The Internal Revenue Service is trying to close the “tax gap”. They believe that Americans are underreporting their income by $450 billion per year. They further estimate that over 30% ($141 billion) of that underreporting is by small businesses. To counter that alarming trend, the IRS has mandated that Payment Settlement Entities (read credit card companies) must report all payments made in settlement of payment card activity if the company’s transactions total over $20,000 or if there are more than 200 reportable transactions.
This means that the Internal Revenue Service has access to all of the credit card sales made by a business and they can use that information to compare the total amount of sales reported by a business on its income tax return.
The tax agency currently has targeted 20,000 small businesses with a letter suggesting that they may have underreported their income and that they have 30 days to explain their potential underreporting. The IRS has developed their income expectations by comparing the total credit card sales with the total sales as reported by the taxpayer and has made assumptions regarding the amount of non-credit card sales that they believe should have been reported.
This is probably a case of having just enough information to be dangerous. The service is attempting to draw conclusions from inadequate or incomplete data, and they are requiring that the business owner respond to their expectations. This puts the business owner in the position of explaining a negative. How does one explain variances to averages, or to someone else’s expectations?
Admittedly, there most likely will be many business owners who will not be able to successfully explain the differences between their numbers and those expected by the IRS. Some of the differences may be from underreporting. But, there are several reasons why the amounts reported to the IRS will not reconcile to the correctly reported sales on a tax return. For instance, sales tax collected and/or customer returns may not show up in the numbers reported to the IRS by the credit card companies.
While the current program involves only 20,000 businesses it appears likely that this program will be expanded if it starts to produce meaningful additional revenue.
Written by: Gary D. Levin, CPA, CVA