The Internal Revenue Service (IRS) recently unearthed yet another undesirable side effect of Obamacare—one that will hit the taxman as well as business owners.

The Taxpayer Advocate Service, “an independent organization within the IRS whose employees assist taxpayers,” reports that both the IRS and taxpayers will have trouble complying with the health care law’s extensive new tax reporting regulations.

The regs will affect 40 million businesses, from international mega-corporations to Mom-and-Pop shops on Main Street. The Taxpayer Advocate Service says it “may propose administrative or legislative recommendations to modify the provision.”

Starting in 2012, Obamacare requires any business, tax-exempt organization, or government entity to file a 1099 form detailing purchases from all vendors that have sold over $600 of goods to the company. The Taxpayer Advocate gives the following example: “If a self-employed individual makes numerous small purchases from an office supply store during a calendar year that total at least $600, the individual must issue a Form 1099 to the vendor and the IRS showing the exact amount of total purchases.”

The National Federation of Independent Businesses says it would be a “crippling” burden for small business. The Taxpayer Advocate agrees that the new reporting scheme could have “distortionary effects” on taxpayer behavior, pushing businesses toward larger vendors at the expense of smaller local suppliers.

The requirement would trigger a paperwork avalanche at the IRS. The report notes that the tax agency “currently is neither structured nor funded to do the job effectively.” Nina Olson, head of advocate services, says, “If the IRS continues to ramp up enforcement while reducing taxpayer service programs, I would be concerned about its ability to administer the new health care credits and penalty taxes in a fair and compassionate way.”

The Taxpayer Advocate warns that this provision “could exacerbate underassessment of penalties in some cases and overassessment of penalties in others.” Bottom line: “It is highly likely that the IRS will improperly assess penalties.”

Rather than increase the size and scope of the IRS, the better solution would be to get rid of this entirely unnecessary requirement. The Taxpayer Advocate reports that this 1099 provision was “likely intended to detect unreported income or gross proceeds.” In other words, this provision was included to find new revenues to fund Obamacare.

It’s doubtful this provision will yield any significant tax revenue. But its costs to 40 million employers will be immense. That means less money available for pay raises, job creation… or even employee benefits—like health care!

Attempts to repeal this provision of Obamacare are currently underway in Congress. Who knows, perhaps lawmakers won’t stop there, but will continue to push for the repeal of the entire health care overhaul.