Small Businesses Are IRS Targets?

That’s what the Wall Street Journal reported. Apparently, an estimated 20,000 of small businesses received letters from the IRS questioning whether all of their cash receipts were reported.

What are these letters and what do they mean to recipients?

Audits?

The IRS says they aren’t correspondence audits (letters that constitutes audits). Instead they are “inquiries” of targeted businesses. However, recipients who fail to respond within 30 days could come under examination. The IRS has general instructions for small businesses receiving 1099-K inquiries.

Targets?

The letters are being sent to small businesses that received Schedule 1099-Ks reporting transactions on credit and debit cards as well as electronic transfers (e.g., PayPal) and then reported a small amount of revenue relative to the amount of transactions reported on the 1099-Ks. So the inquiry is aimed at businesses large enough to receive these forms (there’s no 1099-K required unless there are more than 200 transactions totaling more than $20,000), but not large enough to no longer be viewed as small businesses.

What can you do?

Apparently there’s nothing that a business can do to avoid an IRS inquiry. The IRS is just looking at the numbers and not at normal business and accounting practices.

The numbers reported on the 1099-Ks are the gross transactions that are part of credit card transactions. Businesses do not have to reconcile and report to the IRS the amounts reported on these forms with the amounts reported on their returns when they file their income tax returns. But the inquiry is effectively asking for a reconciliation.

Why the discrepancy between the 1099-Ks and income reported on returns? The 1099-Ks do not take into account:

  • Returns (when customers return merchandise for credits on their charge cards)
  • Chargebacks (when customers dispute transactions and amounts charged are reversed)
  • Gift cards (when customers charge gift cards on credit cards; per IRS instructions merchants do not report them as income until the cards are used)
  • Sales tax (when customers pay sales tax on transactions, it grosses up the amount charged, but the sale tax isn’t income to merchants)
  • Shipping, insurance, and other costs (when customers pay them along with their purchase; like sales tax, these items aren’t income to the merchants)

Sure, there are businesses that under-report their income. But this program doesn’t seem to be the best way to find them. Instead it is wasting time and resources (think of the accounting fees for a response to the inquiry) of honest business owners who follow the rules and are just caught up by the numbers.

This is another example of a government burden on small business owners that impedes their ability to run their businesses.

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