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Small business non-compliance: a view from the trenches.

A View From The Trenches

The National Society of Public Accountants represents some 23,000 independent practicing accountants who provide accounting, tax preparation, tax planning, financial planning and managerial advisory services to an estimated 7.5 million individuals and small businesses nationwide. NSPA's membership is fairly heterogeneous, consisting of certified public accountants, licensed public accountants, unlicensed accountants and enrolled agents. Common features uniting NSPA's diverse membership are the size of its members' practices, the nature of the clients they serve and the fact that they are independent practicing accountants.

The survey questionnaire was sent to 1,000 randomly-selected active members of the National Society -- 207 members responded for a response rate of 21%.

Many of the questions asked were more open-ended than is usually the case for research of this type. After considerable discussion, it was concluded that the nature of the subject matter dictated this approach. Since the point of the survey was to elicit the opinions of those serving directly as small business tax advisors, it seemed counterproductive to overlylimit the universe of potential answers. It was feared that potentially valuable feedback would be stifled if respondents were merely given a limited number of answers from which to choose. In short, since the whole point of the survey was to learn practitioners' views on small business tax issues, it seemed inappropriate to predict them.

Given carte blanche to a particular question, however, few people will supply exactly the same answers. In the overwhelming majority of cases, responses fell into similar groupings for tallying purposes.

Respondents to this survey have an important message, one which tax administrators need to hear. It is hoped that this survey will provide some statistical framework for further study of the practice-oriented approaches to improved small business compliance which it identifies.

Summary

Respondents were then asked to select one and only one of three professional designations. These included "certified," "licensed" and "unlicensed" -- 30.3% of the respondents were certified, 25.9% were licensed, and 43.8% were unlicensed. Those respondents who selected licensed or unlicensed were asked whether they were enrolled agents. Enrolled agents represented 40.3% of total respondents. They also represented 57.9% of total licensed and unlicensed respondents. Of total unlicensed respondents, enrolled agents represented 61.4%.

On average, respondents had over 20 years of public accounting experience. The final demographic section question revealed that respondents served a total of 19,824 small business clients. On average, each respondent serves 102 small business clients. (There were 194 responses to this question.) This number is consistent with data from several other NSPA surveys, thus providing at least some indicia that the sample here is representative.

Question 1

The first question prompted respondents to rank certain tax law areas as to their difficulty.

The categories included payroll taxes, employee versus independent contractor status, the distinction between personal and business expenses, record-keeping, information reporting and treatment of retirement planning. There was also a line for "other" areas of the tax law, which provided an opportunity for respondents to offer their own area of difficulty. The purpose of this question was to provide a framework within which to evaluate certain subsequent survey questions.

The topic that received the most difficult rating was "employee versus independent contractor status." This is significant, given the current legislative and regulatory environments for this issue. It appears that this area continues to plague the small business and tax practitioner communities.

It has been suggested the reason small businesses find this area of the tax law so onerous is the consequences in the event of error. For small businesses, perhaps more so than for larger enterprises, a mistake in this area -- however honest -- can prove fatal. The back taxes, interest and penalties routinely assessed upon reclassification of workers frequently strain a small business' finances beyond a tolerable level.

In this regard, then, it is not surprising that payroll taxes were ranked a close second in terms of difficulty for small business. IRS assessments for back taxes, interest and penalties in the payroll tax area have a similar potential to devastate a small business' cash flow.

These conclusions are borne out by reviewing the responses to question 8 of the survey. Cash flow problems were the second most frequent reason cited for small business non-compliance. Because IRS assessments resulting from independent contractor reclassifications and payroll tax problems have such a disruptive effect on a small business' cash flow, it is not surprising that practitioners view them as the most difficult areas of the law with which small businesses must comply.

It is more difficult to draw conclusions as to what all this implies for tax administration; clearly, the relief many practitioners would recommend, regardless of how appropriate such recommendations may be, would require legislative action. What the data may suggest administratively, however, is a greater need for flexible payment arrangements. The responses to several subsequent questions certainly indicate practitioner sentiment in this direction.

