Keith Hall, CPA
Hall & Hughes, PLLC
House Committee on Small Business
"IRS Latest Enforcement: Is the Bulls-eye on Small Businesses?"
April 5, 2006
Chairman Manzullo, Ranking Member Velazquez and Members of the Committee, thank you for allowing me to testify today regarding the issue of the tax gap and the Fiscal Year 2007 Revenue proposals addressing this issue. According to IRS data from the National Research Program (NRP), the data indicated that the nation’s tax gap, the difference between what taxpayers should pay and what they actually pay on a timely basis, falls somewhere between $312 billion and $353 billion. The tax gap has three key components which include underreporting of income, underpayment of taxes and non-filing of returns. There have been numerous proposals regarding how to effectively address the tax gap and increase compliance. Most recent have been the proposals put forth in the Administrations FY2007 budget.
As a self-employed certified public accountant for 15 years and as a tax consultant for the National Association for the Self-Employed’s TaxTalk program, I am in the unique position of conveying to you both my perspective as a business taxpayer as well as that of a tax professional dealing regularly with the self-employed, regarding the affect that proposals to reduce the tax gap will have on the self-employed and micro-business.
In my testimony today, I would like to address three key areas:
imposing withholding on non-employee payments, specifically payments made to independent contractors; proposed increase in information reporting on payment card transactions as a way to mitigate the tax gap; resource allocation of IRS funding, in particular the service vs. enforcement paradigm.
Withholding on Non-Employee Payments
The NASE and I as a tax practitioner are still gravely concerned about circulating proposals recommending withholding on non-employee payments. We feel that proposals regarding additional withholding are the most burdensome to the self-employed and micro-businesses. For sole proprietors and business owners hiring independent contractors, additional withholding in the range of two to five percent on payments made to contractors will only add to the compliance burden with a whole new set of perplexing and – for many – unmanageable and costly filing requirements. NASE Member Courtney Browning owns Browning Parcel Service in Oklahoma City, Oklahoma. He states, “If this proposal had been in effect the first few years I was in business, things were so financially tight that five percent withheld could have put me out of business. Small business does not need this extra burden.” Tracy Boulware of Houston, Texas remarks, “I own a small company. I pay my taxes. Sometimes my profit margin is only 3.5%-5%. This type of legislation could put me out of business. I need that money for operating capital. It's that simple.”
We have concerns of potential requirements associated with the implementation of an additional withholding mechanism. Specifically, in regarding the requirement to withhold based on gross versus taxable income, a technical flaw that would overstate employers’ liability, since gross income often includes legitimately deductible business expenses. Also, the application of withholding on sole proprietors (Schedule C filers) only would clearly discriminate against this type of legal business structure. Incorporated firms would not be held to this requirement.
NASE Member Ross Kaminsky of Boulder comments, “The scourge of small business is regulatory paperwork including complicated record-keeping for taxes. Adding withholding on contractors will only make that more complicated, increasing the incentive for contractors and their employers a like to hide that business rather than waste more time and money on paperwork. Furthermore, contractors can have complex issues of income and deductions which would make calculating proper withholding nearly impossible.” The NASE feels that rather than adding to the burden of compliance faced by micro-business taxpayers through increased regulations, the goal should be to simplify the tax regulations surrounding independent contractors. We currently have this reporting mechanism on independent contractors through the issuing of 1099 forms. We feel that rather than continue to shift both the cost and overall burden of compliance to business owners already fulfilling their tax responsibilities, the IRS should focus on fair and balanced education and enforcement efforts for those individuals that they have submitted 1099 forms on, yet have either unintentionally or willfully not complied with their tax liability.
Increased information reporting on payment card transactions
Currently, most taxpayers are subject to some level of information reporting and withholding requirements. Employers on behalf of employees must report wages and withhold applicable payroll taxes and federal income taxes. Businesses must report payments made for services in connection with their trade or business of more than $600 per year. Banks must report payments of interest and dividends made to deposit holders. Almost everyone has some type of income that is reported to the IRS by their employer, their bank, or their clients. Each of these forms of reporting also include some form of backup withholding if the taxpayer fails to provide a taxpayer identification number or if the number is found to be inaccurate.
The Administration has proposed for FY2007 increasing information reporting by requiring credit and debit card issuers to report to the IRS annually on aggregate reimbursement payments made to businesses. Also, if the business fails to provide a taxpayer identification number (TIN) or if that number is incorrect, it would require card issuers to backup withhold on all payments. This is basically the same process that is currently in place for wages, interest, dividends and payments for services reported via form 1099. Capturing information can only have a positive impact particularly in light of those taxpayers who consciously choose to avoid reporting income.
While I believe that increased information reporting can be positive, I feel that this particular proposal could have a negative impact on the self-employed and small businesses. The main concern is what would be done with the information that is provided. As will current 1099 reporting, providing a simple match of reported credit card receipts to the applicable income tax return would be positive. The match could provide the IRS with valuable data related to underreported income by businesses with credit card receipts. The small business that simply chooses not to file a return will automatically be identified as having underreported income and appropriate steps could be taken. Taxpayers that willfully avoid their reporting and payment responsibility should be identified then required to comply. This is what the reporting program is designed for.
However, if the credit card receipts were then used to make judgments regarding other items on the tax return, problems will arise. Discussions have included taking the total credit card receipts reported for a particular business and then extrapolating total income based on industry averages. The averages will only provide an additional discrimination against those businesses that have higher then average credit card receipts. That higher average could be a function of the affluence of their community, their own efforts in managing the cash flow of their business and even their own decision of whether to accept a particular credit card. It will be very difficult to determine an applicable average for a particular small business that is relevant. Therefore, any action that would be available to the IRS in the form of examination, request for additional information or even tax assessment could be correspondingly irrelevant.
