	Background

As we reported in 2009, more than 5 million third parties submitted more  than 82 million miscellaneous income information forms (Form 1099- MISC) to the IRS reporting more than $6 trillion in payments for tax year  2006. The types of payments reportable on a Form 1099-MISC—shown in figure  1—and their reporting thresholds vary widely. By matching 1099-MISCs received from payers with what payees report on  their tax returns, IRS can detect underreporting of income including  failure to file a tax return. 1099-MISC Information Reporting Increases Voluntary Taxpayer Compliance, Reduces the Cost and Intrusiveness of IRS Compliance Programs, and May Reduce Payees’ Costs of Preparing Their Tax Returns

Third-party information reporting is widely acknowledged to increase  voluntary tax compliance in part because taxpayers know that IRS is  aware of their income. IRS has long  recognized that if payments made to businesses are not reported on 1099- MISCs, it is less likely that they will be reported on payee tax returns. IRS  estimated the gross tax gap—the difference between what taxpayers  actually paid and what they should have paid on a timely basis—to be $345  billion for tax year 2001, the most recent estimate made. Of  this, IRS estimated that $68 billion was caused by sole proprietors  underreporting their net business income. In the report, we noted that a key reason  for this noncompliance was that sole proprietors were not subject to tax  withholding, and only a portion of their net business income was reported  to IRS by third parties. The 1099-MISCs are a powerful tool through which IRS can encourage  voluntary compliance by payees and detect underreported income of  payees that do not voluntarily comply. To help IRS improve its use of 1099-MISC  information, we recommended in 2009 that IRS collect data to help refine  its matching process and select the most productive cases for review. IRS does not know the magnitude of 1099-MISC payer noncompliance or  the characteristics of payers that fail to comply with the reporting  requirements. Third Parties Incur Costs to File 1099- MISCs, but Case Study Entities Reported That the Costs of Complying with Current Requirements Were Relatively Low

Existing information reporting requirements impose costs on the third- party businesses required to file Form 1099-MISC. In the nine case studies we conducted in 2007, filers of information returns  told us that existing information return costs, both in-house and for  external payments, were relatively low. While these nine case studies are  not to be generalized to the entire population, they do provide examples of  costs and insights from the perspective of organizations of different sizes  and from different industries and of organizations filing their own  information returns and those filing on behalf of others. One small business employing under five people told us of possibly  spending 3 to 5 hours per year filing Form 1099 information returns  manually, using an accounting package to gather the information. Two external parties selling services reported prices  for preparing and filing Forms 1099 with IRS of about $10 per form for 5  forms to about $2 per form for 100 forms, with one of them charging about  $0.80 per form for 100,000 forms. These prices do not include the payers’  recordkeeping costs. According to IRS, advisory group members, and others we  interviewed for our 2009 report, payers are confronted with a variety of  impediments to preparing and submitting 1099-MISC forms. Opportunities Exist to Mitigate the Burden and Promote Reporting Compliance for Third Parties Submitting 1099-MISC Information Returns

Although businesses will face additional costs for each additional Form  1099, some options for modifying the 1099-MISC reporting requirements  could help mitigate the burden and promote payer reporting compliance. Some options to change 1099-MISC reporting  requirements require congressional action, and other options would be  costly for IRS to implement. To reduce the submission burden facing many payers submitting small  numbers of 1099-MISCs, we also recommended that IRS evaluate the cost- effectiveness of eliminating or relaxing the red ink requirement to allow  payers to submit computer-generated black and white 1099-MISCs. Our prior work did not assess requiring 1099-MISC reporting on payments  for goods.
Why GAO Did This Study

Third parties, often businesses, reported more than $6 trillion in miscellaneous income payments to the Internal Revenue Service (IRS) in tax year 2006 on Form 1099-MISC. Payees are to report this income on their tax returns. It has been long known that if these payments are not reported on 1099-MISCs, it is less likely that they will be reported on payee tax returns. In 2010, the reporting requirements were expanded to cover payments for goods and payments to corporations, both previously exempt, beginning in 2012. This testimony summarizes recent GAO reports and provides information on (1) benefits of the current requirements in terms of improved compliance by taxpayers and reduced taxpayer recordkeeping, (2) costs to the third-party businesses of the current 1099-MISC reporting requirement, and (3) options for mitigating the reporting burden for third-party businesses. GAO has not assessed the expansion of 1099-MISC reporting to payments for goods.

What GAO Found

Information reporting is a powerful tool for encouraging voluntary compliance by payees and helping IRS detect underreported income. Also, information reporting may sometimes reduce taxpayers' costs of preparing their tax returns, although by how much is not known. IRS estimated that $68 billion of the annual $345 billion gross tax gap for 2001, the most current available estimate, was caused by sole proprietors underreporting their net business income. A key reason for this noncompliance was that sole proprietors were not subject to tax withholding and only a portion of their net business income was reported to IRS by third parties. The benefits from information reporting are affected by payers' compliance with reporting requirements and IRS's ability to use the information in its process that matches third-party data with tax returns. However, IRS does not have estimates of the number or characteristics of payers that fail to submit 1099-MISCs as required. To improve its use of 1099-MISC information, IRS has collected data to help identify ways to refine its matching process and select the most productive cases for review, as GAO recommended in 2009. Current 1099-MISC requirements impose costs on the third parties required to file them. The magnitude of these costs is not easily estimated because payers generally do not track these costs separate from other accounting costs. In nongeneralizable case studies conducted in 2007 with four payers and five vendors that file information returns on behalf of their clients, GAO was told that existing information return costs were relatively low. One small business employing under five people told GAO of possibly spending 3 to 5 hours per year filing Form 1099 information returns manually, using an accounting package to gather the information. Two vendors reported prices for preparing and filing Forms 1099 of about $10 per form for 5 forms to about $2 per form for 100 forms, with one charging about $0.80 per form for 100,000 forms. However, these prices did not include clients' recordkeeping costs. Payers face a variety of impediments preparing and submitting 1099-MISC forms, including complex rules and an inconvenient submission process. For example, payers must determine whether payees are incorporated, must get the payees' taxpayer identification number, and must use special forms if filing on paper. A variety of options exist for mitigating the costs of filing Form 1099-MISC. Most have pros and cons. IRS has already exempted payments, including those paid by credit card, which will be reported to IRS by other means. Other options include improving IRS guidance and education; adding a check-the-box question to business tax forms that would force return preparers to ask their clients whether they have complied with 1099-MISC reporting requirements; waiving late submission penalties for first-time payers; raising the payment reporting threshold; initially limiting the types of payments covered; having IRS develop an online filing capability; and allowing paper filers to submit computer-generated black and white 1099-MISCs rather than IRS's printed forms.

What GAO Recommends

GAO is not making new recommendations in this testimony. In 2009, GAO suggested that Congress consider requiring payers to report service payments to corporations. GAO did not study reporting of payments for goods. Other prior GAO recommendations included ways for IRS to improve its use of 1099-MISC information received. IRS agreed with six of eight recommendations and is taking action to address them.