Payers are required to submit 1099-MISCs for a variety of payments made in the course of a trade or business. For 1099-MISC reporting, a trade or business generally includes businesses, non-profit organizations, and federal, state, and local government agencies. The types of payments reportable on a 1099-MISC and their reporting thresholds vary widely. These include payments to nonemployees for services of at least $600 (called nonemployee compensation), royalty payments of $10 or more, and medical and health care payments made to physicians or other suppliers (including payments by insurers) of $600 or more. Personal payments, such as a payment by a homeowner to a contractor to paint his/her personal residence, are not reportable on a 1099-MISC. Other payments that are not reportable on a 1099-MISC generally include payments to a corporation, payments for merchandise, and wages paid to employees. Wages paid to employees must be reported on a form W-2. There are many other types of payments that must be reported and numerous exceptions to these general rules. IRS provides eight pages of instructions detailing what payments to whom are reportable on the 1099-MISC. The form—shown in figure 1—consists of 14 boxes for reporting the various types of miscellaneous payments. The Bush Administration’s fiscal years 2008 and 2009 budgets proposed legislative action further expanding 1099-MISC reporting to include service payments of $600 or more to corporations by all third-party payers. According to the Department of the Treasury’s estimate, the Bush Administration’s fiscal year 2009 budget proposal would generate about $8.2 billion over the 10-year budget period from 2009 through 2018, in part because of increased voluntary compliance and IRS’s ability to detect underreported payments received by businesses. For tax year 2006, more than 5 million payers submitted more than 82 million 1099-MISCs to IRS, reporting over $6 trillion in payments. Nonemployee compensation payments totaled about $2.3 trillion and accounted for about 55 percent of all 1099-MISCs submitted. Medical and health payments totaled about $1.2 trillion and accounted for about 25 percent of all 1099-MISCs submitted. Each of the remaining payment types accounted for less than 10 percent of the number of 1099-MISCs submitted. Figure 2 shows the distribution of 1099-MISC payments types and amounts reported for tax year 2006. In addition to the 8 pages of instructions for 1099-MISC reporting, IRS also has 19 pages of general instructions for third-party information reporting, detailing how and when payers are to submit 1099-MISCs to payees and IRS. Payers must provide 1099-MISC statements to payees by the end of January. Payers submitting fewer than 250 1099-MISCs may submit paper forms, which are due to IRS by the end of February, along with a Form 1096, Annual Summary and Transmittal of U.S. Information Returns. Payers submitting paper 1099-MISC are required to use IRS’s official forms or substitute forms with special red ink readable by IRS’s scanning equipment. Photocopies and copies of the 1099-MISC form downloaded from the internet or generated from software packages in black ink do not conform to IRS processing specifications. Payers submitting 250 or more 1099-MISCs are required to submit the forms magnetically or electronically. Electronic submissions due at the end of March can be submitted through IRS’s Filing Information Returns Electronically (FIRE) system. As shown in figure 3, most 1099-MISCs for tax year 2006 were submitted electronically. However, most payers submit small numbers of 1099-MISCs, and most payers submitted paper 1099-MISCs. IRS’s four business operating divisions are generally responsible for ensuring payers comply with their 1099-MISC reporting requirements. The Wage & Investment Division, Tax Exempt and Government Entities Division (TE/GE), Large and Mid-Size Business Division (LMSB), and Small Business and Self-Employed Division (SB/SE), as a part of their duties, conduct examinations of tax returns and documents to verify compliance with tax laws. Examinations can include checking payer compliance with 1099-MISC reporting requirements. IRS can penalize payers for failing to submit or submitting an inaccurate 1099-MISC. The penalty is generally $50 per information return, increasing to $100 each for intentional payer noncompliance of 1099-MISC requirements. To encourage voluntary reporting compliance, the penalty is $15 (up to a maximum of $75,000 per calendar year or $25,000 for small businesses) if the 1099-MISC is submitted within 30 days of the due date; $30 (up to a $150,000 maximum per calendar year or $50,000 for small businesses) if submitted after 30 days but by August 1, and $50 (up to a maximum of $250,000 per calendar year or $100,000 for small businesses) if submitted after August 1 or not