The recently passed Inflation Reduction Act includes $80B in new IRS funding over the next ten years, earmarked for increased tax enforcement, technology investments, customer service, and other hiring. What does this mean for small businesses? Should we expect more audits and fines?
Recent lows at the IRS
From 2012 to 2019 the IRS budget was reduced by 14%, effectively halting investment in new technology and reducing headcount. The IRS was already behind on software technology and, in fact, is still using computer programs from the 1960s. Imagine if your business stopped adopting new software tools 6 years ago – how far behind would you be now? This austerity, compounded with complex Covid tax relief measures, means the IRS is 6+ months behind in processing tax returns, audits, and even opening the mail.
Customer service at the IRS has also suffered due to understaffing, resulting in 250 million dropped taxpayer calls in 2021 after waiting on hold for 3 hours.
The backlog at the IRS has two major consequences on small businesses:
- Processing of returns, disputes, and amendments is outrageously slow.
- Enforcement activity, including audits, has focused almost exclusively on high-income individuals and corporations, not small businesses.
How does IRS funding affect small businesses?
In the short term, there will be few changes at the IRS. Government hiring is slow in a normal economy – in today’s low unemployment economy, hiring will be even slower. The fastest and easiest agents to hire are data processors and customer service agents, which greatly benefits small businesses.
In the long term, the IRS will hire more auditors including auditors for small business returns. The Treasury Department says enforcement will be focused on individuals earning over $400,000 per year but that policy is not written in the law, and thus subject to administrative changes.
At CFOshare, we hope the money will implement the IRS Modernization plan, speeding up processing and online interfaces.
Does corporate minimum tax affect small businesses?
Businesses that earn less than $1 billion per year are not subject to the new corporate minimum tax in the Inflation Reduction Act.
What will the IRS do with all the new funding?
The Inflation Reduction Act sets provisions for the next 10 years. However, congress also sets annual appropriations for the IRS, so there may more or less funding in the future.
The IRS does plan to hire 87,000 new employees over 10 years, of which 50,000 are replacements for retirees and 37,000 are new positions. New IRS hiring will take 3-5 years to ramp up, leaving taxpayers plenty of time to prepare.
How do I avoid an IRS audit?
Audits, fines, and other IRS disputes are a major distraction from routine business. To avoid such costly issues, follow these three basic steps:
- File your tax returns on-time. Late returns are always subject to additional scrutiny, and the statue of limitations for audits begins upon date of filing, not date the return should have been due.
- Be honest on your returns. Electronic payment processing has increased IRS visibility into business revenues, so do not try to hide your cash flow. Accurate bookkeeping and accounting are good for business management too.
- Do not waste time on tax-saving gimmicks. As your taxable income rises you may be tempted to reduce your tax burden by creating an overseas company, starting a defined contribution retirement plan, creating a trust, or performing a corporate restructure. These moves may reduce your income taxes, but they also increase IRS scrutiny. Additionally, tax-saving measures often bear significant professional service fees which offset your tax savings.