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January 7, 2021
Author : Amy Chan
Despite studies showing that 800 small businesses are closing every day in the US, the Internal Revenue Service is planning a 50 percent increase in audits of small businesses.
“The IRS is focusing our efforts to increase compliance activity in this area of not only partnerships, but also investor returns related to pass-throughs,” the IRS deputy commissioner of examination for small businesses De Lon Harris said, according to Bloomberg. The agency is “planning for 50 percent more [small business audits] than we had in the previous year.”
While the number of small businesses audits are historically low, meaning that the 50 percent increase still won’t bring the audits up to pre-2010 levels, the ramp-up could have huge implications for mom-and-pops and startups alike.
According to Harris, the IRS is hiring 50 “specialized auditors” to handle the increased caseload and will be examining returns that are up to three years old, with the potential for going back even further should they find irregularities. And because of a law passed by Congress in 2015, the IRS can now collect money directly from partnerships instead of having to hunt down investors.
The newly added levels of scrutiny of small businesses comes at a time when the small business ecosystem is in free-fall with some studies showing that 800 small businesses are closing per day in the US.
In 2019, 91 Fortune 500 companies paid zero in taxes. But between income tax, self-employment tax, employment taxes, excise taxes, and estimated taxes, to many small business owners it can be overwhelming.
Because of the heavy tax burden small business owners face, many try to hide their profits. This is particularly common in the restaurant industry, which includes huge overhead costs between labor and supplies and also the risk of lawsuits, making the survivability rate in a normally functioning economy extremely low. As Contractor News has reported, one-in-six restaurants have closed down because of the coronavirus pandemic. That number could potentially increase over 2021.
Meanwhile, according to a study from the National Taxpayer Advocate, an independent office inside the IRS, construction companies — whose plight during the coronavirus has also been covered here at Contractor News — are more likely to fall short on tax compliance than other industries. The same goes for real estate rental firms, who were barred from taking coronavirus relief funds.
So, with the heavy hand of the IRS potentially looming, here are some things you can do to make sure you aren’t raising eyebrows at the agency, and also some ideas on dealing with the IRS if the tax collector comes knocking.
Keep Track of Mileage: Many small business owners use company cars, but using it to commute is not tax-deductible. Make sure to document your personal and professional use of company-owned vehicles in case the IRS requests this information from you.
Don’t Play Santa Clause: Gifts to your associates, clients and employees during the holiday season are not tax deductible if they are more than $25 per person. According to small business expert John Nealon, many make the mistake of sending a gift basket to an entire office, but addressing it to just one person. Don’t do that.
Set Interest Rates on Personal Loans to You Company: If your company is falling short and requires an investment, don’t just write a check to it. You need to charge at least some interests on loans, or the IRS might set an interest rate and force you to pay up on the interest you should have gotten. The IRS has what’s called an Applicable Federal Rate (AFR), which sets the minimal interest rates on loans between related parties. You can check the IRS standards here. If your rates are lower, you may have to pay more in taxes.
Classify Your People Correctly: Make sure that you are complying with your 1099 forms and avoid classifying your employees as contractors to lessen the burden. The IRS looks closely at these things. Make sure that any contractor or business you pay more than $600 in a tax year gets a 1099 form.
Keep Business Outings Within Reason: If you are on a business outing, whether it being meals or entertainment, it may be tax deductible at a rate of 50 percent. But don’t regularly spend extravagantly, and saving your receipts could save you a headache down the line.
You are not your company: Corporations may be people in terms of political campaign finance, but they are absolutely not as far as small businesses are concerned. Make sure to open a bank account strictly for your company, and that contracts specify your corporation — not yourself — as the provider.
Do Your Homework: Do some research on how much people in your profession make in your area. The IRS uses those figures to determine how much money you should be making in what they call “reasonable compensation.” It’s best to pay yourself a bit more than your highest paid employee.
Document, Document, Document: Keep records of your business’ reinvestment needs as they are useful explanations to the IRS for why you are not paying profits to yourself as salary and are retaining them for your business.
Organize Your Documents: Keep your bills for your work separate from what you bill for subcontractors and employees. According to Forbes, “money earned from marking up other folks’ work is easier to wave off as profit.”
If you owe taxes to the IRS and risk having to close your business because of it, there are a number of things you can do to avoid that. Nolo, a legal publishing company with a do-it-yourself approach, has a number of suggestions:
Don’t Ignore the IRS: If they have come for you, they will come back again until you are squared away. Keep in contact with the agency so interest and penalties don’t mount up even higher. “Most tax debts compound at a rate up to 14 perent,” the outlet notes. They will hound you unless you are basically homeless, and have the power to make you homeless if you don’t comply.
Slow and Steady: The IRS doesn’t have a huge staff, so it takes them time to take cases up and to follow-up on those cases. It’s easy for them to send tax bills and telephone calls but not so easy for them to actually assign a person to your case. Work with them and let the process bare out. It could be a while, which buys you a lot of time to work things out on your end.
Comply With Financial Information Requests: Give the IRS the information they ask for. Don’t lie, but you also don’t have to give them information about your assets or finances until you are served with a summons.
The IRS Can be Full of Hot Air: The agency often threatens to shut down businesses but rarely does. When they do follow through on their threats, it’s usually over unpaid payroll taxes. Catch up on those and you may find yourself out of the water.
Work Out a Deal: Try to get the IRS to agree to some kind of payment plan in monthly installments, but keep in mind that interest and penalties accumulate. It also doesn’t hurt to ask for a reduction in the amount you owe them. There is also the “offer in compromise” route, which works for about one-in-four businesses. It’s a gruelling process but it can result in you only having to pay a fraction of what you owe. The IRS is more likely to accept these appeals if they believe that you won’t have the money to pay-up in the future. “Something is better than nothing” being the rationale.
You can also make an appeal for “uncollectible status” if it’s really a situation of them trying to squeeze blood from stone. You’ll still have to pay up with increased interest and penalties, but it can buy you a good amount of time.
If you are all out of options, consider filing for bankruptcy. The IRS may tell you otherwise, but doing so can reduce or even free you of some of your tax debts.
Good luck and godspeed from the Contractor News team.
We leave you with the words of the Beatles’ song Taxman: If you drive a car, I'll tax the street. If you try to sit, I'll tax your seat. If you get too cold, I'll tax the heat. If you take a walk, I'll tax your feet