IRS: The Small Business Bully

IRS: The Small Business Bully

By Peter Schweizer - October 25, 2012

President Barack Obama and Governor Mitt Romney continue to tussle over tax rates and deductions. Ignored, however, have been questions about tax collection and enforcement—tools presidents use to achieve their economic policy goals. Hit a wall ramming your tax hike or cut through Congress, simply increase or decrease tax enforcement and audits.

Under the Obama Administration, the Internal Revenue Service has placed small and medium-size businesses—the engines of job creation—in its auditing crosshairs.

According to IRS statistics, from 2009 to 2011, the coverage rate (number of audits as a percentage of total returns filed) for corporations with assets between $10 million and $50 million has increased 32 percent. The coverage rate for corporations with assets between $50 million and $100 million has increased at the same rate. Some businesspeople file individual returns, and those with incomes higher than $1 million have experience a 94 percent increase in their coverage rate, and a 29 percent increase in the actual number of exams since 2009. Those with incomes $200,000 and higher have seen a 36 percent increase in their coverage rate.

So, has ratcheting up audits on small and medium-size businesses produced more revenue bang for the IRS’s buck? Hardly.

Using 2011 IRS data, the Transactional Records Access Clearinghouse (TRAC) at Syracuse University found that audits of a company with assets between $10 and $50 million yielded $702 in recommended additional taxes per hour. For large corporations with assets of $250 million or more, the recommended additional taxes are $9,173 per hour. Yet while the coverage rates of companies with assets between $10 to $50 million are up 32 percent, rates for companies with assets of $250 million or higher are up just 7.4 percent.

In short, for every hour the IRS spends auditing a small or medium business, it would have recouped $8,471 more dollars auditing a large corporation. Nevertheless, the IRS continues to aggressively increase audits on small and medium companies over their larger counterparts.

That small and medium businesses generate the bulk of U.S. jobs is hardly in question. Both Mr. Obama and Mr. Romney say as much on the stump, and they’re right. The Small Business Administration says that over the last 15 years employers with less than 500 workers have created more than two-thirds of net new jobs. So why is the IRS hassling job creators when such audits yield so little tax revenue?

As Treasury Inspector General for Tax Administration (TIGTA) Russell George put it in a report this past July, “the agency is spending a significant amount of resources on unproductive audits and burdening compliant taxpayers with unnecessary audits.” Furthermore, IRS statistics reveal that under the Obama Administration freelancers and the self-employed are increasingly targeted for auditing. Indeed, chances of a Schedule C being audited are twice as great as a corporation getting audited. Three percent of small businesses under Schedule C got audited, compared with one percent of corporations.

Since small business owners are more likely than large corporations to represent themselves when challenged in court by the IRS, the aggressive auditing adds pressure and costs that are harder for small operators to absorb. That means more time spent battling the IRS and less time growing a business and creating jobs. Given that only three percent of all tax issues examined result from deliberate or intentional failures to report income, such scrutiny seems misplaced and unwarranted.

Even as the IRS has ramped up audits on America’s job creators, it has increasingly turned a blind eye to policing stimulus-related checks to low-income individuals seeking tax credits.

In 2009, the federal stimulus provided for an additional $1,000 per child tax credit for low-income Americans. The law prohibits aliens residing without authorization in the United States from receiving most federal public benefits. However, those who can’t obtain a Social Security number can obtain an Individual Taxpayer Identification Number (ITIN) number. When the IRS was flooded with applications from ITIN-number holders for tax credit checks, senior managers purposely discouraged IRS employees from scrutinizing the requests.

According to a July 2012 report by the TIGTA, “IRS management created an environment which discourages tax examiners responsible for reviewing ITIN applications from identifying questionable applications; eliminated successful processes used to identify questionable ITIN application fraud patterns and schemes; and established processes and procedures that are inadequate to verify each applicant’s identity and foreign status.”

For example, the review found 154 individual mailing addresses were used 1,000 or more times on an ITIN application, but the IRS failed to use information in its computer systems to identify potential fraud schemes. Robust fraud controls are extremely important since $6.8 billion in tax refunds were paid out to 2.9 million ITIN tax returns for processing year 2011.

Another report by the TIGTA in July of 2011 found that individuals using ITINs made claims for $4.2 billion in Additional Child Tax Credit (ACTC) funds, a four-fold increase from the $924 million submitted in 2005.

Tax collections and enforcement can be just as redistributive as tax rates. As the numbers show, the IRS is increasingly placing job creators under the auditing hatchet while shirking oversight of the billions in new tax credits flowing to those claiming low-income status.

Put simply, the Internal Revenue Service is morphing into the Internal Redistribution Service. 

Peter Schweizer is the William J. Casey Fellow at the Hoover Institution at Stanford University, president of the Government Accountability Institute and author of “Throw Them All Out” (Houghton Mifflin, 2011).

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