After payroll taxes, record-keeping received the third highest ranking, followed by information return reporting, treatment of retirement planning, the distinction between personal and business expenses and finally, "other." The most prevalent responses to the "other" option related to state sales tax issues.

Question 2

As a practitioner, what is the most important thing you do to help clients separate and understand the difference between business and personal expenses?

Fifty-three percent of survey respondents indicated that some form of education and review ("constant training and explanation") was their primary means for helping clients separate business from personal expenses. This turned out to be a constant theme throughout the survey. Explanation and reinforcement appear to be the most prevalent approach to helping small business clients comply with the tax laws.

Nonetheless, other approaches were suggested by a large number of respondents. Thirteen percent indicated that they urge their clients to use separate business and personal bank accounts. This practice has potential implications for the Service on several fronts.

First, in response to questions 3 and 5, a few practitioners have suggested that the IRS should consider encouraging this approach itself. Moreover, since so many practitioners already encourage separate accounts as a means of segregating records, substantiation issues necessarily arise.

When a taxpayer is under examination by the Internal Revenue Service, bank records, including canceled checks, often are not accepted as adequate substantiation of business expenses. This procedure may or may not be sufficiently justified from a tax administration perspective.

Nevertheless, since so may practitioners recommend it, perhaps the agency needs to address it. Certainly, if the IRS has identified poor record-keeping as a major factor contributing to small business non-compliance, bank records must be viewed as preferable to no records at all. Encouraging the establishment of separate business bank accounts by the IRS would facilitate this process. Accordingly, a few of the responses to question 5 suggest either that IRS stress the need for separate business bank accounts or that the agency be more willing to accept checks as evidence of business expenses.

Procedural safeguards would necessarily be required were such an approach pursued. Merely establishing separate business accounts does not ensure the accuracy or legitimacy of business expenses if funds are separately co-mingled. However, absent indicia of such abuse, the responses merit further consideration.

Eleven percent of the respondents indicated that review and reallocation of small business records was necessary. These practitioners apparently chose to make the distinctions for their clients. While this may ensure a higher degree of accuracy for the time period reviewed, it does not necessarily produce improved long-term compliance results.

Finally, 9% of respondents indicated that setting up proper charts of account was the most important thing they do to help their clients in this area. Presumably, these practitioners later review these records with their regular clients. In this respect then, this response may be viewed as complementary to the 11% response just discussed.

Before leaving this question, one particular response deserves mention. Although it is quite beyond the agency's ability to remedy, it is noteworthy: "If the government wants taxpayers to separate business from personal expenses, it should not mix the two (e.g., the deductibility of medical expenses by sole proprietors)."

Question 3

As a Federal agency, what is the single most important thing the IRS can do to help taxpayers separate and understand the difference between personal and business expenses?

The similarity of responses to questions 3, 5 and 7, all of which dealt with actions the IRS could take to improve small business compliance in identified areas, was striking. More or less, the answers in each case were, in terms of frequency:

1. Educate taxpayers; 2. Simplify the rules; and, 3. Be more understanding.

It is also worth noting that increased calls for IRS enforcement were recommended rather consistently in all three questions after the items above.

Some of the more noteworthy methods of education suggested include media spots and expanded IRS small business seminars. Again, this was a fairly consistent recommendation throughout questions 3, 5 and 7.

Similarly, in all three cases respondents suggested that IRS take advantage of its regular contacts with taxpayers to provide information to them. Materials routinely sent by the agency to taxpayers with regard to payroll tax deposits and employee identification numbers were most frequently mentioned as sources of contact. Respondents generally asked for greater use of examples in current IRS literature. Perhaps not coincidentally, this would also be of service to the practitioner community.

