Small businesses are more likely to comply with the tax laws if they are in certain communities in the country and if they have more trust in their tax preparer, according to a report by the Taxpayer Advocate Service.
The Taxpayer Advocate Service, which is part of the Internal Revenue Service, surveyed sole proprietors who file Schedule C with their 1040 tax returns, to better understand the factors that may affect their income tax reporting compliance.
“Identifying how to improve compliance among this segment is particularly important because sole proprietor income is generally not subject to information reporting, is difficult for the IRS to detect, and represents the largest portion of the tax gap—tax that is not timely and voluntarily paid,” said the TAS in a section of the annual report to Congress from National Taxpayer Advocate Nina Olson. “Because actual reporting compliance is difficult to measure, TAS used IRS tax compliance estimates to identify sole proprietors most likely to have high or low levels of reporting compliance.”
The report found that taxpayers in the high-compliance group expressed more trust in government and the IRS. Those in the low-compliance group expressed less trust in tax preparers. Although most used a tax preparer, they were less likely to follow the preparer’s advice.
Taxpayers in the low-compliance group were more likely to participate in local organizations. They were also significantly more likely to report that other participants view the law and the IRS negatively. Both groups professed a “moral” obligation to report income accurately.
The responses did not indicate that economic deterrence motivates compliance decisions. Those in the low-compliance group were less likely to agree that noncompliance goes unpunished.
Most of the respondents agreed the tax rules are so complicated that it is very difficult to get a tax return exactly right. Those in the high-compliance group were somewhat more likely to agree with this statement, potentially suggesting they were more concerned about getting a return exactly right.
The Taxpayer Advocate Service also conducted a community survey, which revealed a number of key findings. There were more low-compliance communities than high-compliance communities because taxpayers with high compliance were not concentrated in communities. Respondents from the low-compliance communities were suspicious of the tax system and its fairness, whereas those from the high-compliance communities viewed govern¬ment positively.
The Associated Press reported that small business owners in certain communities in the South and West might find themselves more subject to an audit as a result of the IRS data used in the National Taxpayer Advocate report. “You might also be wary if you're a small-business owner in one of dozens of communities near San Francisco, Houston, Atlanta or the District of Columbia,” said the AP. “A new study by the National Taxpayer Advocate used confidential IRS data to show large clusters of potential tax cheats in these five metropolitan areas. The IRS uses the information to target taxpayers for audits.”
The AP noted that many of the communities identified by the study are very wealthy, including Beverly Hills and Newport Beach, Calif., while others are more middle class, such as New Carrollton, Md., near Washington, D.C., and College Park, Ga., near Atlanta.
The TAS report noted that respondents from the high-compliance communities were more likely to rely on tax preparers.
Among business classifications, the biggest cluster in low-compliance communities was under “professional, scientific, or technical services.” In high-compliance communities, they were in “other” service industries, such as repair and maintenance, personal and laundry, and private household services.
“The low-compliance community respondents reported more participation in civic institutions than their high-compliance counterparts,” said the TAS. “The high-compliance community respondents were motivated by morals and deterrence. The effect on compliance of financial concerns was unclear. Those in the high- and low-compliance communities responded similarly to questions addressing tax complexity.”
The report noted that all of the groups and communities agreed that it is morally wrong to cheat and that they would feel embarrassed if others learned they were not reporting all of their income. Those in the low-compliance group were more likely than those in the high-compliance group to believe that the IRS detects and penalizes noncompliance. “Thus, other factors appeared to overshadow these positive moral, social, and economic pressures for those in the low-compliance group and communities,” said the report.