IRS Errors Snag Entrepreneurs

Oops! The IRS misreads thousands of K-1s, to the chagrin of S corps and LLPs.

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The program created an "UNNECESSARY burden" for some small businesses.

Sens. Olympia J. Snowe of Maine and Christopher S. Bond of Missouri in a recent letter to the commissioner of the IRS

In the past two years, thousands of business owners had to prove to the Internal Revenue Service that they paid their taxes, thanks to flaws in a program meant to catch cheats. Starting in 2001, the IRS began cross-referencing Schedule K-1 forms with individual tax returns--K-1s record income that comes from various sources, from real estate to family trusts. Among the groups that use K-1s are entrepreneurs who own a stake in a "flow-through entity," such as an S corporation or a partnership. A test run of the matching program went smoothly, but when the agency started to double-check a larger number of K-1s, more than 69,000 taxpayers were red-flagged, two-thirds of whom were later found to have been in compliance, the General Accounting Office recently reported. The IRS promises that it is reworking the program for the 2003 tax year, but Ken Vacovec of Massachusetts tax law firm Vacovec, Mayotte & Singer says that the real problem is that K-1 forms are used as a catchall form for all types of income. "We handle tax returns involving as many as 30 or 40 K-1 forms," he explains. "W-2s and 1099s are effective because they're limited."

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