at all. IRS will waive the penalty if the payer can show “reasonable cause” or if the error or omission does not prevent or hinder the IRS from processing the 1099-MISC. In IRS’s fiscal year 2009 budget proposal, the Bush Administration proposed increasing the $50 and $100 penalties to $100 and $250 respectively for each information return. In 2007, we suggested that Congress consider requiring IRS to periodically adjust penalties for inflation, and round appropriately, the fixed dollar amounts of civil tax penalties to account for the decrease in real value over time and so that penalties for the same infraction are consistent over time. Payees are responsible for reporting payments they received from payers on the appropriate lines of their tax returns. Payees are also responsible for paying self-employment taxes if they received nonemployee compensation. For example, a sole proprietor receiving a 1099-MISC for nonemployee compensation is to report the payments on Schedule C of the 1040 tax return and file Schedule SE to pay the associated self- employment taxes. Sole proprietor payees are supposed to report 1099- MISC payments as gross receipts and separately report their expenses rather than reporting only net amounts. Figure 4 shows the automated process IRS uses to detect mismatches between nonemployee compensation and other payments reported on 1099-MISCs and payees’ income tax returns. The Nonfiler program handles cases where no income tax return was filed by a 1099-MISC payee. The Automated Underreporter (AUR) program handles cases where a payee filed a tax return but underreported 1099-MISC payments. AUR’s case inventory includes payee mismatches over a certain threshold, and IRS has a methodology using historical data to select cases for review. AUR reviewers manually screen the selected cases to determine whether the discrepancy can be resolved without taxpayer contact. For the remaining cases selected, IRS sends notices asking the payee to explain discrepancies or pay any additional taxes assessed. According to IRS, third-party information reporting increases voluntary tax compliance in part because taxpayers know that IRS is aware of their income. For wages and salaries subject to tax withholding and substantial third-party information reporting, the percentage of income that taxpayers misreport has consistently been measured at around 1 percent. In contrast, for non-farm sole proprietor income subject to little or no third-party reporting, taxpayers misreported more than half of such income in 2001, according to IRS’s most recent tax gap estimates. IRS does not have an estimate of 1099-MISC reporting compliance or know the characteristics of those payers that fail to comply with the reporting requirements. Without an estimate of payers’ 1099-MISC noncompliance, IRS does not know to what extent such noncompliance allows payees to underreport their income without being detected. If a large number of payers fail to submit required 1099-MISCs, then the resulting decrease in payee tax compliance and lost revenue could be large. According to IRS, it is a common misconception among payees that they are not required to report payments if they have not received a 1099-MISC from payers. IRS has invested significant resources in measuring compliance with other aspects of the tax laws. For example, the National Research Program (NRP) estimated the compliance rate for individual taxpayers for tax year 2001 based on an intensive review of a sample of 46,000 tax returns. IRS is in the process of completing a new study of the rate of tax compliance by individual taxpayers for tax years 2006 and 2007, and is conducting a similar study of S-corporations. IRS uses such research to understand where compliance problems are greatest and to understand the sources of noncompliance. Armed with such understanding, IRS can make better decisions about where and how to deploy its resources to address noncompliance. Our analysis of 1099-MISC submission patterns by small businesses as well as past studies of federal, state and local government agencies suggests that payer noncompliance with 1099-MISC reporting requirements may be potentially significant. Our analysis of IRS’s PMF data for tax year 2005 (the last complete year available) showed that, in aggregate, 8 percent of small businesses (sole proprietorships, and corporations and partnerships with assets under $10 million) submitted a 1099-MISC. As shown in figure 5, over 4 million small businesses submitted 1099-MISCs in tax year 2005, and in comparison, 50 million small businesses filed income tax returns with IRS that same year. Results were similar for the three previous years. The fact that a relatively low percentage of small businesses submitted a 1099-MISC does not indicate on its own that there is a significant payer noncompliance problem.