It is common knowledge that the tax collection system of the United States is based on voluntary compliance with its tax code and that there are penalties imposed on those who fail to report, or report incorrectly, their income. The difference between the amount of taxes which should be collected and are actually paid or reported is known as the tax gap. In April, 2012, the General Accounting Office of the United States (GAO) reported that the tax gap in 2006 was approximately 450 billion dollars. This is the latest analysis and the percentages are reasonably consistent.
According to the GAO, sole proprietors are responsible for a substantial portion of the gap. These taxpayers file a Schedule C and their income is not subject to any payroll withholdings, the way that an ordinary employee is.
Buried in the legislation, popularly called Obamacare, which according to then - Speaker of the House Nancy Pelosi ,had to be passed so that we would know what was in it, was a little gem that gave many sole proprietors a potentially large tax windfall. The legislation said that people receiving money from third-party electronic payment systems, such as PayPal, had to receive a form 1099-K if their proceeds were greater than twenty thousand dollars or they had more than two hundred transactions. Previously, they would have received a 1099-MISC if they had received at least six hundred dollars. This effectively means that people who are receiving less than the amount are not going to have that information reported to the government, quite likely will not report it (after all, look at the source of the tax gap), and the burden of the loss of tax revenue will fall on the burden of the ordinary, everyday taxpayer.
The IRS has many tools at their disposal in order to track or reconcile the income reported on a return. Among these tools are certain forms which are known as information return. The W-2 that you receive from your employer is just one of these forms, as are the 1099-INT and 1099-DIV which you receive from any organization that pays you more than ten dollars in interest or dividend. If you receive social security or money from a pension or retirement account, you will receive a 1099-R. Of course, the IRS also receives this information and if you do not report the twenty three dollars in interest income that you received, the IRS will send you a friendly little notice, pointing out your sinful behavior and then letting you know how much more you owe them. They will gladly calculate the additional interest and penalties if any.
Self-employed people would get a form 1099-MISC which is to report monies paid by other businesses to non-employees. The law required that payments made by check or bank, deposit be reported on this form and that it had to be issued once the total paid to one person was six hundred dollars or more.
The information return provides the IRS with a record that you may have received income and it also serves as a voice of conscience to most taxpayers, who correctly reason that it is silly to hide income from the IRS if the person who paid you is also advising them of the transaction.
In an era of humongous budget deficits and widening tax gap, you have to wonder why any elected official in their right mind give such a loophole to a group of taxpayers, who according to the GAO are major contributors to our countries revenue woes. Congress did not vote for a reduction in taxes, they simply passed legislation which altered the reporting requirements of payments made and that is just one of the dangers in passing legislation which is so voluminous, cumbersome and largely unread.
*Note: This was written by a Yahoo! contributor. Do you have a personal finance story that you'd like to share? Sign up with the Yahoo! Contributor Network to start publishing your own finance articles.
- Investing Education