Dec. 15, 2005--With the Internal Revenue Service set to receive more money for enforcement in 2006, critics are expressing concern that the wider dragnet will trip up more small businesses.
On November 30, President Bush signed into law an act designating $4.7 billion for enforcement, an increase of $362 million from 2005. Small-business advocates are already sensitive to heightened scrutiny of tax compliance following an announcement this summer that the IRS would conduct 5,000 random audits of small businesses over a three year time period. They fear that the IRS is targeting small businesses, which already grapple with complicated, expensive, and time-consuming tax compliance procedures.
But the IRS is stepping up enforcement for all groups of taxpayers, not just small businesses, according to Bruce Friedland, an IRS spokesperson. "We are trying to raise the audit rate coverage across all areas, and are not targeting specific groups, he said.
Increased enforcement is necessary, Friedland added, because a recent analysis of 2001 tax returns found that underreporting by individuals and small businesses accounted for 80% of the roughly $330 billion tax gap -- the difference between what the government says taxpayers owe and what they pay.
"The latest review of data indicates that one of the areas where there is ongoing underreporting has been in the sole proprietor area, Friedland said.
The IRS has audited 17,867 small businesses in 2005, fewer than the annual average of 20,500 since 1996.
But business advocates fear that the increased scrutiny will unfairly punish smaller operations already strapped for personnel and resources.
"Our members are law-abiding citizens and this can take time away from them that they need to run their business, said Ryan Peebles, legislative affairs manager for the National Federation of Independent Business. "We feel like it's kind of a witch-hunt.
According to Peebles, the majority of the NFIB's members have five or fewer employees. Having one or two of them working with auditors can seriously dent their output, he said.
Chris Edwards, a tax policy analyst with the pro-business CATO Institute in Washington, D.C., said that small-business productivity will suffer because owners will spend more time filing taxes and disclosing information to the IRS. He also fears increased enforcement may lead auditors to use "tough-handed tactics, like unannounced spot checks of a company's books, that were prevalent in the mid-1990s.
"I think that there's always the threat that auditors will violate civil liberties and go too far in searching a company's files for evidence of wrongdoing, Edwards said.
Dan Mastromarco, a small-business tax attorney with the Washington, D.C.-based Argus Group, said that the IRS should instead focus on reducing complexity in the tax codes that result in honest mistakes in filings.
"Throwing more money at enforcement is not going to solve the IRS's problems, said Mastromarco, a former federal prosecutor.
But Paul Gada, a small-business tax adviser with Illinois-based CCH Group, does not foresee more aggressive prosecution of small businesses in general. Instead, Gada said the IRS is targeting phony home-businesses set up to claim deductions on expenses for personal use, such as home mortgages, furniture, and automobiles.
"What the IRS is really cracking down on is businesses falsifying the information they provide to knowingly avoid tax obligations, Gada said. "They're looking for long-term trends that signal tax avoidance, like a company that historically has more expenses and deductions than earnings. They're not selectively picking out individual businesses for harassment.