by Brian Mahany
Many claim that small businesses are the backbone of our national economy. If the Obama administration and IRS have their way, they may soon be the source of an additional $68 billion in tax revenues.
The IRS’s National Research Program estimated that unreported business income by sole proprietors accounts for 20 percent of the nation’s $345 billion tax gap. That equates to $68,000,000,000. The Treasury Inspector General for Tax Administration (TIGTA) released a report in September recommending that the IRS take stronger measures to collect that missing money.
What does this mean for small businesses? Longer and more audits, of course.
The 21-page report is long on conclusions but short on actual guidance. How will the IRS crack down on small businesses and unreported income is still unknown. One idea that has been stated is a closer look at personal living expenses. The IRS has agreed to start examining the sole proprietors’ personal expenses at the same time it is auditing the business.
For most taxpayers, these new audits means more hassle and expense.
If you have a $500,000 house, spend $10,000 per month on a credit card and drive an Escalade, expect questions if you say your business loses money each year.
Attached to the TIGTA report is an audit form for estimating personal living expenses. Suddenly we go from an audit of our medical practice or carpentry business to estimating how much the owner spends on “snacks,” “alcoholic beverages,” “dry cleaning,” “newspapers” and “entertainment.” Is there a better way for auditors to spend their time? Of course.
Unreported income is a problem. No one likes to pay taxes and people dislike it even more when they are paying but their neighbor isn’t. Unfortunately, putting the tobacco purchases of small business owners under a microscope will not help the IRS close a $68 billion hole in our revenues.
What lead the Treasury to focus on sole proprietors? A random sample by TIGTA found that when auditors look at personal living expenses and compare them to business income, significant disparities exist in 13% of the audits. In other words, of the 227 random audits examined by TIGTA, in 30 of those cases the business owner was spending considerably more than his business records and tax returns could substantiate.
The flaw in TIGTA’s findings is that the random sample fails to recognize that there can be a number of legitimate reasons for a taxpayer’s personal expenses to exceed their business income. Perhaps the person is simply spending the proceeds of a loan. Perhaps they are receiving financial assistance from a family member. Perhaps they are simply enjoying the profits from prior year’s savings.
Of this 13%, the odds are high that many have no unreported income. They, like the other 87% of sole proprietors, can expect more frequent, more intrusive and longer audits.
Mahany & Ertl, LLC is a full service law firm concentrating in tax matters, asset recovery, white-collar crime and business solutions. We assist businesses and small businesses with a wide array of tax matters including audit defense, tax court litigation, criminal tax (tax evasion) defense, offers and compromise and tax collection.
Call Brian Mahany at (414) 704-6731 for a confidential, informal review of your matter. Or visit our website at http:/www.mahanyertl.com.
Our tax services are available in Milwaukee, Wisconsin, Madison, Eau Claire, Green Bay and anywhere in the U.S.