By David Hogberg; Investor's Business Daily

A little-noticed provision in the new health care law may not only dramatically increase paperwork for small businesses, but also put them at a disadvantage against their larger competitors.

At issue is the law's Section 9006, which is supposed to generate tax revenues by expanding the reporting requirements for 1099 tax forms.

Under current law, a company has to file a 1099 only when it pays an independent contractor more than $600.

A provision in the new health care law requires a company to file a 1099 form every time it makes cumulative purchases of $600 or more from any... View Enlarged Image

Beginning in 2012, a company will have to file a 1099 every time it makes cumulative purchases of $600 or more from any business.

"That means (we'll file a 1099) for everyone from Staples (SPLS) to United Airlines (UAUA) to FedEx (FDX) to the catering business that brings in box lunches for our conferences," said Grace-Marie Turner, head of the conservative Galen Institute, itself a small business.

Advantage For Big Business

Rep. Dan Lungren, R-Calif., suggests that small businesses will get hit with more than just the compliance costs.

"The incentive now will be not to buy from small businesses," he said. "If you want to minimize the number of 1099s you file, you go to the big guys. If you need to buy hardware, do you go to Lowe's (LOW) or the small store down the street?"

Lungren has filed legislation that would repeal Section 9006.

Supporters of the 1099 provision note that the health care overhaul includes many tax breaks for small businesses.

"Health care reform includes more than $35 billion in tax cuts for small businesses," said a Senate Finance Committee aide. "On top of that, Congress created even more small-business tax cuts in the recently passed HIRE Act, indicating that during these tough economic times, Congress is delivering the tax breaks small businesses need to thrive, time and again."

"Not all small businesses are going to get those tax credits," replied Bill Rys, tax counsel for the National Federation of Independent Business. "And to get those tax credits, a small business will have to purchase health insurance for its employees. If a small business is not already offering insurance, then it will have to take on a big new expense to qualify for the credit."

Small firms remain under pressure despite the return to economic growth.

The NFIB said Tuesday that its small-business confidence gauge did rise 3.8 points to 90.5 in April, its highest level since October 2008, but it remains below its historical average of 100.

It was also the 17th straight month in which more businesses reported reducing prices than raising them, the NFIB said.

Targeting Unreported Income

The Joint Committee on Taxation estimated that the 1099 measure would take in $17 billion in revenues from 2012 to 2019.

Policymakers assume that firms underreport a lot of income, according to Rys.

"The theory here is that it is harder for a business to underreport income if there is a third party reporting the income to the IRS," Rys said. "The other is the deterrent effect, that you won't under-report income if you know someone is reporting it."

Said Turner: "The government thinks the whole country is a bunch of tax cheats."

Supporters suggest that the reporting requirements won't be so onerous.

"Small businesses are already required to file 1099s on noncorporate service providers, and current reporting requirements certainly aren't burdensome," said the Senate aide. "A 2007 Government Accountability Office report found that one small business employing five people only spent three to five hours per year filing 1099s. Because of current law requirements, small businesses already have the procedures in place to make reporting quick and painless, and increasing the number of filings required will have a marginal impact."

However, that GAO report interviewed only one small business of that size.

Turner suggests that for her, the impact would be more than marginal.

"We would have to file scores ... probably over a hundred more" 1099s, she said.

To reduce compliance costs, businesses may try to consolidate their purchases by buying only from megastores such as Home Depot (HD), Staples and Wal-Mart (WMT).

This could put local small businesses at a further disadvantage.

"We don't know exactly what the consequences will be, but it's something worth considering," Rys said. "There are always consequences to adding new burdens like this, and I don't think this proposal has been given the time to answer those types of questions."

The Senate aide says the Finance Committee takes that issue seriously.

"That's why the Treasury Department has the regulatory authority to guide small businesses and prevent onerous, duplicative reporting," the aide said. "In fact, under current law, banks fulfill the information-reporting requirements on behalf of small businesses when the businesses use credit cards to make payments. Thus, in the same way a large company cuts back on reporting by consolidating purchases, small businesses have an equal advantage because their banks can file reports for them automatically."

"They do use credit cards," said Joe Kristan, an accountant with Roth & Co. "But that's only one part of the purchases that businesses make. So many businesses still run a month-end accounts payable, where they pay all their bills with checks. Those businesses, and there are a lot of them out there, are going to be hit with this."