Eight Focused Audit Areas on Small Businesses by the IRS

The IRS announced eight areas that it will focus on for audits of small businesses. The IRS said it is increasingly its oversight of small businesses. They believe that the small business underreporting is responsible for 84% of the $450 billion tax gap.

Below are eight areas the IRS is targeting:

  1. Fringe benefits The IRS audits indicate that employers are not reporting employee fringe benefits like personal use of company vehicles on Forms 1099 or W-2. If the company allows the employees or company owners to drive the vehicle for personal business, it is required to keep a log to keep track of all trips taken in the car. The log should include the date, mileage of the trip and purpose of the trip. If you do not have a completed vehicle log, it will be assumed by the IRS that you used the vehicle entirely for personal use. According to IRS Publication 15-B, “Any use of a company-provided vehicle that is not substantiated as business use is included in income.” the IRS requires employers treat the personal use of business cars as a  taxable fringe benefit and include the fair market value in compensation paid to the employee. As such, taxable fringe benefits are subject to employment taxes. There are special rules to withhold, deposit and report the employment taxes on these benefits.
  1. High income taxpayers The IRS defines high income taxpayers as those who bring in a total income of more than $200,000 a year. Total income includes all gross receipts and sources of income before expenses and deductions. In 2013, the IRS will focus on taxpayers with a total income of more than $1 million who file a Schedule C business return. Last year, the IRS audited 12.5% of all individuals with incomes of more than $1 million.
  1. health care credit for Small business This credit was first made available in 2010 and is now coming under IRS scrutiny. The IRS will look for compliance with eligibility requirements. A qualified employer must have fewer than 25 full-time employees or a combination of full-time and part-time (for example, two half-time employees equal one employee for purposes of the credit); the average annual wages of employees must be less than $50,000, and the employer must pay at least half of the insurance premiums. The employer must also pay premiums under a “qualifying arrangement.”Small businesses cannot take a tax credit for insurance premiums paid for owners of the business. This means that owners of corporations, partners in a partnership, and sole proprietors. For small businesses structured as a C-corporation, no tax credit is available for employees who own 5% or more of the corporation. For S-corporations, no tax credit is available for employees who own 2% or more of the S-corporation.Partners, members of LLC treated as a partnership, owners of a single-member LLC, S-corporation shareholders owning 2% or more of an S-corporation, and sole proprietors are all treated as self-employed persons for health insurance purposes, and are eligible for the self-employed health insurance deduction instead of the tax credit.
  1. Form 1099-K matching The IRS announced that it will start Form 1099-K matching in late 2013. The IRS provided a reprieve from merchant card reporting on business returns for 2011 Schedule C and Forms 1065, 1120S and 1120; however, the IRS plans to change its approach after 2012 returns are filed. The IRS has indicated that it plans to pilot a business-matching program that can address a large amount of small business noncompliance. Business taxpayers will receive Form 1099-K (merchant card and third-party network payments) to report amounts received from payment settlement entities (debit/credit cards and third-party network payers such as PayPal). For 2012 business returns, Form 1099-K receipts should be to separately reported as line items on their returns.
  1. International transactions The IRS will continue to focus on the international tax gap. The IRS’ third voluntary initiative for foreign bank account reporting is under way, and the IRS will be looking to aggressively pursue taxpayers who hide assets overseas. The IRS will also focus on offshore transactions for large and small businesses. Here are is a list of some  international transactions. A “person,” can be a business entity, estate or trust, as well as an individual.
    • U.S.property is purchased from a foreign person
    • Payments made to a foreign person
    • A foreign person acquires stock in a U.S.corporation
    • A foreign person becomes a partner in a U.S. Partnership
    • A U.S.person becomes a partner in a foreign partnership
    • Transactions are denominated in a foreign currency
    • A U.S. person controls or has an interest in a foreign account
    • Property or currency is transferred into or out of the United States
    • Business operations are conducted in a foreign country
    • International transactions are conducted with a related person (transfer pricing).
  1. Partnerships. This is a new area of emphasis for the IRS. The IRS is expected to target large loss partnerships and specific abuses that emerge from the ongoing auditing.
  1. S corporations. The focus will be on deducting losses from S corporations and the use of S corporation distributions to avoid payment of Social Security taxes. The IRS is interested in S corporation audits in which losses are taken in excess of basis on shareholder returns. The IRS will review basis computations in these audits to determine whether tax preparers are properly completing due diligence requirements before deducting losses on Form 1040. The IRS is also interested in the use of S corporation distributions to avoid payment of Social Security taxes. The IRS will focus on S corporations with income, distributions and little or no salary paid to officers.
  1. Proper worker reclassification. Almost all business audits also include employment tax issues because the IRS believes that there is significant noncompliance in this area. In particular, the IRS is interested in worker status. The IRS understands that businesses have an economic incentive to misclassify workers as independent contractors rather than employees. The IRS will continue to focus its field examination resources in this area.

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