New Tax Rule Will Bury Small Businesses in a Blizzard of 1099s

You might not have noticed, but a sneaky new tax rule was slipped into the recently passed federal health care reform law. It's a change that piles a ton of new paperwork on companies, and it will probably hit small companies harder than their larger counterparts.

Under the current tax code, businesses are required to send 1099s to people receiving payments of $600 or more from them for services rendered.

For the most part, 1099s currently don't need to be sent to companies. The 1099 has been focused on individuals receiving payments for services: The requirement was put in place to make sure that individuals being paid for work would report the income on their taxes.

That all changes in 2012, when businesses will be required to send 1099s to anyone and everyone -- individuals and companies, alike -- that are paid $600 or more for products or services. Maybe that means nothing to you. But it sure means a lot to small business owners. Companies will now have to send 1099s for virtually every product or service they purchase.

Making Sure Everyone Pays Their Fair Share

As a small business owner, I typically send three or four 1099s per year. It is an annoying paperwork exercise done every January, but it's manageable. Under the new rules, I'll have to collect a tax identification number from every person or company I pay. Then in January, I'll have to send them all 1099s. That will end up being 30 to 40 forms, making 10 times as much paperwork for me.

Of course, those who inserted this new rule into the health care law can easily fall back on the fairness argument to defend their actions: "We just want everyone paying their fair share of taxes, and this rule forces people and companies to report all their income."

I don't disagree that taxpayers should honestly report their income and pay the taxes due under the law, and I know that lots of people cheat on their taxes. But this new rule is not the answer. It creates a mountain of paperwork that hurts small businesses disproportionately. It's simply too much work, and experts say that the cost of complying will be far higher than any additional taxes the IRS might collect because of this procedure.

Tax Policy Discourages Entrepreneurship

It's also not the only tax hit small businesses are likely to take in the next couple of years. One proposed change is to levy additional payroll taxes on S-Corporations if their primary asset is the skill and reputation of three or fewer employees. My small business would have to pay this additional tax, but larger companies that provide the same services would be exempt because they have more employees. How's that for unfair to the small business owner?

Politicians far and wide have adopted the stance that more taxes are better for us. Instead of cutting spending appropriately, the politicians spend more and penalize those people and businesses that are perceived as having or making too much money: They can theoretically "afford" to pay more taxes, so let's make them pay more.

The unfortunate result of such a policy is that it discourages people from taking chances on starting new companies. Entrepreneurship is a risky venture, and even if you're one of the few successful business owners, count on the government to target you and take away an ever-increasing portion of your profits. An accounting firm with three employees may be expendable to the politicians, but to those three employees, the jobs are likely priceless.

If the desire is greater tax collections, the best way for our government to achieve that is by lowering the tax burden in a way that encourages entrepreneurship and risk-taking. If we have more businesses generating more income, the tax collections will increase overall. As it stands, every attempt to stick it to business owners hurts the chances of new job creation for enterprising entrepreneurs.