Last month, the IRS updated its Audit Techniques Guide (ATG) for cash-intensive businesses and the complexities of e-commerce. This means they will ramp-up the number of audits for businesses in this area–the IRS likes to go where they feel there is a large amount of money to be gained and a good likely-hood of conducting a successful audit. (Kind of sounds like why you do business where you do, doesn’t it?)
|Money you make online will be scrutinized
more carefully by the IRS.
Photo by Becky McCray.
The IRS’ interest in this area is part of its compliance efforts aimed at closing the tax gap, which is the difference between taxes owed and taxes actually paid. Small businesses are among the largest contributors to the $450 billion a year tax gap, and as they increasingly do business online, the IRS has become more interested.
- Online sales and customer payments for goods and services
- Advertising income
- Internet auctions and bartering
- Online “tip jars” used by visitors to support websites
- Sale of customer lists
- Referral fees from list sharing
Last year, Congress gave the IRS more information statements aimed at helping with e-commerce underreporting – namely, Form 1099-K, merchant card and third-party network payment reporting. These reporting requirements are aimed at businesses that conduct e-commerce through credit and debit card payments and third-party network payment providers, such as PayPal. The resulting Forms 1099-K will be a cornerstone to a future business income-matching program that does not exist today.
In addition, last year, the IRS completed a significant update to its Internal Revenue Manual audit procedures, and many of the changes focus on unreported income in e-commerce activity. The IRS added instructions for auditors on how to examine businesses with e-commerce activities, including several techniques to question whether all income is reported on a tax return and additional guidance on audit trails to pursue. Agents are instructed to:
- Reconcile merchant card payments to bank deposits, books and records, and the tax return.
- Investigate website traffic and volume that could be indicative of a high volume of business.
- Review websites for historical activity.
IRS agents may now ask these questions in their examinations:*
- Do you do business online?
- What payment methods are accepted through your website?
- What products, services and other items can be purchased on your website or through email marketing?
- What websites do you own? How do you account for income from each website on your return?
- Do you sell advertising on the Internet?
- Do you sell products and services through other online providers?
- Do you sell products and services from other business partners?
- Does your site make sales to customers in foreign countries?
In the next several years, expect the IRS to look closer into e-commerce as a comprehensive strategy to address small business noncompliance and narrow the largest segment of the tax gap. The IRS thinks that there is substantial noncompliance in the following e-commerce areas, which it will target in compliance initiatives going forward:
- Unreported income on sales of goods, including sales from home-based online businesses
- Unreported income on the sale of appreciable assets, such as collectibles and antiques
- Offshore activity, including unreported income from foreign customers
- Abuse of the home office deduction
- Abusive home-based business tax avoidance schemes that deduct personal, living or family expenses
- Internet businesses that generate losses but are actually hobbies
Prevention is always best: Prepare a complete and accurate return. Do what the IRS agents are instructed to do before an audit and closely review and reconcile your small business income, including any Forms 1099-K received.
[This post was inspired by an article that originally appeared at the Beyond415 Knowledge Center.]
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