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Income reporting by small businesses, part 2

In part one of this post, we reported efforts by the IRS to tighten scrutiny of income reporting by small businesses. The IRS has already sent out about 20,000 letters to businesses that contain this sentence: "Your gross receipts may be have underreported."

As we discussed last week, the letters do not constitute notice of a formal tax audit. But the wording prompted a reply from Rep. Sam Graves, the chairman of the small business committee in the U.S. House. Rep. Graves wrote a letter to the IRS, expressing concern that the letter could intimate small business owners. The letter could also be a sign that they are unfairly being targeted for scrutiny.

In this post, let's look in more detail at what may be going on.

There is little doubt that a core part of the IRS's mission is going after uncollected taxes. The agency estimates that, nationwide, the amount of uncollected taxes is a whopping $450 billion. Somewhat less than one-third of that amount, a total of about $140 billion, is estimated to be due to underreporting of income by small businesses.

But just because $140 billion is a big number doesn't mean that any particular small business has underreported its income. And yet the IRS has not disclosed detailed reasons why certain businesses are getting letters about possible underreporting while others do not.

The IRS has said only that it is using income averages for various industries in looking at businesses' transactions and income reporting for income tax purposes. But the agency has not explained where those supposed industry standards came from or how they were developed.

In short, in order for its letters to small businesses to be more than a generalized shot across the bow, the IRS must do a better job of articulating the letters' purpose.

Source: MoneyNews, "Customers' Card Use Causes IRS to Target Small Businesses," Michelle Smith, August 20, 2013