The scandal over the IRS’s extra scrutiny of conservative groups is leading some politicians to investigate another matter: Does the IRS unfairly target certain small businesses?
On Friday, Rep. Sam Graves (R-Mo.), Chair of the House Small Business Committee, sent a letter to Acting IRS Commissioner Daniel Werfel asking how the IRS determines which small businesses it audits. The letter may be politically motivated, as congressional Republicans have been using the IRS scandal as ammunition to try to overturn federal health care reform. However, the answer to that question could be enlightening for many small-business owners.
The IRS has long been tight-lipped about how it determines which individuals or businesses it audits. The reasoning is that disclosing such audit procedures makes it easier for taxpayers to cheat the system.
But details over IRS auditing procedures have emerged over the years—and mostly from the IRS itself. According to the IRS stats, the agency audited about 1 percent of all returns in 2012. However, it audited 3.7 percent of all individual returns with more than $200,000 in income and about 12 percent of those with more than $1 million in income.
The IRS audited 1.12 percent of tax returns from small corporations—those with less than $10 million in assets—while auditing nearly 18 percent of large corporation returns.
A recent study by the Taxpayer Advocate Service used confidential IRS data to determine where potential tax-evaders are located. The IRS uses this data to help determine where it audits, so it’s feasible to assume a business owner who fits these criteria may have increased odds of an audit. The study found, for instance, that small-business owners in Los Angeles, San Francisco, Atlanta and Washington D.C. faced a higher chance of audit. It also discovered that specific industries, such as construction firms and real estate rental companies, were more likely audit targets than other types of businesses.
Another factor: Business owners who claim unusually large deductions compared to their income were particularly likely to be audited.
The study focused on sole proprietors, since they have more opportunity to cheat, according to an AP article about the study. The IRS uses a confidential computer program to score returns. Businesses with higher scores are more likely to be audited.
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