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Small business and tax audits, part 1: IRS shifts priorities

The tax compliance challenges faced by small business owners are one of the important threads in this blog. A few months ago, for example, we devoted a two-part post to issues involving income reporting by small businesses. 

In that post, on August 16 and August 23, we discussed threatening letters sent by the IRS to many small business owners. The letters did not formally initiate tax audits. But they warned businesses about the consequences of underreporting income.

In today's post, let's follow up on that discussion by looking at indications given by the IRS this month about its approach to small-business tax audits.

The indications on the IRS's small-business audit priorities came from Faris Fink, the head of the Small Business / Self Employed Division of the IRS. Speaking at a national conference for certified public accountants, Mr. Fink said the IRS intends to reorient its approach to audits of small businesses.

This reorientation involves focusing more attention on partnerships. In the past, the IRS has devoted considerable energy to auditing corporations. As corporate forms have evolved, however, partnerships have increasingly become a preferred form of business organization.

The IRS now appears to recognize that it has been behind the curve in keeping up with the trend toward more businesses choosing to use various partnership forms. But the agency clearly aims to catch up, and so is making this known now to the small-business community.

To be sure, so-called "pass through" businesses, such as sole proprietorships and S corporations, are still very popular. These are businesses where the income tax burden gets passed along to individual owners.

But the number of tax returns from partnerships has been increasingly significantly in recent years. In part two of this post, we will discuss some of the steps the IRS is taking to respond.

Source: Bloomberg, "Small-Business Partnerships to Be Priority of IRS Exams: Taxes," Ludia Beyoud, Nov. 11, 2013

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