Tax Gap Solutions Burden Small Businesses

Proposals recently issued by the Treasury Department to close the tax gap, which focus on small businesses and the self-employed, would generate only $2.9 billion in revenue, one percent of the estimated total, while they would increase the paperwork requirements on small businesses, and even turn them into tax collectors, bizjournals.com reports.

“That’s 1 cent on the dollar,” Senator Max Baucus, (D – Mont.) told Treasury Secretary Henry Paulson. “We need a lot more from you.” Baucus wants the Internal Revenue Service (IRS) to recover around $30 billion a year, MarketWatch.com reports.

The Treasury Department has targeted small business because underreported business income and unpaid self-employment taxes account for more than half of the tax gap.

A key element of the government’s strategy is to increase third party reporting to the government that would come from additional paperwork to be done by small businesses.

The proposals would require:

  • Businesses to file Form 1099 for payments of $600 or more to corporations that provide services,
  • Businesses to check the Taxpayer Identification Number of their contractors with the IRS and withhold taxes if the TIN is not verifiable,
  • Credit card companies to report their annual payments to small businesses and sole proprietors.

Macey Davis, tax counsel with the National Federation of Independent Business, told officials at a meeting at IRS headquarters, according to MarketWatch.com, that the current tax system already forces small businesses to spend money on compliance rather than on growth and warned that added burdens could alienate them.

“We are biting the hands that feed us,” she said.

The proposal requiring credit card companies to report payments made to small businesses would allow the IRS to compare the payments with self-reported revenues on tax returns Small business organizations worry that this proposal would result in fee increases from the credit card companies.

Some analysts believe audits are the best way to close the gap, USAToday reports, and Schedule C filers are more likely to be audited than individuals who do not file Schedule C. “Chances are, you’ll be audited if you’re in business long enough,” Frederick Daly, a tax attorney, told USA Today.

IRS Taxpayer Advocate Nina Olson believes audits can be more effective if they’re targeted at specific groups such as self employed workers who are paid in cash, USAToday said.

If the IRS audited a food vendor in New York, he would probably talk about it, she said. “They’d get nervous and start reporting more of their income. That’s more effective than “scattershot audits.”

Congress rebuked the IRS in the late 1990s over overzealous audits, and the number of IRS audits declined. In 2002 the Service reinstated the practice of random audits, and last year the IRS conducted 1.2 million audits, the highest number since 1998, Forbes.com reports.

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