $75,000 per calendar year.

If such a person files a correct information return more than thirty days after the prescribed filing date but on or before August 1, the amount of the penalty is $30 per return (the “second-tier penalty”), not to exceed $150,000 per calendar year.

If such a person does not file a correct information return on or before August 1, the amount of the penalty is $50 per return (the “third-tier penalty”), not to exceed $250,000 in a calendar year.

For certain small filers whose average annual gross receipts do not exceed $5,000,000, the maximum calendar year limit is $25,000 (instead of $75,000) for the first-tier penalty, $50,000 (instead of $150,000) for the second-tier penalty, and $100,000 (instead of $250,000) for the third-tier penalty.

If a failure is due to intentional disregard of a filing requirement, the minimum penalty for each failure is $100, with no calendar year limit.

B.   Reasons for Change
Generally, compliance increases significantly with respect to amounts reported on information returns. Increasing the penalty amounts, which were established in 1989 and have not been increased, will help to ensure the timely filing of accurate information returns.

C.  Proposal
The first-tier penalty would be increased from $15 to $30, and the calendar year maximum would be increased from $75,000 to $250,000. The second-tier penalty would be increased from $30 to $60, and the calendar year maximum would be increased from $150,000 to $500,000. The third-tier penalty would be increased from $50 to $100, and the calendar year maximum would be increased from $250,000 to $1,500,000.

For small filers, the calendar year maximum would be increased from $25,000 to $75,000 for the first-tier penalty, from $50,000 to $200,000 for the second-tier penalty, and from $100,000 to $500,000 for the third-tier penalty. The minimum penalty for each failure due to intentional disregard would be increased from $100 to $250. The proposal would also provide that every five years the penalty amounts would be adjusted to account for inflation.

The proposal would be effective for information returns required to be filed after December 31, 2010.

D.  Commentary
While one always could argue that penalties are too high or too low, this proposed change is certainly a change in a constructive direction.  IRS data establish a clear correlation between information reporting and tax compliance. Thus, the creation of an enhanced incentive to comply with information reporting obligations is salutary.

Nonetheless, while a doubling of the penalty amounts might be appropriate, it seems inappropriate to increase the maximum penalty amounts by a higher multiple.

While taxpayers hitherto have been willing to assist the IRS in performing its tax administration function, it seems inequitable to subject taxpayers to draconian sanctions for information-reporting mistakes. Thus, at most, the maximum penalty amounts should be increased by the same 100% as the underlying penalties.