Small Business Tries Not to Fall into 'Tax Gap'

Small business advocates who keep tabs on Washington policy have been marshalling forces against recent administration efforts to close the "tax gap."

The gap is the difference between the amount of tax that taxpayers owe the U.S. government and the amount that the IRS collects. Congress has been pressuring the IRS to quickly close this gap, which is partly caused by underreporting of income, underpayment of taxes and not filing returns.

The IRS estimates that $68 billion of the annual $345 billion gross tax gap for 2001 was due to sole proprietors, who underreported their net income by 57 percent, according to the Government Accountability Office. Sole proprietors' income is not subject to withholding and only a portion is subject to information reporting to IRS by third parties.

While most everyone believes that the IRS should be able to collect legally owed tax revenues, groups like the National Small Business Association say the collection should not be "at the undue expense of the privacy and integrity of honest, hard-working entrepreneurs."

The issue is not relegated only to small businesses, but the community believes the IRS has unfairly targeted small entities as the main wrong-doer. The NSBA launched a campaign in April aimed at quashing efforts to narrow the gap.

The GAO released a report (pdf) last month recommending that the government create a strategy to narrow the tax gap by addressing sole proprietor compliance and coordinate it with broader tax gap reduction efforts.

National Taxpayer Advocate Nina Olson delivered a report (pdf) to Congress last month saying IRS efforts to satisfy Congress's demand for more revenue will overreach, harm taxpayers and "cause a backlash from the same Congress that is now urging it forward."

"IRS oversight should not just be limited to urging the IRS to collect more tax revenue," Olson wrote. "Even as Congress directs the IRS to address specific areas of noncompliance, Congress should require the IRS to adopt a long-term research strategy that focuses not only on 'closing the tax gap' but also on understanding what it takes to encourage taxpayers to be voluntarily compliant and how to change taxpayer behavior."

The National Federation of Independent Business is lobbying against current proposals to bridge the gap as part of the Coalition for Fairness in Tax Compliance. It believes that simplifying the tax code is a solution that will help reduce the tax gap. "Even honest and compliant taxpayers make mistakes and errors when filling out their tax forms," states an NFIB position paper. "Taxpayer mistakes and errors would be substantially mitigated if the tax-code rules were easier to read and follow." Other coalition members include the NSBA, the National Association for the Self-Employed, groups representing home builders, travel agents and community bankers, among many others.

The NFIB says that according to the IRS's tax gap estimates, $109 billion of the gap is attributed to underreported income, with $39 billion of that figure attributed to underreporting of self-employment taxes.

Sen. Charles Grassley of Iowa, who is the top Republican on the Finance Committee, responded with some comments that heartened the small business community: "Honest taxpayers shouldn't be forced to bear the brunt of IRS efforts to crack down on bad actors." He added that small businesses shouldn't have to be "overburdened" as Congress, the Treasury Department and others aim to solve the problem.

Grassley and Senate Finance Chairman Max Baucus (D-Mont.) on Tuesday asked (pdf) the GAO to investigate the growing problem of tax fraud related to identity theft, and how it contributes to the tax gap.

By Sharon McLoone |  August 29, 2007; 2:43 PM ET Regulation Legislation
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Those who want to find out why the tax gap is mostly illusion should check out

Posted by: Scott O | August 30, 2007 12:01 AM

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