Congress plays chicken over paying for 1099 fix

NEW YORK (CNNMoney) -- There's one legislative issue lawmakers on both sides of the aisle overwhelmingly agree on: The onerous 1099 tax-reporting mandate that snuck into the health-care reform bill has to be repealed.

The Republicans promised to eliminate it in their Pledge to America, and President Obama did the same in his State of the Union address. So nearly one year after its passage, why isn't the law dead yet?

Money. Congress can't undo the looming 1099 tax mess without finding $2 billion a year to offset the government revenue the wildly unpopular provision is expected to generate.

Starting in 2012, the new regulations require any taxpayer with business income to issue 1099 forms to all vendors from whom they purchased more than $600 of goods and services in one tax year. That's a massive expansion in the role of the 1099 tax form, which is currently used only to document non-wage income for individual workers. The IRS' National Taxpayer Advocate estimates that this change will affect 40 million taxpayers, creating a compliance burden that could be "disproportionate as compared with any resulting improvement in tax compliance."

Translation: This is a paperwork-intensive tax nightmare. And it might have unintended consequences. Critics of the provision are concerned that it could prompt businesses to consolidate their purchases with a few large vendors in order to cut down on their paperwork, making it harder for small businesses to compete.

The 1099 expansion is universally reviled among both business groups and in Washington: There's rare bipartisan agreement that including it in the health-care bill was a mistake.

But it's a hard one to undo. The expanded 1099 reporting mandate was placed in the health reform bill in late 2009 by the Senate Finance Committee, which was looking for ways to raise revenue to help make health reform "revenue neutral" -- a key demand of Obama's. The bipartisan Congressional Joint Committee on Taxation estimated requiring all purchases of goods and services to be reported on 1099 forms would reduce the "tax gap" on income that businesses collect but don't report could by about $2 billion a year.

Ever since, repeal efforts have foundered on the question of how to replace this federal revenue. The Statutory Pay-As-You-Go Act, better known as in Washington as "paygo," requires nearly all Congressional legislation that cuts taxes or raises expenditures to be accompanied by an equal amounts of new revenue or spending cuts. The goal is to keep the federal deficit from increasing.

So if lawmakers want to eliminate a health-care act provision that the Joint Committee on Taxation says will generate $21.9 billion over the next 10 years, they have to come up with that money in some other way.

Where should they scrounge up the cash? That problem is confounding Congress.

Last year, the Senate repeatedly failed to pass repeal legislation, after senators were unable to agree on how to make up the shortfall in funds.

To break the logjam, the Senate earlier this month resorted to what amount to a legislative sleight-of-hand. As part of a 1099 repeal amendment that she attached to a Federal Aviation Administration funding bill, Sen. Debbie Stabenow, a Democrat from Michigan, included a clause requiring the Office of Management and Budget to identify $44 billion in "appropriated discretionary funds" -- in other words, money that has been allocated to government programs but not yet spent -- and eliminate them. (A Stabenow spokesman confirms that it would be left entirely up to OMB to figure out where to make the cuts.)

The House, meanwhile, moved ahead with its own bill, introduced by longtime 1099 crusader Rep. Dan Lungren, a California Republican. That bill is due to be marked up by the powerful Ways and Means Committee on Thursday. Less than 48 hours in advance, committee chair Dave Camp -- a Republican from Michigan -- added in a revenue offset provision.

The Camp bill would raise the missing $2 billion a year through an entirely different mechanism than the House version. Its solution: Increase penalties for individuals who, based on their most recent income tax filings, receive tax credits to help pay for health coverage under Obamacare, then turn out to have incomes too high to be eligible.

As Camp's committee wrote in its overview of the legislation: "Because financial circumstances can change significantly in two years (e.g., a new job, a promotion, or a spouse returns to work), subsidies could therefore be provided to many individuals with actual incomes that exceed subsidy eligibility thresholds."

Basically, if you think you qualify for this tax break and then get a new job or bigger paycheck and find out that you don't, you'll have to write a check to the government to pay it back for the money it shelled out on your behalf.

The trouble comes for individuals whose income changes dramatically from year to year. These new health-care subsidies are targeted at low- and middle-income taxpayers.

"Say one wage earner didn't have a job, and their income was 200% of the poverty line, and then midway through the year they get a job and the credit stops," says Judy Solomon ,of the liberal Center on Budget and Policy Priorities. "But at the end of the year, if their income was over 400% of the poverty line, they have to pay everything back."

The Camp bill, says Solomon, would change what had been a stair-step scale for repayment into a series of cliffs. For some households, the results could be dramatic: The Kaiser Commission on Medicaid and the Uninsured estimated recently that for certain families with two working parents earning a combined $90,000, a sudden $5,000 end-of-year bonus for one parent could push the family over the subsidy line and stick it with an unexpected tax bill of $11,200.

So what happens if Camp's 1099 repeal bill passes the House, which seems likely?

It will end up in a conference committee to reconcile the differences with the Senate version -- and it's tough to say how the Democrat-controlled Senate will respond to a bill that pays for a 1099 fix with decreased health-insurance subsidies.

There is some precedent: Congress used a similar maneuver in December to find $19 billion to pay for its "doc fix," the annual band-aid it slaps on legislation that would otherwise lead to a 25% cut in doctors' Medicare reimbursement rates. But the move was controversial, and that fight went right down to the deadline wire.

Which means small business owners -- the ones who will be most affected by the 1099 paperwork blizzard if it takes effect next year, as scheduled -- should brace themselves for a long slog toward repealing this mandate that both Republicans and Democrats want to kill off.

"I don't think we have any sense of where that is heading right now," Solomon says. "It'll probably be a while."