(This column originally appeared in The Guardian)
The tax man is receiving a whopping $80bn thanks to the Biden administration’s recently passed Inflation Reduction Act. Some people are losing it.
“It’s a middle finger to the American public,” says Florida’s governor, Ron DeSantis. Small business will be the first to suffer, Joe Hinchman, executive vice-president at the National Taxpayers Union Foundation, told the New York Post. “The IRS [Internal Revenue Service] will have to target small and medium businesses because they won’t fight back,” he said. “We’ve seen this play out before … the IRS says, ‘We’re going after the rich’ but when you’re trying to raise that much money, the rich can only get you so far.”
The IRS and the Biden administration, naturally, say small businesses shouldn’t be concerned.
“These resources are absolutely not about increasing audit scrutiny on small businesses or middle-income Americans,” the IRS commissioner, Charles Retting, wrote in a letter to lawmakers. There will be “a lower likelihood of audit due to improved technology and customer service”, says the treasury secretary, Janet Yellen.
Who to believe? Will your small business face greater scrutiny from the IRS? Will your tax bill go up as a result? The answer to both questions: don’t panic.
It’s true that the IRS is going to use part of the $80bn in funding to hire about 87,000 new agents. But 50,000 IRS employees are expected to retire or otherwise leave the agency in the next five years. So many of those employees will be replacing current ones. Admittedly, the IRS does currently have about 74,000 employees, so even adding 37,000 net new employees is a huge jump.
The remainder of the funding — which will come over the next 10 years, by the way — will be targeted at upgrading the agency’s woefully outdated systems. These are the systems that are behind the delays in getting out refunds and which currently spew out countless incorrect notices that cause countless hours of wasted time by business owners and their accountants attempting to respond.
More agents. Better systems. Yes, there will be more audits. And many small businesses will be affected. But again, don’t panic. Just look at the historical compliance data from the IRS.
Just 2.9% of corporate returns were audited in 2019. But these are not really small businesses. If you own a small business it’s highly probable that you file some sort of a pass-through tax return like a partnership or an S-corporation. In 2019, 9,093,343 of these returns were filed and 5,283 of them were audited. No, I’m not missing any zeros. That’s less than 0.1% of all small business tax returns. The audit rates for individuals between $50,000 and $500,000 are also around 0.1%. That’s one-tenth of 1%.
Let’s say the number of small businesses audited triples over the next 10 years. Using the above numbers we’d see a “whopping” 15,849 businesses under scrutiny. Meanwhile, 9,077,494 will remain untouched. There are better odds of winning roulette in Vegas than being picked for an audit.
Yes, I get that even if your books are squeaky clean just responding to a simple notice from the IRS can wreak havoc and waste time. I know that most business owners report their income honestly. I’m aware that dealing with the government is painful and that no one likes to pay their taxes.
But there’s also something that many of us don’t like to admit: audits are actually a good thing. They keep some taxpayers honest out of the fear of getting caught. They’re a necessary evil to ensure that taxes are collected by those who owe them. In fiscal year 2021 alone the IRS closed 738,959 tax returns examinations, resulting in nearly $26.8bn in recommended additional tax. Without audits, who’s going to make up for that shortfall? You and me, that’s who.
Another thing: most experts don’t see an increase in audits happening until at least 2026, so we’ve got a few years to prepare. And there are plenty of things a small business can do to avoid getting flagged. Simple things.
Pay your estimated taxes on time. Reply to requests promptly. File your returns when they’re due. Make sure things add up correctly and tie out to the documentation (like W-2s and 1099 forms) that are separately reported. Don’t pay yourself too little. Don’t pay yourself too much. Don’t take excessive deductions. Don’t make too much money in one year and don’t lose too much money in multiple years. If you do, then at the very least, have very, very good explanations … and documentation.
As an accountant and a business owner, it may surprise you that I’m in favor of the $80bn going to the IRS. Why? Because the more this agency can do to improve its efficiency the quicker we can get our questions answered. And the more that the agency can leverage technology to do its grunt work the greater the likelihood that I will deal with them less, and my clients more. Let them audit. We’re ready.