Small businesses in the United States create more jobs than any other sector in our economy. Yet according to tax data from recent years, businesses with the lowest levels of income ($200,000–$400,000) get audited most frequently.
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While the Internal Revenue Service (IRS) tells the public that they keep their small business auditing practices random through a complicated and secret algorithm, many business owners feel that they’re being deliberately targeted for audits, and at least one expert agrees.
In 2016, Donald Williamson, a tax professor at American University’s Kogod School of Business, provided written testimony before the United States House of Representatives Committee on Small Business, arguing that “most audits are not random, i.e., the IRS has a secret algorithm for determining how likely each taxpayer is to have unreported income.”
“Employing this calculus, the IRS has concluded that small businesses are less likely to be paying their fair share of taxes relative to much larger enterprises,” Williamson continued, “a surprising conclusion in light of frequent press reports of multi-national corporations allocating billions of dollars of profits to no- or low-tax jurisdictions to avoid U.S. income taxation.”
THE IMPACT OF IRS TARGETING SMALL BUSINESSES FOR AUDITS
The IRS targeting small business owners is problematic for numerous reasons, but three main issues seem especially troublesome.
1: IT CAN CREATE DISTRUST
First, if the IRS is targeting small businesses but publicly stating otherwise, why are they being knowingly dishonest? While few people would go on about their love and admiration for the IRS, most of us still expect them to follow a certain ethical code, especially since they are charged with assuring we do the same.
How can the IRS go about the business of verifying taxpayer’s honesty and accountability and maintain credibility when they can’t be honest and forthright themselves?
2: IT IMPLIES FAVORITISM
Secondly — and this is Mr. Williamson’s main point — why is the IRS deliberately pursuing small business audits despite widespread suspicion (bordering on common knowledge) that multi-national conglomerates successfully exploit all kind of loopholes to avoid paying taxes?
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If this is true, it topples the notion that everyone should be paying their fair share and implies a degree of collusion on behalf of the IRS to ensure tax breaks for the mega-rich while suppressing small business growth in the United States.
3: IT CAN LIMIT PRODUCTIVITY AND GROWTH
Lastly, and most important for business owners, these small business tax audits take a significant toll on their finances and day-to-day operations.
According to research conducted by the National Taxpayer Advocate, small businesses in the U.S. spend roughly 2.5 billion hours preparing tax returns and responding to IRS inspection of those returns. The Advocate also notes that this time equates to about 1.25 million full-time jobs.
Williamson states that 70 percent of small businesses hire tax professionals to prepare and file their returns and then represent them in their dealings with the IRS. These consultations from attorneys, accountants, and other tax professionals come at a total cost of more than $16 billion every year.
These expenditures are mostly unavoidable for small business owners under the current state of affairs since the ever-expanding tax code and list of regulations is simply too complex for the average business owner to understand and comply with on their own. And the incredible amount of time and money business owners spend trying to navigate these murky waters negatively impacts their companies’ efficiency and growth.
Small Business Audits: The Waiting Game
Not only are these audits inconvenient, but according to Williamson, the inefficiency of audits often makes them a drawn-out process, which can further drain a small business’ resources. In many cases, he notes, business owners’ responses to written IRS notices remain unassigned and unattended to for weeks or even months.
“Once a taxpayer’s response to a written notice is actually reviewed by an IRS auditor, it is often the case that the auditor will find the taxpayer’s response to be insufficient, [which sets off] a new round of correspondence consuming several more weeks or months,” Williamson says. Instead of this outdated method of correspondence, he suggests that these cases could be settled much faster with a face-to-face meeting or phone call.
Williamson’s main argument during his testimony in front of the House Committee is that the IRS appears to unduly and excessively focus on small business tax returns and that this is a gross misallocation of IRS resources. In closing his testimony, Mr. Williamson urged the IRS and Congress to “streamline and simplify the small business audit process.”
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