Next Target of IRS Robo-Audits: Small Business

The IRS’s secretive plan for high-tech audits sees small businesses as the biggest tax evaders.

The IRS’s secretive plan for high-tech audits sees small businesses as the biggest tax evaders
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The IRS says tax cheating is rampant among small businesses, however, which it claims make up 60 percent of uncollected taxes and will be the main target in the next phase of the high-tech program. Now that the agency has added credit-card data payments to its robo-audits, it will have a much clearer, more immediate view of small-business income from third-party sources.

But small business owners are largely unaware of the heightened scrutiny they face, says tax lawyer Atkinson. What's more, IRS agents are not prepared to assess the massive new amounts of data they will have at their disposal.

"Just looking at restaurants, the records they require for credit card transactions will include charge records that include tips," says Atkinson. "Those [tips] will have to be backed out. And small-business reporting requirements vary from state to state, and in different kinds of businesses, and that makes it even harder."

The IRS has been slammed by both the IRS National Taxpayer Advocate and the IRS Information Reporting Program Advisory Committee for failing to provide guidelines on how to report transactions for the new third-party information for small businesses.

The IRS should post guidelines not only in the interest of fairness but also as a deterrent to spur greater compliance, says Michael Knoll, co-director of the Center for Tax Law and Policy at the University of Pennsylvania Law School. "I would think they would want people to know, as a deterrent. I don't understand the secrecy." In its own mission statement, the IRS says its role is to provide taxpayers "top quality service by helping them understand and meet their tax responsibilities and enforce the law with integrity and fairness to all." And in its own studies, the agency says compliance is high among wage earners because they know their salary information will be cross-checked against W2 and 1099 forms.

[Read: IRS Data Web Snares Mostly Low- and Middle-Income Taxpayers.]

In the secretive rollout of new information reporting, the agency instead appears to be using a "gotcha" approach to catch people unaware, tax experts say. Some speculate this tactic will yield results that show more impact for critics in Washington who want to see increased revenue.

Ultimately, though, the effort could backfire in unpredictable ways. Cooperation of the public will be needed for the IRS to carry out its use of electronic filing, since it remains voluntary for individual filers. Given slack job growth in recent years, the tax system could be flooded with more self-employed people and contractors filing returns, not just the "unretired" who have lost jobs and take contract work. The IRS will be pressed to educate and inform this population as it fends for itself at tax time, Atkinson says.

"The IRS needs to give very clear guidance because they are part of the government and have as social contract they need to honor," says Atkinson. "If the taxpayer feels the system is fair, even if they think it is bad for them, they will comply begrudgingly. But when the perception is that they are the only ones doing so, people are more willing to go underground and hide what they make. And that will hurt everyone. "