IRS fishing for underreported income from small business

   Small businesses across the country have been receiving Notice of Underreported Income letters from the Internal Revenue Service over the summer in an effort to reduce the “tax gap.”
   The IRS estimates the difference between the amount of taxes owed and the amount paid is about 17 percent. 
   While the so-called CP2000 notice is not a bill, many mistake it for one, according to Cory Gallivan, a tax manager with Scheffel and Company, P.C. in Alton. The notice includes a calculation of taxes, interest and penalties owed. He said a lot of small business owners are reacting negatively to such letters because of how they are worded. 
   “The IRS is basically going fishing, looking for revenue that may or may not be there,” said Greg McCalley, president of Donohoo McCalley and Associates in Wood River, adding that he is not aware and does not suspect there is any widespread underreporting of small business income.
   McCalley said he also sees similar efforts by both the Illinois Department of Revenue and the Missouri Department of Revenue. With the state of Illinois in such dire straits financially, McCalley commented, it is obvious that its usage of a similar tactics with small business owners is an attempt to generate more revenue.
   With budgets being squeezed at both the federal and state levels, McCalley and Gallivan agree that underreported income notices could possibly be expanded in the future. But, Gallivan said that he hopes the IRS will reconsider its approach.
   “The idea is fine but this is just not the way to do it,” he said. “They need to modify their approach to it and I would not be surprised if they did. The way it comes across is not appreciated by some.”
   There are a lot of reasons why the income figures on some small businesses’ tax returns do not match with other numbers, both Gallivan and McCalley agree. One issue, they say, is the IRS’ 1099K process, which takes in debit card and credit card transaction information. 
   Such card receipts can include money the customer takes back in the form of a rebate or other reward policy and could also incorporate third party fees or even sales taxes. These can all factor into making the reported income from a specific small business owner look less than what is shown when the tabulation of credit and debit card receipts is reviewed by the IRS as part of total income reported.
   The issuance and return of these 1099K forms — something that started only three years ago, according to McCalley — is a big part of what the IRS is apparently utilizing in its comparisons with actual reported income returns. 
   Further complicating the situation, Gallivan said, is the fact that some businesses operate on a fiscal year basis that is different from the calendar year used by the IRS. This can throw some of the numbers askew in terms of the 1099K forms and therefore may be unfairly considered in terms of any discrepancies.
   “It will be interesting to see how the IRS reacts to what people are saying about them,” Gallivan said, “There are a lot of reasons why some of the income is not showing up like the IRS thinks it should. The spirit behind it is well intentioned but most people are not really underreporting their income.”
   It’s conceivable also, McCalley said, that the IRS is comparing the reported income numbers it receives from small business owners to the same kind of information that is available at the state level. The state of Illinois is trying to exhaust every possibility for increasing its revenue, he said, and the IRS may be trying to do the same.
   Gallivan said that he did not know what criteria the IRS is using to trigger the CP2000, but his clients are apprehensive about the possibility that they, too, could be targeted.  He said that he believes the prevalence of underreported income is nowhere near the number represented by the letters the IRS has sent to small business owners.