SBA Advocacy Report Questions IRS Targeting Small Business

SBA Advocacy recently released an important report, “An Examination of the 2001 IRS Tax Gap Estimates’ Effects on Small Businesses.”  The “tax gap” is the difference between the tax that is collected and the tax that should be collected.   In the current budgetary climate, this term is becoming more important. 

In 2007, the IRS released a report on the estimated 2001 tax gap.  That report found over a third ($109B out of $290B) of the estimated non-collected tax gap was due to underreporting of business income by small businesses.   This finding confirmed what had been the prevailing wisdom over the last decade, resulting in increased scrutiny and audits by the IRS of small business returns.  Of course this translates into increased compliance costs for many small businesses, including tech companies.

With respect to increased audits, the SBA Advocacy report warned against “ … broad-brushed enforcement activities, such as the extensive use of intrusive audits and expanding burdensome recordkeeping and reporting requirements that apply to all small businesses whether they are compliant or not … .”  Instead, it recommended a variety of approaches, including:

1. Improving education and outreach to small businesses to help them become compliant;

2. Providing small businesses with a representative to help them earlier in the audit process;

3. Reviewing the way that penalties are assessed and abated with respect to small businesses to try to reduce the assessment of needless penalties; and

4. Improving the quality of third-party return preparers frequently used by small businesses.

The SBA Advocacy report concludes that IRS estimates that small businesses account for a third of the tax gap might not be correct.  It notes, “The international and corporate tax gaps are missing from the 2001 NRP estimates.  Should the IRS revise the tax gap estimates to reflect more accurately the true size of the tax gap in the United States, the portion of the tax gap attributable to small businesses would be much smaller.”

This report was released at an opportune time.  When Congress is searching for ways to increase revenue, this finding puts a visible crack in the prevailing thought that small businesses are the principle cause of the tax gap.