IRS Scrutinizing Small Businesses for Underreported Income

The IRS has reportedly sent “Notifications of Possible Income Underreporting” to approximately 20,000 small businesses based on the information reports it has received on their debit and credit card transactions. Many clients who are small-business owners may have already received these letters from the Internal Revenue Service questioning whether they are underreporting their business income, as part of a broad federal initiative to boost tax receipts and ensure compliance.

The IRS believes many small businesses fail to report all cash sales in order to minimize tax bills, and insists the letters are just a request for more information. Business owners and lawmakers alike are alarmed. Daszkal Bolton expects to see the program expand, and advises that it can often be difficult to match credit transactions with income.

In 2008, the agency was given broader access to merchants’ credit-card and debit-card transaction records. The IRS has been comparing this data to information that small businesses report on their tax returns. If the data suggests an unusually large percentage of receipts come from card transactions, the IRS might send a letter asking the business owner to explain why cash receipts seem relatively low.

In this notification letter the IRS instructs the owner to complete a form within 30 days explaining why the portion of gross receipts from non-card payments appears unusually low. Many believe the letter implies that the IRS is looking for more than just additional information, that this is a serious matter that could lead to assessments of additional tax, penalties and interest.

There are legitimate reasons why a business might report relatively high proportions of card receipts versus cash receipts. Card receipt totals can include cash that the customer takes back. Sales of gift cards, which for accounting purposes don’t count as a sale, look that way to a credit-card company. There might be a discrepancy because payments data includes sales tax, which isn’t included in revenue claimed in tax returns. For small retailers sales tax is a liability and is not reported as revenue.

The IRS said it is working diligently to minimize the burden on both taxpayers and tax professionals while giving taxpayers the opportunity to explain and fix errors. The IRS has told accountants it is looking to verify the quality of the card-transaction data it is getting. However, the notice gives business owners no idea how much of a discrepancy there is, or the source of the information, so they can verify the claim and confirm that it is a valid comparison.

CONTACT US:The instructions for step 5 on page 2 of the IRS notification form imply that the taxpayer’s gross receipts are less than expected, but what that might mean is that merchant card receipts are higher than expected but the total receipts and tax paid will be correct. If you are a concerned small business owner or a client that has received a “Notification of Possible Income Underreporting”, please contact Michael I. Daszkal, CPA, Partner, at 561-367-1040 or mdaszkal@dbllp.com.