IRS Audits of Small Companies Rising
According to Fortune Small Business and other sources, the IRS has increased its audits of small companies. The rise in tax audits has implications for records management in small firms because records that document tax deductions often come under scrutiny during audits and must be held from destruction while an audit is in progress. Inability to destroy records on hold can add to costs for records storage and maintenance.
A study by the Transactional Records Access Clearinghouse (TRAC) at Syracuse University showed that small companies were audited 41 percent more often in 2007 than in 2005. TRAC's report also noted that companies with $10 million to $50 million in assets were 29 percent more likely to be audited. In contrast, major corporations – those with assets of $250 million or more – had only a one-in-four chance of being audited in 2007 compared with a three-in-four chance in 1990.
The IRS believes that small businesses are a big reason for the tax gap, which is the difference between the amount of taxes paid and what the government is actually owed. But the TRAC study shows that, on average, large company audits turn up about $7,500 per hour in additional taxes owed compared with $474 per audit hour in small firms.
Reasons given for the focus on small businesses vary. A spokesperson for the National Treasury Employees union told of reports from IRS employees who said they were under pressure to increase productivity by limiting the scope of audits. The theory is that, under such pressure, auditors will pursue smaller, easier audit targets. The IRS has responded that it is actually focusing on the use of partnerships and other entities that companies of all sizes use to minimize taxes. A deputy IRS commissioner told The New York Times that the IRS is focusing on private partnerships that some large corporations use to avoid paying taxes.
The Kiplinger Business Resource Center notes the areas most likely to be examined during IRS audits of small businesses are:
- Worker classification – documentation that distinguishes independent contractors from employees
- Retirement plans – particularly documentations showing mistakes made in administering simplified employee pensions plans
- Tip reporting – forms used by restaurants and other service businesses that require them to allocate tips according to a percentage of sales
Small business owners who believe that they are "under the radar" for tax audits because of their size should take heed. One small business owner estimates that he spent $50,000 on the tax audit process that lasted 18 months. Ironically, the IRS has instituted a CAP program for large corporations that results in tax audits closing within six months of filing returns, allowing major savings for records whose retention is designated as "close of tax audit."
ARMA International IMN, June 2008