The Internal Revenue Service had some activity this past week that employers should keep an eye on. One was a new “Tax Gap” study, which analyzed the 2006 tax year. It found that overall compliance was statistically unchanged from 2001. Initial compliance was slightly better, but within the statistical margin for error, while payment of late fees and penalties was slightly lower as a percentage of the overall tax liability, again not at a statistically significant level. This study is important for employers, since it perpetuates the view of the IRS, and then eventually to Congress, that there are lots of funds available for the taking, without changing tax rates. Moreover, the view of the IRS, as reported in the stud, is that compliance depends in large part upon whether there is “third party” reporting. In other words, where employers provide W-2’s, compliance is allegedly close to 100%, while payments of cash or payment to independent contractors, with or without 1099 reporting is only a bit above 50%. The essence of the Report is reflected in the following excerpt:
The tax gap can be divided into three components: non-filing, underreporting and underpayment.
As was the case in 2001, the underreporting of income remained the biggest contributing factor to the tax gap in 2006. Under-reporting across taxpayer categories accounted for an estimated $376 billion of the gross tax gap in 2006, up from $285 billion in 2001. Tax non-filing accounted for $28 billion in 2006, up from $27 billion in 2001. Underpayment of tax increased to $46 billion, up from $33 billion in the previous study.
Overall, compliance is highest where there is third-party information reporting and/or withholding. For example, most wages and salaries are reported by employers to the IRS on Forms W-2 and are subject to withholding. As a result, a net of only 1 percent of wage and salary income was misreported. But amounts subject to little or no information reporting had a 56 percent net misreporting rate in 2006.
The problem for employers is that this mindset results in additional burdens being imposed on them to prevent alleged tax evasion by the people the employers contract with or employ. It also encourages false counting of government revenue in legislation, such as the ridiculously costly 1099 requirement contained in the Affordable Care Act and finally repealed in 2011.
Speaking of the Affordable Care Act, there is a provision in it that requires employers to provide a report to employees, on their W-2’s, of how much the employer pays to provide health care to them. There is no additional tax, but the thought apparently was that employees did not appreciate how much their insurance coverage cost, so they would keep agitating for more costly coverage. In turn, that would drive up demand for health care services and increase the cost of health care overall. The law did not limit the report to the specific cost of health insurance. That would probably have been too simple and might not have allowed any assumption about reduced demand for health coverage. Rather, the figure is supposed to include all the employer costs, for example, contributions to Health Reimbursement Arrangements, other supplemental plans and subsidies. There were issues about whether the reporting was to be on an individual basis, or averaged over the entire employee base. The IRS was unable to develop rules in time for the initial reporting, so it gave employers an extension. Earlier this week, it issued additional guidance in Notice 2012-9 for employers on the reporting that will be required on the W-2 forms for 2012, which must be provided by January 31, 2013. Notably, employers who do not have to provide more that 250 W-2’s are completely exempt for 2012. There are a number of other limitations on the reporting required of larger employers. HRA amounts are includable, but Flexible Spending Account expenses generally are not. Most costs that are taxable to employees will not have to be included. Most of the interpretations make it easier for employers to do the calculations, although the literal language of the Act could well support broader reporting. There is nothing to prevent reinterpretations in the future that would make the process much more burdensome for employers. For the time being, however, small employers can breathe easier for another year and large employers should be able to cope without excessive costs. Of course, with the limitations on reporting, the alleged benefits for the health care system of this requirement are slight. The cost-benefit analysis still comes out on the far negative side of the ledger.