IRS SBSE priorities: 2004 and beyond.

At the July 2004 IRS/Texas Society of CPAs Liaison Committee Meeting, an IRS representative outlined numerous Small Business/Self-Employed (SBSE) priorities for 2004 and the next few years. This item summarizes throe priorities.

Although the SBSE is not the largest division in terms of the number of taxpayers served, the taxpayers falling into this category present the most compliance challenges. Most of these taxpayers use professionals to prepare their returns. Thus, through its Taxpayer Education & Communication pre-filing compliance activities program, the SBSE is enlisting the support of the professional community, to help meet the challenge.

SBSE Strategic Goals

Primary strategies for FYs 2004, 2005 and beyond intend to:

* Increase compliance among SBSE taxpayers;

* Prevent the formation, use and effects of promoted abusive tax avoidance transactions;

* Improve service to SBSE taxpayers;

* Improve business results, by enhancing operational practices aid processes;

* Reduce the burden on small business taxpayers; and

* Ensure that E-File and E-Pay become the preferred option for these taxpayers.

Priorities

In addition to the primary strategies, there are numerous supporting priorities.

Abusive tax avoidance transactions:

These include domestic trust arrangements in which taxpayers use trusts to hide the true ownership of assets and income or to disguise a transaction's substance.

Off-shore credit card schemes are another form of abuse. Taxpayers use cards issued by tax-haven-domiciled banks to repatriate anonymously and covertly off-shore funds that may not have been previously taxed.

The Service is also targeting credits taken under the Americans with Disabilities Act. Promoters generally entice investors into believing they are entitled to a disabled access credit for nonqualified expenditures.

Employment tax schemes that promote employee leasing, pay wages in cash and, in some cases, the false payroll tax forms, have also come under IRS scrutiny. The IRS will ,also identify and take action against promoters of all these types of arrangements, when necessary.

High-income/high-risk taxpayers:

The compliance risk associated with these taxpayers has centered on the IRS's ability to verify income and deductions through its various matching programs (such as Schedule K-1 matching), especially for income reported by corporations or passthrough entities.

High-income nonfilers: The population in this category is growing. The IRS is increasing the number of audits conducted. To identify nonfilers, it is contacting state licensing agencies (e.g., state bar associations) and filing agencies to match its data against theirs.

Unreported income: Unreported income is the largest component of the tax gap. The IRS has developed a new tool, known as "unreported income discriminant index formula" (UI DIF), to use along with its basic DIP formula. The score generated by the UI DIF formula indicates and rates the probability of income being omitted from a return.

Returns with the highest risk for unreported income are then systematically selected for audit. Returns will now receive both a DIF and a UI DIF score. For years, the IRS has used the DIF process to identify returns with a high probability of error. Now, with its new tool, it is focusing on spotting returns with a high probability of unreported income.

NRP: Through mid-March 2004, the IRS had (1) selected all the returns for its National Research Project (NRP) sample; (2) determined the type of contact required; (3) mailed letters to taxpayers requiring examinations; and (4) completed examinations in about 50% of the cases. Final data from this first phase of the NRP is expected by December 2004; a major analysis and use of the data will begin in 2005. The new audit selection formulas are expected to be implemented in early 2006. The second phase of the NKP will focus on Forms 1065, U.S. Return of Partnership Income, and 1120S, U.S. Income Tax Return for an S Corporation; pilot efforts will run through 2005.

Burden reduction: The IRS is continuing to focus on reducing the taxpayer burden. Recent successful initiatives include (1) raising the income threshold on Form 1040, Schedule B, to $1,500; (2) permitting the use of the standard mileage rate for small bust nesses for up to four vehicles; (3) allowing the use of standard rates for daycare providers; and (4) adding a flowchart to Form 2210, Underpayment of Estimated Tax by Individuals, Estates, and Trusts.

Additional burden reduction initiatives are in various stages of development and include (1) redesigning Schedule K-1 (for Forms 1065, 1120S and 1041, U.S. Fiduciary Income Tax Return) to look more like Form 1099); (2) redesigning Form 941, Employer's Quarterly Federal Tax Return, to a two-page scannable form; (3) eliminating quarterly Forms 941 in favor of an annual return, for certain small businesses; and (4) reducing the number of extension forms from 11 to four, creating a uniform six-month extension period for all extensions and centralizing submission sites.

Conclusion

Some of these changes are long overdue; their successful implementation will require cooperation between tax advisers and the IRS. Interesting times lie ahead.

RONALD S. FIEDELMAN, CPA, PHILIP

VOGEL & CO. PC, DALLAS, TX