The IRS recently announced that it is hiring 50 more specialized auditors who will be ready to begin in February. The agency is planning to ramp up small business audits by 50% over its historically low rates for these taxpayers.
This could mean increased audit activities around small retail stores, tech startups, partnerships and LLCs. Investor returns in pass-through entities like S corporations, LLCs, partnerships and sole proprietorships will face additional scrutiny in the coming year.
“The IRS is focusing our efforts to increase compliance activity in this area of not only partnerships, but also investor returns related to pass-throughs,” said a spokesperson for the IRS. Next year, “we are planning for 50 percent more than we had in the previous year.”
Pass-through entities aren’t separately taxed. Instead, the profits and tax liabilities belong to the investors and are paid on their individual tax returns.
One reason pass-through entities don’t get audited as often as other businesses is their potential complexity. Often, they involve numerous inter-related entities, many of which have tax liabilities related to their participation in the pass-through organization.
Audits of small businesses are at historically low rates
According to a Bloomberg News analysis, in 2018, the IRS only audited a total of 140 partnership returns out of over 4 million filed. That’s a rate of 0.00004%. In 2010, by contrast, 0.5% of partnership returns were audited.
Similarly, 2018 only saw audits of 397 S corporation returns, which is roughly 0.01% of all filings.
A 50-percent increase in these audit rates may not make much of a dent in compliance.
The IRS can go back three or more years
Whenever you file, keep in mind that the IRS can select returns up to three years old for audit. Then, if the agency finds significant issues with those returns, it can delve deeper.
An audit can result in anything from a demand letter for back taxes to an appointment with an auditor at your place of business. If you receive a notification from the IRS that your tax return is being challenged, don’t panic. You will have an opportunity to dispute any adverse findings. Talk to a tax lawyer for a specific strategy.