IRS Letter Targets Small Business Owners

Letters question income under-reporting

The IRS recently sent letters to approximately 20,000 small business taxpayers claiming that the businesses might be under-reporting their gross receipts. The letters are based on credit card payments reported to the IRS, the total gross receipts reported on the tax return, and industry averages. For example, if the IRS has determined that a typical bar and restaurant receives 50% of its gross receipts from credit cards, it might question why a taxpayer in that business received 80% of its gross receipts from credit cards. The IRS letter begins by saying:

• Your gross receipts may be underreported. Your tax return and Form(s) 1099-K, Merchant Card and Third Party Network Transactions, show an unusually high portion of gross receipts from card payments and other Form 1099-K reportable transactions. Your type of business consistently has a much lower portion of gross receipts from card payments and other Form 1099-K reportable transactions, and a higher portion of gross receipts from other sources (e.g., cash and checks).

The letter goes on to list gross receipts per the tax return, and gross receipts reported on Form 1099-K. It then instructs the taxpayer to provide a written explanation within 30 days:

• If you believe you filed your tax return correctly, please provide a written explanation telling us why the portion of your gross receipts from card payments and other 1099-K reportable transactions may be higher than expected.

The letters are an attempt by the IRS to close part of the tax gap, the difference between taxes owed and taxes paid. In 2006 (the most recent year with available data), the total tax gap was estimated at $450 billion, with $140 billion attributable to small businesses.

IRS questioned on letters

House Small Business Committee chairman Sam Graves has written a letter to the IRS expressing concerns with the letter, including:

• The IRS had said the program would merely seek additional information, but the tone of the letter implies it is a more serious matter.
• The letter says that taxpayer’s credit card gross receipts are off from an average, but gives no idea what the average is, how it was determined, or how far off the taxpayer is from the average.
• The notice requestes a complete and accurate response within 30 days, but the taxpayer is not told what it is expected to prove.

What you should do

If you receive this letter from the IRS, please call us and forward the letter immediately. We will verify the gross income reported on the letter, and assist in your response.