I just did a workshop on eBay today covering 25 common mistakes that can lead to an IRS audit. It was a lively workshop with a lot of questions regarding business structures, sole proprietorships and audits, and the big one “I just sell a few things on eBay – do I have to report that income and pay taxes on it?” (The answer is “yes,” BTW).
Ironically, later that same day I read a press release put out by the U.S. Treasury talking about just how money had been lost due to the mismatching of names, Social Security Numbers and other identification numbers on tax returns. And that made me more convinced than ever that the number of audits is going to increase, as the government tries to recover this money. Read on to learn more!
At a time when the IRS is trying to close a $300 billion tax gap, it is potentially losing billions of dollars in revenue because of mismatched names and Social Security or other identification numbers on information returns and tax returns, according to the Treasury Inspector General for Tax Administration (TIGTA).
In a report issued recently by TIGRA, the IRS owned up to the fact that more than 48 million miscellaneous income and wage statements, reflecting $900 billion in income, could not be used in recent years because of missing or wrong identification numbers.
This primarily impacts the flow-through business entities (S corporations, limited liability companies and limited partnerships). Normally, when these businesses file their tax return they also file a number of K-1 forms, showing how much income (or loss) was distributed to the business’s owners. Business owners, in turn, are required to report that profit or loss on their own personal tax returns, and pay any taxes due. The problem comes when the numbers reported by the business and the business owners don’t match up. When the IRS comes across one of these situations it usually sets up an underreporter case to determine if further investigation is needed. If a match shows income but no return, the IRS may initiate a nonfiler case.
The problem is especially acute with independent contractors, according to TIGTA. “The absence of withholding and full information reporting creates opportunities to underreport income on tax returns and avoid detection by the IRS.”
When asked to respond, Acting IRS Commissioner Kevin M. Brown told TIGTA that the cost of improving the system may not outweigh the monetary benefits. Matching reports are generally done manually, meaning a lot of extra manpower would go into collecting this tax, and by the time the dust settled the IRS may not come out ahead.
Commission Brown also noted that the Treasury Department has recommended legislation to require companies to verify the accuracy of identification numbers for independent contractors. Companies who don’t comply would be subject to backup withholding procedures for their independent contractors – meaning those would become responsible for withholding and paying payroll taxes.
So what does this mean? Well, I believe it means that the chances of being audited are going to go up if you operate a business as a Schedule C, or, sole proprietor. This group is already heavily targeted – the last IRS statistics I saw indicated that sole proprietors are 10 times more likely to be audited than incorporated businesses. The cost of setting up and maintaining a business structure may be considerably smaller than the cost to defend yourself against an audit.
I also believe that it’s more important than ever to make sure your tax returns report accurate information. This may mean hiring a bookkeeper or accounting professional to manage your books, and prepare your tax returns – and checking those returns to make sure the number on your K-1 matches the number on your return. Again, the extra costs you outlay for this work could more than pay off down the road. And they’re all deductible, too!
Oh, and just in case you’re interested, here’s a link to the eBay workshop. http://forums.ebay.com/db2/thread.jspa?threadID=1000589431&tstart=0&mod=1193869681148. I do a workshop on the second Wednesday of each month, and you’re always welcome to join in!