Audits of Small Business Often Unproductive, IRS Acknowledges

In the traditional children’s story of the “boy who cried wolf,” an attention-seeking adolescent raised too many false alarms about dangers from a threatening beast. Because he had been wrong so many times before, the boy ended up not getting the response he needed when he truly was in danger.

Broadly speaking, the moral of the story is that concerns should not be raised unless they are legitimate. And yet the IRS frequently makes small business go through time-consuming tax audits even when no additional tax is owed.

Last week, Russell George, the inspector general for tax administration at the Treasury Department, reported that the IRS has been devoting significant levels of resources on unproductive audit cases of small businesses. The audits were unproductive in the sense that no additional tax was owed.

Such audits have been particularly common for S-corporations. But they can affect many different types of small businesses.

Following the 1986 overhaul of the tax code, individual and corporate tax rates have become greater. This has made the S-corp more popular, because it allows profits from a small business to be taxed at the individual rate of the owners rather than the corporate rate.

The inspector general’s report found that in the most recent fiscal year, 62 percent of the audits of S-corps in the research sample did not require any recommended changes to the tax returns. In other words, more than 6 times of every 10, the audit did not discover the need to pay any additional tax.

Source: “Small business audits often find no more taxes due – IRS watchdog,” Reuters, 7-26-12

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