Many small business taxpayers are facing unwelcome scrutiny from the Internal Revenue Service (“IRS”) through a new source. Recently-enacted laws require credit and debit card processors, as well as e-payment servicers, to annually report gross receipts remitted to their vendors. The IRS has started to compare segments of this reported data to receipts included in tax returns of specific taxpayers. Gaps in what the processor reports to the IRS and the amount shown on a taxpayer’s return are now resulting in IRS notices requesting additional information to evaluate the accuracy of the taxpayer’s reported income (an “Accuracy Notice”).
If a taxpayer receives an Accuracy Notice, it is critical that the taxpayer provide an appropriate response. Any reply to an Accuracy Notice should be truthful and complete in order to avoid unwarranted concern from the IRS. By failing to truthfully and fully answer an Accuracy Notice, the taxpayer is exposed to significant, and often unnecessary, legal risks. The facts underlying the collection and processing of gross income will dictate the proper response. For example, if the taxpayer properly defers the recognition of credit card proceeds generated by the sale of gift cards, a simple response explaining this fact may suffice. On the other hand, if the taxpayer determines a prior good-faith mistake led to a material underreporting of gross receipts, a proper response might include filing an amended tax return correcting the error. Not surprisingly, because the relevant facts in each case will almost always differ, a proper response must be developed on a case-by-case basis, taking into account the taxpayer’s overall tax profile.
Of course, this new level of information matching by the IRS to target income underreporting comes as no surprise. Recent U.S. Treasury estimates suggest underreporting tax liability is one of the more significant causes of revenue loss to our country. The Accuracy Notice program combats this loss by generating taxpayer-specific federal income tax audits of the recipients and likely serves as a general deterrent to tax underreporting, particularly when done through a mass-mailing campaign.
We believe the current IRS Notice program will increase tax compliance costs for both the honest small business taxpayer and the under-reporter alike.