One of the suggestions specific to question 3 deserves mention. Significantly, 13% of those recommending education as the preferred IRS approach to improving compliance suggested that the agency provide more lists of personal versus business expenses. This is perhaps a discrete permutation of the more general desire for greater use examples discussed above. The suggestion does merit agency consideration.

Question 4

As a practitioner, what is the single most important thing you do to help clients create and maintain adequate business records?

Forty-four percent of respondents indicated that reviewing a client's records was their method of choice in helping the client create and maintain adequate business records. There was fairly consistent sentiment running through these responses that part of the practitioner's job is to review and maintain a client's business records.

This sentiment was echoed by the small minority of respondents (6%) who, in question 5, indicated that the IRS should not be in the business of helping taxpayers create and maintain adequate business records. Moreover, it is borne out by the 13% of respondents to this question who assume responsibility for client record-keeping themselves.

Another 25% of respondents pursue an analogous approach, setting up books of account and record-keeping systems for their clients' use. Although it was not indicated, it seems logical to assume that these practitioners must perform some manner of review with regular clients. Certainly such review is, at a minimum, inherent in the return preparation process.

In summary, the responses to this issue may suggest a dilemma for the IRS. On the one hand, they do suggest some new approaches the Service may wish to consider that can assist taxpayers in keeping adequate business records. On the other, there is at least some indication that the practitioner community does not view any form of assistance in this area as an appropriate agency pursuit.

Question 5

As a Federal agency, what is the single most important thing the IRS can do to help taxpayers create and maintain adequate business records?

As discussed in question 3, practitioner recommendations as to how IRS can assist small businesses generally relate to education, simplification, sensitivity and enforcement. The general analysis provided there more or less holds here.

However, one particular education suggestion merits further consideration and exploration; 23% of respondents recommending enhanced agency education efforts indicated that IRS should develop and make available to small business a standard set of books. While the possibilities inherent in this suggestion, as well as the difficulties, certainly are beyond the scope of this survey, this intriguing recommendation deserves further review.

Question 6

As a practitioner, what is the single most important thing you do to help clients understand their information reporting obligations?

There was surprisingly little variety among the responses given to question 6; 50% of the respondents indicated some form of education efforts as their primary tool for helping clients in the information reporting area.

If the response "send reminders to clients" is included, this figure jumps to 72%. This response was grouped separately, however, because the education efforts indicated by other respondents were more explanatory than merely sending out reminder notices, and were usually face-to-face.

Interestingly, 14% of respondents perform this service for their clients. The responses did not indicate whether this is because practitioners have "thrown in the towel" on trying to keep their clients complicant or simply reflects client preference. Moreover, the respondents did not indicate whether or not they charged separately for these services. Since professional assistance may be one solution to this area of non-compliance, further consideration should probably be given to these issues.

Question 7

As a Federal agency, what is the single most important thing the IRS can do to help taxpayers understand their information reporting requirements?

Because the responses to question 7 so closely follow those discussed under questions 3 and 5, no separate analysis was performed on this question.

Question 8

Question 8 asked respondents to consider the greatest contributor to small business non-compliance. Respondents were asked to choose one (and only one) factor from a list of five options:

1. Complexity of the law; 2. Carelessness by small business

owners; 3. Cash flow problems of the

business; 4. Resentment toward paying taxes;

and, 5. Other.

By far, complexity of the law was seen as the major cause of non-compliance. This choice represented 51% of the total responses. Cash flow problems of the business was a distant second choice representing 25% of the total responses. Carelessness of the business owner, "other" and resentment toward paying taxes represented 9%, 8% and 7% respectively. The amount of time consumed by the requirements of the tax laws was the most frequent "other" explanation offered. Although complexity of the law ranking as the major contributor to non-compliance was not unexpected, the magnitude by which it exceeded the other responses is noteworthy. This ranking demonstrates how the complexity of the tax law continues to be a significant problem for the business community.

Question 9

As a Federal agency, how can the IRS administer the tax laws to improve small business compliance?

