Who does the IRS trust, and are you on the list?

Using IRS data on tax filings and audits in 2012, I look at what types of businesses, tax forms, and income levels are at the greatest risk of an audit

Occasionally an article will pop up about the hard-edged stance the IRS takes with small businesses, and particularly sole proprietorships.

Always, the implicit assumption is that the IRS treats specific groups unfairly.

Just the hint that a group with so much power might be biased in some way really gets under my skin. Then again, the media can be biased too, so I decided to take matters into my own hands.

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The IRS publishes an annual report on its website called the Internal Revenue Service Data Book.

The report furnishes the public with statistical information, including:

1. Returns filed, taxes collected and refunds
2. Examinations
3. Enforcement
4. Taxpayer Assistance
5. Tax-Exempt Activity
6. Chief Counsel (court) Activity; and
7. IRS Budget

I took a closer look at the examinations category, which includes data on the types of entities receiving the most scrutiny.

How the IRS targets small businesses

The IRS chooses to examine 0.9% of all tax returns filed in the United States. Roughly half a million examinations are conducted “in the field” (the harrowing face-to-face interaction involving sweat and hand-wringing). Over one million are conducted via correspondence, or by mailing a request for additional substantiation or documentation. So that is the norm. Now let’s look at small businesses.

The general consensus is correct inasmuch as small businesses are examined more frequently than the average. However, if you take a look at the number of correspondence examinations for firms earning less than $25k, you will see that there are roughly 7.5 times the number of examinations conducted via correspondence than in person. The IRS is taking a closer look at this group but is not truly scrutinizing and squeezing them.

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The aberration is caused by the Earned Income Tax Credit, which the IRS claims was the basis for 487,408 examinations of small business returns. So while the percentage of businesses earning less than $25k is double the average, examinations conducted in person are actually more rare than the average.

Businesses earning more than $25k were more likely to be examined and more likely to come face-to-face with an auditor. The IRS was less likely to examine a corporation earning between $5 and $10 million than a small business earning between $100 and $200k.

Next week, I will tell you why.

 

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