Wednesday, June 1, 2011

Small Businesses Fight IRS Over Data


The Internal Revenue Service, moving aggressively to collect more taxes from small businesses, is telling companies being audited to turn over exact copies of the electronic records kept in their business-software programs, according to a letter from an agency official to the American Institute of CPAs.

The accounting group fears this will force small businesses to turn over customer lists, personnel data, confidential client information and other unrelated information often contained in the off-the-shelf software programs many businesses use to manage all aspects of their finances.

Small-business groups are beginning to push back, saying the agency shouldn't treat small firms like bigger businesses, which usually have elaborate accounting systems and are able to give the IRS only the data the agency seeks. Small businesses, defined by the IRS as those with assets of less than $10 million, often use one off-the-shelf software program such as Intuit Inc.'s QuickBooks or Sage Group's Peachtree.

A spokesman for Intuit said the Mountain View, Calif., company "was aware that the IRS has purchased copies of small-business accounting software to use in its tax audits." The IRS declined to comment.

"Many accountants are worried this could lead to fishing expeditions" to find problems beyond the scope of the requested information, said Danny Snow, a certified public accountant in Memphis who is active in the American Institute of CPAs, or AICPA. "It's not like what the IRS asks of large companies."

The group said it has had numerous inquiries from members with clients who have received requests for software files. The IRS declined to give a number on how many requests it has made.

John Maguire, an owner of Simplicity Urgent Care in Arlington, Va., a walk-in clinic, isn't facing an audit. Still, the physician said he is alarmed at the potential effects of the IRS requirement on medical practices: "Many firms, although not mine, enter patient information directly into QuickBooks. Would turning over the information endanger patient privacy?"

In the April letter to the AICPA, the IRS said its request for complete software files is part of an effort to modernize. Chris Wagner, Commissioner of the IRS's Small Business/Self-Employed Division, wrote that the small-business audits require "unaltered metadata" so examiners can "properly consider the integrity and veracity of the electronic files."

The IRS declined to make him available to comment.

The IRS has been ramping up its tax-collection efforts in recent years, increasing the number of audits on companies and individuals and clamping down on overseas tax evasion, agency data show.

Small businesses are among the largest contributors to the "tax gap," or the amount of taxes owed but not paid because of noncompliance with tax laws, according to the IRS. In 2001, the last time the agency measured the shortfall, nonfarm sole-proprietor income was estimated to account for about 20% of the $345 billion gap.

A Government Accountability Office report from November said smaller companies don't comply with tax law in part because they often aren't subject to withholding rules and other requirements. This year, Congress repealed a provision passed in 2010 that would have required businesses to issue 1099 reports to vendors to whom they pay more than $600 in any calendar year.

The problem with new IRS software requests, according to AICPA, is that small-business record-keeping software is flexible enough to bring in unrelated financial data that are fully integrated with the tax-preparation information.

Mr. Snow, the CPA, said the small-business rules aren't analogous to what the agency does with large businesses, which typically can furnish rigidly segregated electronic data. "For example, an agent will ask for a month of accounts payable or certain payroll records," he said. Large businesses often have tax professionals on staff to handle such requests and restrict access to unrelated information.

Small-business advocates said that if a company turns over its complete electronic records, there is no way of knowing what the IRS might do with it. Typically the agent takes the file offsite to examine it using IRS software, Mr. Snow says. "This is creating angst in the minds of small-business owners," said Giovanni Coratolo, a small-business expert with the U.S. Chamber of Commerce. "When you give that much data, it opens the doors to mischief."

Others are concerned about agents' access to unrelated data such as customer lists, fearing what would happen if word got out that a business was talking to the IRS. "Believe me, small businesses don't want the IRS calling their customers" and asking questions, said Benson Goldstein, senior technical manager of taxation at AICPA.

In a March letter to the agency, AICPA suggested companies be allowed to redact software to release only relevant data. Agents have accepted such information in the past.

The IRS rejected the request, suggesting that small businesses back up a year's data at the end of each year, so that the IRS would get only a year's data at a time. Experts say such back up isn't allowed once an audit request is received by a taxpayer. The IRS also said it would allow businesses to "condense" data—or reduce the detail—for years not under audit.

The IRS didn't address the issue of unrelated information that could remain available, except to say "privacy of return information" is "of utmost importance" to the agency. If the policy remains in place, business owners will be faced with the uncomfortable choice of turning over their complete file or making the IRS issue a summons for it.

Spokesmen for Intuit and Sage said both companies are aware of the issues raised by the accounting group but said they couldn't provide information about possible modifications of current or future products.

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