One of the more nerve-wracking aspects of taxes for many snow and ice management contractors and business owners is the possibility of being audited. Surprisingly, the IRS’s own figures reveal that, in general, only 1 or 2 percent of all taxpayers actually have their returns audited each year.
However, once a large and inefficient federal bureaucracy, the IRS is changing to become more streamlined and, most importantly, catching more tax offenders. The IRS enforces the tax law in a number of ways; the more common methods include correspondence (examination by mail) and field (face-to-face audit) examinations.
According to the latest figures, the IRS audited almost 1.1 million tax returns, approximately 0.5 percent of all returns filed in 2016. The majority of audits conducted during 2017, 70.8 percent, were via correspondence. The remaining 29.2 percent were field audits. Of the more than 1.1 million audits, almost 34,000 resulted in additional refunds totaling more than $6.6 billion.
Agents in back offices are being replaced by computers with complex algorithms that cast a wide net, one that pulls many law-abiding citizens into the chaos of an audit. The result is that many seasonal and, often cash-basis, snow removal businesses are being scrutinized far more often than the numbers indicate.
EMPLOYMENT TAX BUG-A-BOOS
According to the latest available figures, as of December 2016, 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest and penalties. Lawmakers, as well as the IRS, are aware that noncompliance with employment taxes, such as withheld income taxes, Social Security and Medicare taxes, is a growing problem.
Employment taxes, including withheld income, Social Security and Medicare taxes, account for nearly 70 percent of taxes collected by the IRS. The Trust Fund Recovery Penalty is a weapon that allows the IRS to assess a civil penalty against any “responsible person” who willfully fails to pay over a business’s withheld employment taxes. It also makes it a crime to willfully fail to collect or pay over these taxes.
In addition to employment taxes being a large target for IRS auditors, taxable wages for worker classification and fringe benefits were among the most frequently misreported, leading to the highest wage adjustment amounts on average. Worker classification issues arise when employers misclassify employees as independent contractors or other nonemployees and fail to withhold and pay employment taxes.
The IRS’s 2016 Data Book, indicates a greater-than-40 percent increase in all employment tax civil penalties assessed in 2016 from those in 2015. This appears to signal a greater focus on employment tax enforcement is underway and likely to continue.
PARTNERSHIPS VERSUS PARTNERS
Thanks to the Bipartisan Budget Act of 2015, the rules governing partnership audits were replaced with a new centralized program that, in general, assesses and collects tax at the partnership level. Under the new rules that kicked-in this year, any adjustment to partnership income, gain, loss, deduction or credit as well as any partner distributive share of these adjusted items is treated at the partnership level. In other words, any income tax resulting from an adjustment in assessed and collected at the partnership level – not from the partners. It is a similar story with any penalty, addition to tax or additional amount related to an adjustment which is determined at the partnership level.
The new rules outline the procedure a partnership can use to elect out of the centralized partnership audit program. Only eligible partnerships, one that has 100 or fewer “eligible” partners, may elect out of the centralized partnership audit regime.
An eligible partner is any person who is an individual, regular ‘C’ corporation, eligible foreign entity, S corporation or the estate of a deceased partner. Unlike other sections of the tax law, a husband and wife are not treated as a single partner.
POOR DOCUMENTATION IS A DEATH SENTENCE
Many snow removal contractors and business owners, even those with no intent to commit fraud, often fall short when it comes to documentation and paperwork. The IRS appears increasingly determined to find and audit these businesses. Once sent only to those suspected of failing to comply with the tax laws, IDR are being sent out in record numbers as a screening tool. Even if the snow removal business pays its taxes dutifully, it may be penalized for lacking documentation.
The law requires every taxpayer to retain the records used when preparing returns. Those records generally should be kept for three years from the date the return is filed.
The Taxpayers Bill of Rights, part of the IRS Restructuring and Reform Act of 1998, requires the IRS to provide a written statement detailing the taxpayer’s rights and the IRS’s obligations during the audit, appeals, refund and collection processes.
These rights include:
- A right to professional and courteous treatment by IRS employees.
- A right to privacy and confidentiality about tax matters.
- A right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided.
- A right to appeal disagreements, both within the IRS and before the courts.
Among the most important of the rights given any taxpayer whose returns are targeted for an audit is whether to be represented by a tax professional or attempt to answer the IRS's questions alone. Another important consideration is where to hold that meeting.
HURRY AND GET IT OVER
The increased emphasis on small business tax audits comes hot on the heels of an IRS announcement that it hopes to speed up the audit process with something called the Fast Track Settlement (FTS) program..
The IRS’s Small Business Employed Fast Track Settlement Program (SB/SE FFS) was created to provide an expedited process for resolving disputes with small businesses and professional practices. SB/SE taxpayers that currently have unagreed factual or legal issues in at least one open year under examination can work together with SB/SE and the Office of Appeals to resolve outstanding disputed issues while the case is still in SB/SE jurisdiction. Once an application is accepted, the IRS’s goal is resolution within 60 days.
HAVING THE LAST WORD
Until a snow removal contractor or ice management professional agrees with the IRS, the appeals process remains open. Most importantly, from the initial screening for accuracy that each return receives up to the final appeal has been exhausted, mistakes in the favor of the taxpayer are discovered in about 25 percent of all cases.
The IRS is usually sympathetic to honest mistakes and willing to discuss underpayments of taxes that may result from the many "gray" areas of our tax rules. They'll frequently negotiate the amount of tax due on occasion. But they don't like fraud.