An IRS study shows it is planning many serious small business attacks. These IRS small business attacks are in a study of the tax gap (supposed uncollected taxes). This gap increased from $345 billion in 2001 to $450 billion in 2006. IRS says 83% of it is due to to underreporting (understating income and overstating deductions). The IRS small business and other attacks will try to narrow the supposed gap with pre-refund notices and return rejections, under reporter inquiries and audits. It audits areas that seem to have the highest misreporting.
IRS attacks will address:
- Misreporting stock basis: A new law requires stock brokers and mutual fund companies to report basis and other information for most 2011 stock purchases and all 2012 and later purchases. Form 1099-B will report this to investors and IRS. IRS will use under reporter programs and audits for this.
- Offshore tax disclosure: IRS is continuing to press foreign financial institutions to disclose US account holders. It also has a voluntary disclosure program for taxpayers.
- Underreporting business income: IRS now require Form 1099-K for recipients of payment card transactions or payments through third-party networks, such as PayPal. IRS expects more than 56 million 2012 Forms 1099-K for matching against filed and unfiled returns.
- Worker classification: IRS employment tax research concluded that 17% of the tax gap is due to underpayment of tax. The main issue is worker classification (independent contractor or employee). IRS employment audits have an 86% change rate. Form W-2 recipients are 99% compliant in reporting income, but 43% of independent contractors and small business owners report improperly.
The last two of these are IRS small business attacks, though IRS says small business underreporting makes up only 40% of the tax gap. IRS will continue to focus on:
- Cash-based businesses: Taxpayers who do not get information statements, such as small cash-based businesses, are the most noncompliant. Information reports, fear of an audit and personal integrity were important in getting compliance. IRS will continue to focus on retail, web and service businesses to find unreported income.
- S corporation and partnership losses: A 2009 Government Accountability Office report said 68% of all S corp returns misreported at least one item. Inaccurate S corp losses were often on shareholder returns because of insufficient basis. The average error was $21,600. More than 90% of S corps use a paid preparer, so IRS will use tax preparers to correct this with preparer penalties.
- S corporation shareholder compensation: The 2009 study found that S corporation shareholders underpay themselves to avoid employment tax. About 13% of S corps pay inadequate wages, as S corp distributions are not subject to self-employment tax (unlike partnership distributions). Average underpaid shareholder compensation was $20,127 ($1.5 billion a year in unreported tax). The IRS expects to examine more 2011 S corporation returns.