DON'T BALANCE THE BOOKS ON SMALL BUSINESS’ BACK

By Todd Stottlemyer • February 2007

For many small business owners, three little words-Internal Revenue Service-can send chills down the most steely of spines. The IRS recently announced that the agency intends to target small businesses for increased scrutiny and audits to close what's called the tax gap - the difference between what's owed to the government and what's actually collected.

The IRS estimates that the net tax gap - which includes unpaid and under reported taxes - is about $290 billion. The agency says that under reporting income is a significant source of the gap, although by no means all of it.

Of course, no one defends tax scofflaws. We all need to pay our taxes owed, and to punish those who intentionally evade their tax liabilities. But what no one knows is exactly what portion of the tax gap is due to evasion, and what is due to simple mistakes. What percentage of the tax gap is attributed to the complexity of the tax code? And what other external factors, such as the nature of these business' transactions, affect their tax reporting?

For example, if you're engaged in business to consumer transactions, it's hard for the IRS to track your activities. Unreported income from these transactions could be a significant contributor to the tax gap, but data to prove it one way or another isn't thorough enough to warrant drastic measures.

The IRS claims that individuals under report business income by an estimated $109 billion. Of that, $68 billion is attributed to under reporting by Schedule C filers or sole proprietors. The balance is due from large corporations and other taxes, such as employment and estate taxes.

In tax year 2001, 20.6 million individual tax returns reported non-farm income on Schedule C. Two thirds of these Schedule C businesses are very small; about 13 million had gross sales of $25,000 or less. If you include those with sales of up to $100,000, the total rises to nearly 17 million. Clearly, the IRS is looking to gore the wrong ox, and one that's working very hard for the nation's economy.

The IRS tacitly admits that small businesses are simply easier to pursue. Big corporations can employ evasive tactics such as offshore tax havens and other shelters.

Last year, Commissioner Mark Everson testified to an investigative subcommittee of the Senate Homeland Security and Governmental Affairs Committee, "We have real difficulties finding out what's going on [with large corporations]," he said. "Our challenges are acute and ever growing. offshore abuses are a real problem."

Amid continuing budget deficits and record debt, the IRS and many lawmakers look to tax gap enforcement to find more money.

The budget that the president just released this month recommends 16 proposals to address the tax gap, at least seven of which have the potential to create a significantly increased compliance burden for small businesses.

Small businesses need to be vigilant in order to fend off harmful tax gap proposals. In addition, we need to emphasize that just because large corporations' tax liabilities are more difficult to determine doesn't mean the IRS shouldn't pursue these companies.

Finally, simplifying the tax code to make it easier for small businesses to comply could go a long way to closing the gap.

Todd Stottlemyer is president and CEO of the
National Federation of Independent Business in Washington, D.C.

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