IRS gets tougher on Sole Proprietors The Internal Revenue Service has initiated new audit procedures and additional audit steps during field audits to determine whether self employed businesses and taxpayers are hiding sources of unreported taxable income. The emphasis is that there is an overall belief within the IRS that the self employed are generously underreporting their taxable income. A report issued by the Treasury Inspector General for Tax Administration (TIGTA) found that while IRS field examiners are generally effective in checking for unreported income during field audits of sole proprietors they need to pursue further additional steps to determine whether those under audit have in fact reported all of their income based upon new IRS data. The IRS is now instituting new procedures to discover what they believe to be wholesale tax cheating by businesses across the country. Some of the new and enhanced procedures suggested are: ·         Enhanced bank and brokerage deposit analysis that encompasses all of the taxpayers’ business and personal banking relationships to determine if there is any hidden income that has been deposited to any account and gone unreported; ·         Personal and business expense analysis to determine if the taxpayer is living beyond their reported means; ·         Analysis of deductions to determine if the taxpayer is deducting personal items. While IRS field examiners generally check for unreported income, TIGTA found that IRS auditors could improve the investigation of cashflow transaction analyses by taking greater advantage of some of the new tools available to the IRS under the Patriot Act as well as some of the other recently passed legislation. The TIGTA believes that IRS auditors should delve further into analysis that determines that appropriate personal-living-expense data now available to the IRS are being used during audits to uncover what maybe unreported cash transactions and other unreported income. The TIGTA recommended investigation of business and personal expense data such as personal credit card spending and payment procedures to determine whether the sole proprietor’s income and expenses are being reported accurately. New reporting requirements by credit card companies starting January 1, 2011 will provide further information to the IRS as to cash payments against credit card balances as well as any reporting that the IRS deems appropriate in regards to pattern spending or large transactions. The IRS’s National Research Program estimated that unreported business income by sole proprietors accounted for $68 billion (or 20 percent) of the $345 billion tax gap. The IRS is planning to ramp up their resources and audit coverage across other segments of the tax return filing population, such as corporations and partnerships. TIGTA recommended that the IRS reinforce the requirement and importance of using appropriate personal-living-expense data in preliminary cash transaction analyses. This essentially means that the IRS will now be looking into whether a taxpayer under audit can in fact afford to live the way they do based upon reported income and expenses.