Another concern for this proposal is that these amounts are most likely already reported anyway. The taxpayer who willingly underreports income would not knowingly choose to exclude credit card receipts since those items show up on their bank statements anyway. It is clear that the sales via credit cards are documented and would be revealed upon review and therefore it is unlikely that those amounts would be the key source for intentional underreporting. Therefore, this approach may not be targeting the source of underreporting and could serve only to increase the costs associated with credit card usage without identifying any additional taxable income that would not have already been reported.
Perhaps the most critical aspect of this proposed is its estimated return on investment. The Treasury’s estimate of $225 million related to this proposal compared to the $353 billion tax gap is nominal compared to the burden it may place on both IRS resources and business taxpayers.
The Department of Treasury, specifically the I.R.S., is attempting to strike at the cash economy and those underreporting or not reporting income. However, this proposal addresses income on revenue already being reported and an area (credit card transactions) where there is not a lot of misconduct. In fact, the enhanced backup withholding provisions could cause micro-businesses to face significant cash flow issues. Many micro-businesses operate on limited margins of revenue and withholding on payments could be detrimental to the financial well-being of their business. Additionally, the proposal unfairly targets sole proprietors and all other business entities other than corporations. Finally, and as a general rule, I am always in favor of improving the collection of data and reporting of actual business transactions. However, based on the fact that I believe these transactions are not the source of taxpayer underreporting and the fact that I am uncertain of how the IRS plans to utilize this additional data obtained through increased information reporting in their enforcement efforts, I am concerned about the ultimate benefit of this proposal.
Service vs. Enforcement
I have yet to hear commentary from any group or individual that did not include the goal of providing a fair and equitable solution to the existing tax gap. I believe everyone agrees that any solution should include at it core the goal of providing equity for all taxpayers. However, we also feel that any recommendations seeking to increase compliance and lessen the tax gap should also seek to refrain from increasing the regulatory burden on taxpayers. Furthermore, we feel that ensuring comprehensive, effective taxpayer services is essential to accomplish taxpayer compliance.
As we have highlighted before, the IRS has made positive changes through enhancement of educational and outreach efforts which have had positive affects. Our concern is with the shifting of resources from taxpayer education and services to enforcement. It is evident in the FY2007 Budget that enforcement is being emphasized, and taxpayer services are being cut.
Accurate tax reporting and compliance is extremely important to small business. Those who make a good faith effort, yet are inaccurately complying should be assisted through education and tax simplification efforts. Those willfully disregarding their tax liability should be held accountable. The more assistance offered to taxpayers and the simpler it is to understand and comply with tax laws, the more taxpayers will accurately meet their tax obligations. However, increased enforcement at the expense of taxpayer education will not in the long term accomplish sustained, improved compliance.
Conclusion
Tax compliance and its affect on the tax gap is a significant problem faced by our nation. Yet, in the fervent drive to recoup revenues for our fast depleting federal coffers, we must take the necessary steps to make certain the path we choose is balanced and effective, rather than detrimental. Our collective focus should be on supporting their efforts for survival, growth and innovation as a foundation for long-term economic vitality.
The complexity of the IRS tax code is particularly troublesome for the self-employed business owner and is a snare for unintentional noncompliance. Vague rules and poorly defined regulations understandably result in mistakes. We believe efforts to address the tax gap must focus on overall simplification, eliminating issues of inequity within the tax code, and enhancing taxpayer education and outreach. It is my belief that small business built our economy and will continue to sustain that economy. It is also my belief that most taxpayers want to comply with existing tax laws and that making those tax laws easier to understand is the most effective and equitable way to improve compliance and to reduce the tax gap.
Micro-business Perspectives
The Affect of Withholding on Non-Employee Payments
Tracy Boulware owner of Altra Industries in Houston remarks, “I own a small company. I pay my taxes. Sometimes my profit margin is only 3.5%-5%. This type of legislation could put me out of business. I need that money for operating capital. It's that simple.”
Tracy Boulware
Altra Industries
Houston, TX 77227
Dorie Geniesse states, “My business would suffer tremendously if there was withholding on my independent contractor income. The majority of my work is seasonal so though I make more money early in the year, I make virtually nothing for the second and third quarters. My total taxable income after all is said and done is only $12,000 per year. This would cause me terrible hardship and probably put me out of business.”
Dorie Geniesse
Madison, WI 53711
Courtney Browning owns Browning Parcel Service in Oklahoma City, Oklahoma. He states, “If this proposal had been in effect the first few years I was in business, things were so financially tight that five percent withheld could have put me out of business. Small business does not need this extra burden.”
Courtney Browning
Browning Parcel Service
Oklahoma City, OK 73179
Ross Kaminsky of Boulder feels, “The scourge of small business is regulatory paperwork including complicated record-keeping for taxes. Adding withholding on contractors will only make that more complicated, increasing the incentive for contractors and their employers a like to hide that business rather than waste more time and money on paperwork. Furthermore, contractors can have complex issues of income and deductions which would make calculating proper withholding nearly impossible.”
Ross Kaminsky
Boulder, CO 80302
Jennifer Hassani, a Mary Kay Independent Beauty Consultant from Newnan, Georgia comments, “I was for many years an independent contractor and plan to use them in my business. I feel that creating a Withholding Requirement for businesses will cause undue cost to businesses in the form of extra paperwork and salaries which will cause the businesses to rethink the decision to use independent contractors and therefore many people will no longer be able to make a living. As a future user of independent contractors, I do not have the time to worry about withholdings and paying them to the IRS on a weekly or monthly basis. I will pay "invoices" and print out a 1099 at the end of the year. I will be forced to not use independent contractors if this measure is passed. Not fair to us small businesses and budding entrepreneurs!”
Jennifer Hassani
Newnan, GA 30265
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