For years the IRS has targeted small businesses. Still on the top list of red flags are expenses for automobiles, travel & entertainment, and avoiding payroll taxes by misclassifying workers and under reporting owner compensation. Now, add one more to the list.
The IRS has sent “Notifications of Possible Income Underreporting” to approximately 20,000 small businesses based on the information reports it has received on their debit and credit card transactions. Many clients who are small-business owners may have already received these letters from the Internal Revenue Service questioning whether they are underreporting their business income, as part of a broad federal initiative to boost tax receipts and ensure compliance. We expect to see this program expand.
In this notification letter the IRS instructs the owner to complete a form within 30 days explaining why the portion of gross receipts from non-card payments appears unusually low.
This is VERY serious. The IRS believes many small businesses fail to report all cash sales in order to minimize tax bills, and insists the letters are just a request for more information. We believe that the IRS is looking to see if additional taxes are owed and if fraud was committed. If the IRS finds fraud, this is a felony, which could mean fines, penalties, interest and jail time. It will be expensive to defend an IRS investigation because it is often difficult to match credit transactions with income.
In 2008, the agency was given broader access to merchants’ credit-card and debit-card transaction records. The IRS has been comparing this data to information that small businesses report on their tax returns. If the data suggest an unusually large percentage of receipts come from card transactions, the IRS might send a letter asking the business owner to explain why cash receipts seem relatively low.
There are legitimate reasons why a business might report relatively high proportions of card receipts versus cash receipts. Card receipt totals can include cash that the customer takes back. Sales of gift cards, which for accounting purposes don’t count as a sale, but look that way to a credit-card company. There might be a discrepancy because payments data includes sales tax, which isn’t included in revenue claimed in tax returns. For small retailers sales tax is a liability and is not reported as revenue.
The IRS said it is working diligently to minimize the burden on both taxpayers and tax professionals while giving taxpayers the opportunity to explain and fix errors. The IRS has told accountants it is looking to verify the quality of the card-transaction data it is getting. However, the notice gives business owners no idea how much of a discrepancy there is or the source of the information so they can verify the claim and confirm that it is a valid comparison.
Source: Michael Daszkal, Daszkal Bolten LLP CPA Advisor Newsletter 8/19/13