Tax Gap Plan Vexes Small Business Community

Small business advocates are mobilizing to quash a proposal being considered by a powerful Senate panel that would require credit- and debit-card issuers like MasterCard and Visa to report business owners' electronic payment transactions to the IRS.

The Senate Committee on Finance is considering the plan as part of a greater effort to increase tax compliance and narrow the "tax gap," which the IRS defines as the difference between the amount of tax that taxpayers should pay for a given year and the amount that is paid voluntarily and on time.

The National Association for the Self-Employed wrote to the panel last week, saying that it applauded lawmakers' efforts to encourage compliance, but that it was concerned "that the delicate balance between what is reasonable and what is detrimental has shifted to the latter." The group, which represents 250,000 self-employed individuals and firms that have 10 or fewer employees, said the committee's plan would "hinder tax compliance while also significantly impairing our nation's entrepreneurs."

The association believes the proposal will have unintended consequences, largely because it lacks clear details regarding its implementation.

One of the group's chief concerns is how the IRS would use the data, plus "there has been no clear indication of how this information would facilitate tax compliance," wrote NASE President Robert Hughes.

Treasury Department official Eric Solomon and former IRS Commissioner Mark Everson have both suggested that the data could be used to create industry profiles, by taking the total credit card receipts reported for a particular business field and calculating an industry average. The new industry profiles would then be used by the IRS to judge other items on a tax return.

For example, the IRS might see that florists make an average of 60 percent of their transactions through credit cards, so if the agency reviewed the tax return of a florist that significantly deviated from that average, it may question that return.

NASE posits that "use of these averages will only provide discrimination against those businesses that have higher than average credit card receipts," which could be a factor of a community's affluence, geographic region or even a business owner's efforts to manage cash flow or to accept a particular credit card.

NASE Executive Director Kristie Darien told the Small Business Blog that proponents of the plan say that, of the plans suggested, it would be the least burdensome to small businesses because credit card companies would have to generate the reports, not the small firms themselves. But Darien said it's unclear how a small business would be able to fix an error on the electronic transaction report, which she said would likely be something "like a 1099 form but listing all of a business's electronic transactions." The credit-card issuer would send the report to the business and the IRS.

The proposal requires that the merchant card processor verify the business's taxpayer identification number. If the processor fails to do that or has an incorrect TIN, the processor is required to withhold 28 percent of the money due to the business while the situation is resolved. "That withholding plan would put many micro entities out of business," said Darien.

Some members of the small business community have expressed concern that if the proposal becomes law, some small firms may stop taking credit cards or will have to charge higher prices because of the cost to comply.

The NASE is part of the Coalition of Fairness in Tax Compliance, which is made up of business lobbyists and trade groups. The coalition last week also sent comments to the Senate panel, slamming the plan for its potential cost, effectiveness, intrusiveness and for its 28 percent withholding plan.

By Sharon McLoone |  May 1, 2008; 2:39 PM ET Policymakers
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