The IRS has always been able to match individual tax returns against information statements and propose underreporter adjustments that come in the form of CP2000 notices. ??But things are changing, and a new era at the IRS is upon us. ??Now, the IRS is using information statements to find underreporting on business returns. For practitioners across the country, this will add to the already increasing level of post-filing compliance activity they are seeing. ?
More Interest in Business Income ??
In September, the IRS started its first information return-matching program for business return Forms 1120, 1120S and 1065. This program matched business return incomes to the total amounts reported on all information returns. ??
This year, business taxpayers also started receiving Form 1099-K, Merchant Card and Third-party Network Payments, reporting amounts received from payment settlement entities (from debit/credit cards and third-party network payers such as PayPal). To avoid taxpayer burden, the IRS stated in a letter to the National Federation of Independent Business on Feb. 9 that it will not require taxpayers to separately report amounts from Forms 1099-K on returns, and has no plans to in the future. ??
On Nov. 16, the IRS announced that it will start questioning businesses with smaller-than-expected income, based on its analysis of Forms 1099-K reported to the business. Interestingly, the IRS cannot propose specific adjustments to the return because it can’t match Forms 1099-K directly to line items on 2011 business returns. However, the IRS is contacting taxpayers when it thinks that there is a discrepancy. The IRS determines this probability based on the taxpayer’s line of business and a perceived disproportionate share of credit/debit card and third-party network payments reported on Forms 1099-K, compared with gross receipts from other sources reported on the tax return. ??
Last week, as reported by the National Association of Tax Professionals (NATP), the IRS indicated that it is starting three compliance initiatives: ?
- A soft-touch inquiry that asks taxpayers to review their returns more closely
- A correspondence audit
- An underreporter notice and assessment, similar to the CP2000 automated underreporter program used for individual income discrepancy adjustments
The NATP reported that the IRS will send out about 20,000 letters to small businesses.
The Notices to Expect
As part of this initiative, the IRS created four new letters that question business returns with possible unreported income, based on a Form 1099-K analysis. These letters question the accuracy of your client’s return.
Each letter provides information on the reported gross receipts on the return, as well as the total amount for Form 1099-K payments received. The letter will also provide information on the specific Forms 1099-K filed on your client’s business.
If your client receives Letter 5035, 5036, 5039 or 5043, Notification of Possible Income Underreporting, your client may have underreported gross receipts. The IRS compared the amount in gross receipts reported on the return to the amount in receipts from merchant card payments on Forms 1099-K. Based on the IRS’ analysis of your client’s industry (presumably using the merchant category code on Forms 1099-K), the IRS thinks that your client may have more income than what is reported on the filed return. Depending on the letter, your next steps vary.
Here’s how to respond to each letter.
Actions requested by the IRS: Review the accuracy of the information shown on the notice and the filed return.
How to respond: This is a soft notice, which doesn’t require a direct response. Your client should take appropriate action based on a review of the information provided and the return filed.
Possible next actions by the IRS: None