August 13, 2013

“Your gross receipts may have been underreported,” begins recent letters from the Internal Revenue Service to small business owners across the US.

All around the country, businesses are being “targeted” by the IRS with letters asking if they are underreporting revenue.  Earlier this year, news of the IRS targeting conservative groups didn’t work out so well, and this doesn’t look so good for them either.

Receiving a notice from the IRS at all is enough to make any taxpayer squirm with fear. Is this an audit? Do I owe more money? Did I make a mistake? If you’re on the IRS’ radar, there’s a good chance that any news is bad news. But the latest scandal has the IRS targeting small businesses, particularly small mom-and-pops, to prove that they aren’t underreporting cash sales in order to lower their bill come tax time.

It’s common knowledge that the IRS is automating and streamlining many of its processes, specifically the use of highly sophisticated computerized algorithms when selecting candidates for audits. It’s also well-known that popular sites like Facebook and Amazon use cookies to follow consumers’ movements and searches online to better target advertisements throughout the web.

It is less known that the tax collectors are also able to track what citizens do on social media (good example, Rashia Wilson), who they’re sending emails to, and what digital transactions they’re making. Using big data info to go after individuals and small businesses is to supposedly help the IRS close the “tax gap” by chasing down the estimated $300 billion in lost revenue each year.

Just a Notice, Not an Audit

The letters that tens of thousands of Americans are receiving in the mail aren’t meant to be seen as audits, but more like double-checks to gather information that business owners may have missed.

The IRS is looking at Form 1099 matching—including new merchant reporting of credit cards, mysterious average statistics the IRS uses for comparison and—gulp—cash reporting. Did you remember to record and pay tax on all cash transactions? The controversial IRS notices are titled ‘Notification of Possible Income Reporting.’ — Forbes

Sounds fair, right? Although these are technically not audits, one of the major red flags for an IRS audit is having a cash-only or primarily cash run business. Taxi companies and bars, for example, are seemingly less likely to report all income because of the lack of a paper trail or digital evidence of transactions.

But what the IRS is doing is targeting local stores, independent contractors and mom-and-pops based on secret reports from banks and credit card companies. If the IRS believes that a business has reported an “unusually low” cash amount, with mostly digital payments, the owner has 30 days to make their case.

It’s unlikely that a small business has actually done anything wrong to provoke the notice, but it’s hard to refute a letter from the IRS when a business owner doesn’t know where the data came from or what data went into the algorithm.

It’s Not That Simple

As explained in the Internet Tax debacle, reporting every transaction accurately every time is nearly impossible.

An electronics store that sells big-ticket items like HDTVs and home entertainment systems will most definitely report a low cash amount because customers are more likely to pay with credit or debit cards. Also, when paying with cards, customers have the option of getting cash back, also pushing up the digital payment tally.

It’s especially difficult to match credit and cash transactions when you take into account things that get tacked on during a sale, like sales tax.

“There are so many reasons why, even if you’re the most honest tax payer, you’re not going to match” what card records show, says Fran Coet, whose company advises about 250 small businesses. Ms. Coet cited sales of gift cards, which for accounting purposes don’t count as a sale, but look that way to a credit-card company. — The Wall Street Journal

While large corporations have departments dedicated to protecting their company by managing tax and legal issues, small businesses are much less likely to have the help. Not only are they less financially capable of hiring accountants and lawyers to keep the books up to snuff, taking the time off of work to comply within the tight time constraints to avoid further investigation is tough. They’re losing billable hours in order to protect themselves simply because the IRS has decided to go “fishing.”

And fishing seems like an appropriate term for what the IRS is doing. Instead of looking more closely at the businesses they’re investigating before sending out letters, they’re using their robo-audit software to find discrepancies between digital transactions and tax returns and auto-send the notices. About 20,000 letters have already been sent out with more to follow.

“An important component of this project is [to] help ensure that people who are non-compliant don’t get an unfair advantage over those that play by the rules and follow the law,” says the agency. But if you’re one of the many small business owners that know nothing about why you received a letter or how to respond, contact Optima Tax Relief today for assistance.

Photo: Thomas Hawk