The IRS disproportionately targets small companies for audits, burdening them with extra costs and stealing time that they need to do business, according to an expert who testified at a Small Business Committee hearing Wednesday.
Donald Williamson, executive director of the Kogod Tax Policy Center at American University, says the IRS does this because small businesses receive most of their income in cash, which can be difficult to identify and report.
Even though the IRS can collect more money by auditing large corporations, the IRS continues to audit small and medium size businesses at a high rate.
"The highest number of audits for 2014 of individual tax returns with business income was in the lowest range of business returns, i.e. $200,000 to $400,000, amounting to 50 percent of all audits of upper income individual returns," Williamson said. "Indeed, the chances of a Schedule C being audited are almost twice as great as a small corporation being audited."
"Most audits are not random," he says. "The IRS has a secret algorithm for determining how likely each taxpayer is to have unreported income. Employing this calculus, the IRS has concluded that small businesses are less likely to be paying their fair share of taxes relative to much larger enterprises."
Williamson says this action by the IRS makes it particularly difficult for small business owners who sometimes conclude that getting a professional involved to resolve the audit is not worth the cost.
"Because small business owners rely upon enrolled agents, CPAs or attorneys when they are contacted by the IRS, significant costs arise for even insignificant inquiries," he said. "In fact, many small business owners simply conclude that the cost of their time and professional fees is not worth the effort to dispute the proposed adjustment and opt simply to pay the extra tax—rather than continue to fight."
A former IRS employee admitted to lawmakers that there is "inconsistent treatment’ between small and large businesses by the agency.
"We believe there is some inconsistent treatment of small versus large businesses by the IRS, as well as differing procedures being used in audits of these businesses," said Kathy Petronchak, Director of IRS Practices and Procedures for Alliantgroup, LP, who previously worked at the agency for almost 29 years. "It is vitally important to remember that America’s small businesses do indeed have needs, interests and resources that may differ significantly from those of larger businesses."
"In many cases, small businesses simply cannot afford to hire a professional to deal with the demands of an audit," said chairman of the hearing Rep. Steve Chabot (R., Ohio). "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."
"The agency has failed repeatedly in meeting this obligation to the people it is supposed to be serving," he said.