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Is the IRS targeting small businesses for audits?

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Last September, the House of Representatives Small Business Committee held a hearing provocatively titled, “IRS Puts Small Businesses Through Audit Wringer.” Committee Chairman Steve Chabot, an Ohio Republican, at the outset took the Internal Revenue Service to task for its investigative actions of many small businesses.

“I know members of this committee have heard from constituents who were audited so aggressively by the IRS that they had to close their doors,” he said. “Others are engaged in protracted audits that seem like vague fishing expeditions, with no end in sight. Most are hindered in their ability to actually run their businesses because endless document demands from the IRS require so much of their time and resources. In many cases, small businesses simply cannot afford to hire a professional to deal with the demands of an audit.”

Eric L. Green

Don Williamson, executive director of the Kogod Tax Policy Center at American University in Washington, D.C., testified at the hearing that that the chances of a Schedule C being audited for an individual tax return filer reporting business income is “almost twice as great as a small corporation being audited. This evidence seemingly indicates that small proprietorships are in the audit crosshairs.”

According to a January 2016 MarketWatch report, small C corporations – those with total assets of less than $10 million – were audited at a 1 percent rate, while companies with assets between $1 million and $5 million were audited at a 1.2 percent rate and those with assets between $5 million and $10 million at a 1.9 percent rate. The audit rate jumped to 6.2 percent for middle-sized C corporations with assets between $10 million and $50 million, according to the report.

In Fairfield County, some experts said the IRS often focuses on certain types of businesses for auditing. 

“They try to go after cash-intensive businesses,” said Frederick J. Harmon, visiting professor of accounting at the University of Bridgeport, referring to businesses with off-the-books wage payments made in cash. “These can include restaurants, car washes and nail salons.”

Attorney Eric L. Green, partner at Green & Sklarz LLC in Stamford, said he has seen an increase in audits of those types of businesses. “There was a time where I would get one inquiry a year regarding an audit, maybe two,” he said. “Now, I have five active ones and three inquiries since Friday. Over the last two months, there has been a very big pick-up in activity, almost all involving small business and many in Fairfield.”

Green said two factrors driving these new audits could be reduced staffing and a smaller operating budget for the IRS that has resulted in limited resources, requiring the agency to target areas where audits have a strong chance of uncovering revenue, and diminishing results from audits. According to the most recent federal data, the IRS took a combined total of $7.3 billion in audits for 2015, the lowest level generated in the last 13 years.

Green noted that two industries disproportionately targeted for auditing, restaurants and construction, have a higher-than-average number of illegal immigrants as employees. “We had a restaurant (as a legal client) and all 12 people working in the restaurant are illegals,” he said. “From a government perspective, that (auditing) dovetails nicely with the enforcement of illegal alien laws.”

Some experts, though, did not view small businesses as being unfairly targeted by IRS auditors.

“I don’t think I would characterize IRS paying any more attention to small business than normal,” said Fairfield-based CPA Robert A. Vance. “I think a small business wants to keep in mind how they compare to the industry averages. If there is a deduction line that is substantially larger, it might make sense to take a proactive approach and attach an explanation or documentation to the tax return.”

The University of Bridgeport’s Harmon said another tax-collecting entity should be viewed with even more caution than the IRS. “Small businesses are more likely to be audited by the state,” he said. “In Connecticut, they are all over you like flies because the state is so broke. You have an equal, if not higher, chance to be audited by them.”

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