Perhaps not surprisingly, the responses to question 9 do not invite a great deal of analysis. Many of the thoughts expressed in earlier questions are echoed here. Specifically, the recurring themes of education, simplification and a "kinder, gentler IRS" constitute the clear majority of responses.

Nevertheless, one new response emerged with surprising regularity, given the breadth of the question: intervene in troubled businesses sooner and more reasonably -- 8% of those responding to question 9 appear to be of the opinion that the IRS would be well-advised to get involved in a troubled small business before the entity's tax obligations become insurmountable.

This is consistent with general impressions received from the practitioner community. There is some sentiment that by the time IRS begins collection action against a delinquent small business, it is often too late. The business' finances are too precarious, and its tax liability has grown too onerous, for the business to be able to satisfy its obligations.

Similarly, because of when and how the Internal Revenue Service takes action against these small businesses, the agency frequently is perceived as dealing the "fatal blow" to the enterprise. Thus, in addition to suggesting earlier intervention, this response appears to contemplate more "reasonable" IRS intervention. This is assumed to mean that there needs to be a greater willingness on the part of the agency to accept payment plans, offers-in-compromise and the like. Payment plans and offers-in-compromise have appeared elsewhere in this survey.

By way of summary, one respondent characterized the issue particularly well. He or she saw little point in "IRS waiting until a small business has fallen too far behind to be able to pay its back taxes and still maintain a cash flow. By then, the tax liability closes the business down. Nobody wins here; the IRS never collects all the money it is due; the taxpayers resent the government; the laid-off employees are a drain on the public purse; and, a [perhaps] going concern has been removed from the tax rolls."

Question 10

Do you have any other comments?

Not surprisingly, the answers to such an open-ended question were too varied to create any trends of note. Again, however, the recurrence of simplification as a theme can be observed.

Conclusion

It is very difficult to venture conclusions based on the data accumulated in this survey. While useful and enlightening, they are perhaps better viewed as road signs indicating appropriate directions for further consideration.

Certain trends clearly emerged. The call for simplification was a consistent theme; it is not, however, a new one. Similarly, as if any further evidence were needed, it is plain that the independent contractor issue is in need of resolution. The desire for a "kinder, gentler IRS" was repeatedly expressed; this is consistent with the aims of the Service's own administration.

Concrete recommendations also were presented. Greater use by IRS editors of examples, lists, and the like certainly appear meritorious. Further, the suggestion that IRS develop a standard set of books for small business has considerable appeal.

Nevertheless, additional research is likely necessary before any of the responses presented in this survey can be acted upon. In conclusion, one of the survey respondents provided an accurate, albeit cynical, summary of the difficulty both the Internal Revenue Service and the practitioner community face in attempting to deal with small business compliance: in the end, as this practitioner observes, both are at the mercy of the fortunes of the business. "Probably the majority of small business owners should never have started. They have good ideas, but know nothing about running a business, and are usually undercapitalized. They should be forced to seek the assistance of an accountant before they are allowed to go into business; most seek assistance when it's too late."

Ultimately, the success or failure of any effort to improve small business compliance is to a degree constrained by this unfortunate reality. Those both within or without the government would be well advised to keep this observation in mind as they consider how to allocate scarce resources toward improving small business compliance. [Graphs Omitted]

Peter M. Berkery, Jr., is NSPA's Director of Federal Affairs/Tax Counsel. He received his JD from The American University and his LLM in taxation from George Washington University, both in Washington, DC. He also holds a BA in classical studies from Boston College and an MA in international affairs from The American University. Prior to joining NSPA, he served as counsel to the Federal Affairs Division of the National Paint and Coatings Association. Steven F. Knell, CPA, M.Accy., is a graduate of the George Washington School of Business and Public Management. A former staff tax analyst for NSPA, he has contributed regularly to the National Public Accountant.
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Author:Berkery, Peter M., Jr.; Knell, Steven F.
Publication:The National Public Accountant
Date:Feb 1, 1992
Words:3198
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