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IRS is eyeing your small business
By Joseph Anthony
Here's the way it is: The Internal Revenue Service soon will be doing more audits of small businesses and self-employed individuals than it has in the past few years.
That's the overwhelming message I came away with recently after talking with tax professionals around the country.
Let me offer four reasons why you need to prepare your business for closer scrutiny from the IRS.
1. The agency's restructuring and increased funding. I've written previously about the IRS's restructuring. The agency's new Small Business/Self-Employed Operating Division is going to be able to focus on partnerships and sole proprietors with more than $100,000 in total gross revenues, and small corporations with less than $5 million on their balance sheets. Congress also has approved an increase in funding that the IRS is going to use to try and increase its audit rate.
The IRS's own figures indicate it audited slightly more than 63,000 of these small-business returns in 1999. The agency's initial goal was to try to increase that by 50,000 during the 2001 fiscal year, and by another 50,000 in fiscal year 2002 - an overall increase of 100,000 audits.
Observers now say it's unlikely the agency will meet that goal. However, a significant increase in audits is still a virtual certainty, especially as new auditors are trained and placed in the field.
2. It's time for the pendulum to reverse. Audit rates for small businesses plummeted in the 1990s. In 1997, the IRS audited more than 4% of all sole proprietors with total gross revenues of at least $100,000; by 1999 that figure was down around 2.4%. The audit rate for sole proprietors with total gross receipts of $25,000 to $99,999 fell to 1.3%.
Quite simply, the audit rate has pretty much reached the point where there is nowhere to go but up.
3. The self-employed field Is a happy hunting ground. Sole proprietors and partnerships receiving large cash payments not subject to third-party reporting (i.e., through Form 1099 or other informational forms sent to the government) have been attractive audit targets, as have individual filers with large deductions.
For the most recent year available, fiscal year 1999, tax auditors recommended an average of more than $9,000 in additional taxes for returns that included a Schedule C and had total gross revenues of $100,000 or more.
Robert E. McKenzie, an enrolled agent and attorney in Chicago who specializes in representing taxpayers in disputes with the IRS, says that there's at least one remarkably simple reason for this focus: The IRS figures that self-employed people are less likely to comply fully with the tax code. "The government's own statistics indicate that about 83% of all taxpayers fully comply with the tax code when doing their returns," McKenzie says. "But for people who have self-employment income and should file a return with a Schedule C, that figure is more like 51%."
4. We've gotten lazy and complacent. Some tax pros I talked with say they feel small businesses in general have been influenced by the drumbeat of publicity in the past year about how the IRS has not been enforcing the law aggressively.
"All those stories about people not getting audited, about the IRS not doing anything. . . they have to have had an effect on people," said one tax pro, who asked not to be named. "You just know that a lot of small businesses have gotten lax in their record keeping or a lot more aggressive in the deductions they claim, and the IRS knows that also. I think, unfortunately, that the IRS is going to find this (audit program) to be a fruitful pursuit."
Small businesses aren't the only IRS target
Really, they're not out to get just small businesses. The IRS is also likely to take a closer look in the coming year at other problem spots (or, depending on your point of view, potential revenue areas) that it has identified, including abusive trusts, unpaid payroll taxes and corporate tax shelters.
There's also a plan to try to match the income items from Schedule K-1s against the tax returns filed by partners and corporate shareholders. Several tax pros I talked to were skeptical that the IRS would actually be able to match up all K-1 information to returns accurately.
However, the IRS's programs for matching other "information filings," such as Form 1099 and W-2, to returns have greatly improved over the years. So it's possible that this new matching program could succeed as well.
In general, remember that the IRS is powerful- a lot like the New York Yankees and Los Angeles Lakers. We don't have to root for 'em, but it's not wise to bet against 'em either.
In a future column, I will discuss ways you can help your business reduce its chances of being audited.
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