The nation's small businesses are squarely in Washington's crosshairs - targeted for more rigorous, more painful scrutiny by both federal tax enforcement officials and the nation's auditing standard-setters.The first whiff of the shift in increased enforcement to smaller business came last summer, with a new study by tax researchers at Syracuse University's Transactional Records Access Clearinghouse that discovered that the number of federal tax audits targeting small businesses with between $10 million and $50 million in assets increased by 29 percent from 2005 to 2007. Among the smallest companies - those with assets under $10 million - Internal Revenue Service investigations increased a whopping 41 percent.

In contrast, the researchers found that large companies with more than $250 million in assets were 40 percent less likely to be audited than in previous years.

The IRS isn't alone in tightening its enforcement focus on smaller businesses. Earlier this year, the Public Company Accounting Oversight Board issued new guidance for auditors that effectively directs accountants to take a more skeptical, hard-nosed approach toward audits of their smaller clients.

The new guidance - which is certain to cause additional friction between accountants and their small-business clients - calls on auditors to take special steps to root out fraudulent activity among top management at those companies.

The oversight board concluded that, "The extensive involvement of senior management in day-to-day activities and fewer levels of management can provide additional opportunities for management to override controls in smaller, less complex companies."

This isn't the first warning that the economic downturn may cause audit clients to cut corners. In approving a stiff 9 percent budget increase for its own operations, the PCAOB argued that the extra funding will be necessary to curb an expected rise in financial fraud.

Among the specific actions the new guidance will expect auditors of small companies to take is holding brainstorming sessions or other group discussions by the audit team to assess such fraud risks as "where management could override controls to engage in or conceal fraudulent financial reporting."


Although both the PCAOB and the IRS will be targeting smaller companies for additional scrutiny, there's no indication that Washington is launching a coordinated assault.

At the PCAOB, the concern over corner-cutting by smaller corporations appears to be part of a broader push directed at addressing concerns that the economic downturn is tempting companies large and small to engage in financial chicanery.

In contrast, the IRS's decision to crack down on smaller businesses has been described as "inexplicable" by some.

Researchers for the Syracuse study noted that an average audit hour of large firms yielded the IRS about $7,500, while an hour of auditing smaller companies turned up just $474.

Bureaucratic explanations, however, are plentiful. One IRS examiner told Accounting Today that he has been directed to close audits more quickly to conserve the agency's resources.

One way to do that, according to officials at the National Treasury Employees Union, is to increase productivity by going after "little fish" with fewer resources to fight an audit.

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