Washington, D.C. - During a recent hearing of the House Small Business Committee, lawmakers questioned the Internal Revenue Service as to why small business audits are on the rise as corporate audits fall, and urged them to do more to help entrepreneurs struggling to comply with the complex tax system.

"Ask any entrepreneur what time of year they most dread and they will tell you it's tax season," said Chairwoman Nydia M. Velazquez, D-N.Y. "Small businesses struggling to keep their doors open find themselves spending valuable time and resources just to make sure they follow the rules and pay their taxes on time."

Velazquez grilled IRS Commissioner Doug Shulman about the rising number of IRS small-business audits. A recent study showed that while audits of large businesses are at an all-time low, smaller entrepreneurs are being audited at nearly twice the rate of their bigger counterparts.

In fact, smaller companies were audited 41 percent more often in 2007 than in 2005, and companies with $10 million to $50 million in assets were 29 percent more likely to be audited in 2007 than 2005, according to a study by Syracuse University's Transactional Records Access Clearing House. Meanwhile, the TRAC study showed that companies with more than $250 million in assets were nearly 40 percent less likely to be audited than in previous years.

"I find the IRS's recent shift in auditing attention from large companies to small businesses troubling," Velazquez said. "Our nation's entrepreneurs are having a difficult enough time without the IRS stacking the deck against them."

"We have some concerns about the increase in audits of small businesses," said Bill Rys, tax counsel for the National Federation of Independent Business. "If business taxpayers are willfully trying to avoid tax laws, that's one thing, but the increase in the number, especially during a recession, is a concern."

"We always say the better way is to simplify the Tax Code, rather than continue along with a complicated code and an increase in audits and new reporting requirements," he said.

"The IRS needs to continue to do more outreach to small-business owners," he said. "If businesses are struggling financially and having trouble on the tax side, helping them get through their tax problems is a better solution."

Rys noted that the IRS's Small Business/Self-Employed Division has been reaching out to communicate with small businesses. "They have increased their efforts to help small-business owners in recent years. They've added to their Web site and are looking to communicate more information to first-time Schedule C filers," he said.

ON IT, SAYS THE IRS

Responding to questions about the discrepancy in audits between large and small businesses, Shulman noted that the IRS is eight times more likely to audit businesses with assets between $10 million and $250 million than businesses with less than $10 million in assets, and was 18 times more likely to audit a business with over $250 million in assets.

Shulman met with his senior team last summer to review programs that would be stressed in the deteriorating economy, he said. In written testimony before the committee, he detailed steps that the service is taking to ease the burden on small businesses.

"As the financial crisis deepened, the IRS took deliberate and focused action to provide assistance to individual and business taxpayers in distress, while also preventing others from straying into non-compliance," he stated. "It is inevitable that during times of economic downturn, taxpayers may fall behind in paying their taxes. As IRS commissioner, I am committed to striking the right balance between collecting the revenues needed to fund the government, and using all the tools we have available to us to work with small businesses who find themselves in difficult times."

Among the steps that would benefit small businesses, Shulman noted that examination employees - those who conduct the actual audits - have been reminded of their responsibilities to consider collectability during the pre-audit phase. "They were also reminded of their ability to offer installment agreements at the end of an audit when taxpayers are having difficulty satisfying their obligations immediately, thereby enabling them to minimize interest and penalty charges," he said.

IRS employees may now suspend collection actions in certain hardship cases where taxpayers are unable to pay, he noted. "This includes instances when the taxpayer has recently lost a job, is relying solely on Social Security or other assistance, or is facing devastating illness or significant medical bills. If an individual has recently encountered this type of financial problem, IRS assistors may be able to suspend collection without further documentation to minimize the tax burden on the taxpayer."

In addition, the IRS has added flexibility for missed payments. "The IRS has flexibility in working with previously compliant individuals in existing installment agreements who have difficulty making payments because of financial hardship. The IRS may allow a skipped payment or a reduced monthly payment amount without automatically suspending the installment agreement," Shulman said.

WHERE THE MONEY IS

The increased audit emphasis on small businesses shouldn't come as a surprise, according to Roger Harris, chief executive of Padgett Small Business Services.

"Studies on the tax gap indicate that is where [in small business] they perceive it to be," he said. "If you have a study that says, 'We have a tax gap and it's here,' then it's not a surprise if enforcement is directed toward the area you have the most potential to collect money. In fact, close to half the tax gap is attributable to individuals with small businesses."

The tax gap, the difference between taxes owed and the amount paid voluntarily, stands at roughly $350 billion.

"That doesn't explain the drop in large-company audits, or mean it's necessarily the right thing to do, but it's not surprising. If you're in the IRS, you want to allocate your resources as efficiently as possible," he said.

"That's not saying that I want the IRS to do this," said Harris. "I haven't tracked it as a percentage, but we have had more questions about people being audited - there is more activity in this area."

"But people won't stop speeding unless they think there might be someone on the side of the road with a radar gun," he said. "If you expect a certain amount of compliance, there has to be ... the feeling that if you don't follow the rules you might get caught. For the system to work, you accept that audits will happen - you just want them to be fair both to the small-business owner and the government."

Gene Marks, CPA, president of The Marks Group PC, in Philadelphia, agreed.

"The IRS is working with limited resources and has to decide how to best allocate them," he said. "If all we were talking about were large corporations, small-business owners might be tempted to take a chance. The IRS needs to make a statement about small business that, 'We're watching you, too.'"

Marks believes that small-business owners will be faced with more than just increased audits as Obama administration plans become law.

"Some of [President Obama's] plans will place additional burdens on small business with increased reporting and regulatory requirements," he said. "They haven't been passed into law yet, but we're all expecting it to happen."

(c) 2009 Accounting Today and SourceMedia, Inc. All Rights Reserved.

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