Schedule C is the form that unincorporated sole proprietor businesses use to report their income and expenses as part of their individual tax returns. Schedule Cs have been center stage in recent IRS “tax gap” estimates.
The tax gap is defined as the amount of tax liability faced by taxpayers that is not paid on time. This past January they released the tax gap figures for 2006. You might say that 2006 was quite a ways back, but remember returns are filed in the subsequent year, and then the information must be compiled and analyzed. Thus, most Treasury reports based on filed tax returns are based on information from several years back.
The 2006 report essentially mirrors the 2001 report, except the tax gap has increased from $345 billion to $450 billion. Of that $450 billion, approximately $372 billion is attributed to underreporting in the following categories (in millions):
- Non-business underreporting: 73
- Schedule C underreporting: 193
- Overstated deductions, exemptions & credits: 42
- Payroll taxes: 20
- Corporate income tax: 39
- Estate tax: 5
Since Schedule C underreporting represents the largest category and more than half of the underreporting, it is no wonder that the audit rate for Schedule C returns has increased substantially and is among the highest of the rates. Based on 2010 IRS figures, Schedule Cs have a 300% higher chance of being audited than either a partnership or an S-Corporation. Of the Schedule Cs audited in 2010, the average adjustment exceeded $9,000.
Among the areas of underreporting are:
- Personal Expenses: Over-deductions attributable to the inclusion of non-deductible personal expenses, and the failure to allocate for personal use of a vehicle.
- Underreporting Income: Failure to include all income. To counter this problem, the IRS has initiated merchant card and third-party reporting that will provide the IRS with all income from credit card sales.
- Worker Misclassification: Misclassifying workers as independent contractors rather than treating them as W-2 employees, thereby avoiding the employer’s share of payroll, unemployment and other taxes. The IRS currently has a Voluntary Classification Settlement Program that allows eligible taxpayers to voluntarily reclassify their workers for federal employment tax purposes. Voluntary programs usually precede more aggressive compliance measures.
- Failing to Issue Information Returns: Generally, businesses are required to issue 1099s for fees they pay to individuals other than employees or to corporations. This is a huge area of non-compliance and denies the IRS the ability to ensure the payees are properly reporting their income. In an audit where a 1099 should have been issued and was not, the IRS will generally disallow the deduction for those services. The 2011 Schedule C asks two catch-22 questions: “Did you make payments that would require you to file a Form 1099?” followed by “If yes, did you or will you file all required Forms 1099?”
- Hobby Losses: Some businesses are actually hobbies where there is no real intention of ever making a profit. Businesses deemed to be hobbies have special rules that limit the expense deductions to the income and require the deductions to be taken as an itemized deduction on Schedule A.
In response to the increase in IRS enforcement actions, we are offering you the opportunity to prepay for audit services for federal or state income tax returns. Enrolling in this program yields you five hours of prepaid audit representation and services, which can be used for one of our expert Tax Consultants to respond to IRS correspondence, or for one of our Tax Consultants to attend a meeting with the IRS on your behalf.
You can enroll for a single tax year or for all open tax years. The cost of enrolling in this program for one tax year is $175 per Employer Identification number covered. The cost for all open tax years is $525 per Employer Identification number covered. If you enrolled today, this would cover tax years 2009 through 2011 with 2008 included at no charge. If you enroll more than one Employer Identification number, you will receive a 15% discount for each additional one you add to the program.
At Henssler Financial, we believe you should Live Ready. For our Schedule C filers who are concerned about audit representation costs, this means securing what we hope would be an adequate block of time to resolve such matters at a much lower cost. We hope this gives you confidence in sending us the tax notices you receive and peace of mind that you have us working for you in order to resolve any outstanding issues.
Disclosures:
All material presented is compiled from sources believed to be reliable and current, but accuracy cannot be guaranteed. The contents are intended for general information purposes only. Information provided should not be the sole basis in making any decisions and is not intended to replace the advice of a qualified professional, such as a tax consultant, insurance adviser or attorney. Although this material is designed to provide accurate and authoritative information with respect to the subject matter, it may not apply in all situations. Readers are urged to consult with their adviser concerning specific situations and questions. This is not to be construed as an offer to buy or sell any financial instruments. It is not our intention to state, indicate or imply in any manner that current or past results are indicative of future profitability or expectations. As with all investments, there are associated inherent risks. Please obtain and review all financial material carefully before investing.
