Small Businesses Bear a Significant Portion of Federal Tax Compliance Cost

Editor: Valrie Chambers, Ph.D., CPA

Practice & Procedures

Judge Learned Hand famously wrote that “[a]nyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury” ­(Gregory v. Helvering, 69 F.2d 809, 810 (2d Cir. 1934)). For this reason, choosing a prudent tax adviser is essential to benefit from available deductions and credits and to avoid tax penalties.

However, while using a prudent tax adviser is economical for some, it is a luxury for others, particularly for U.S. small businesses. This item focuses on small businesses that are independently owned, with gross receipts of less than $10 million.

The National Federation of Independent Business’s (NFIB’s) Small Business Problems & Priorities Poll in 2012 found that tax complexity was the second most severe tax-related issue that small business owners faced. According to testimony at the most recent House Committee on Small Business hearing on “The Biggest Tax Problems for Small Businesses,” small businesses with less than $1 million in gross receipts disproportionately bear almost two-thirds of tax compliance costs, relative to revenues or assets of large firms (Marron, “Tax Issues Facing Small Business,” testimony before the House Committee on Small Business, p. 1 (4/9/14)).

Tax compliance costs are measured either quantitatively or qualitatively. Quantitative measures include out-of-pocket costs for paid professional tax services, opportunity costs, and other monetary costs of recordkeeping, tax planning, and payroll. Qualitative tax compliance cost includes behavior(s), i.e., good corporate citizen, reputation risks, or industry norms. Underlying all of these factors is the complexity of the tax Code. In fact, tax complexity ranks seventh out of the 75 top issues for small businesses in the NFIB’s 2012 survey. The hours spent complying with the Code, or responding to notices or an audit, exacerbate the existing tax compliance burden small businesses must face. For example, the instructions to Form 1120S, U.S. Income Tax Return for an S Corporation, provide that the time needed to complete Form 1120S is approximately 56 hours, learning about the form is estimated to average 30 hours, and copying, assembling, and sending the form to the IRS averages almost seven hours. While the instructions estimate the time for recordkeeping related to the form averages approximately 62 hours, depending on the circumstances, the hours it takes could easily be more than the average time. These average times do not include many of the schedules that must be completed to supplement the form.

Many might argue that the use of accounting software eases the compliance burden on small business owners, the tax Code is e-friendly, and all requirements that apply to hard copy books and records also apply to electronic storage systems. Regardless of these factors, which may mitigate the difficulty of preparing a return for a small business, 86% of small business owners will ultimately rely on a paid tax preparer (Reynolds, testimony before the House Committee on Small Business, p. 3 (4/9/14)).

It is not enough to merely pay a tax preparer to determine available deductions and credits. Small business owners should find prudent tax preparers with experience in the particular industry the small business specializes in or risk an increase in tax compliance costs. Due to this dependency, on March 25, 2015, the IRS held a Small Business Forum at the NFIB. One of their current projects is to identify potentially fraudulent payroll service providers that prey on small businesses.

To aid in effective, economical compliance, the Small Business and Self-Employed Division of the IRS will now:

• Send identical notices to both old and new addresses on file for an employer when an address change is received;
• Issue Electronic Federal Tax Payment System (EFTPS) Inquiry PINs;
• Use Form 14157, Complaint: Tax Return Preparer; and
• Implement email confirmations to clients of third-party payers when payments are scheduled, canceled, or returned on their behalf.

The IRS is promoting educational and outreach resources to ease compliance, including:

• “Small Business Taxes: The Virtual Workshop,” available at www.irs.gov;
• Small Business and Self-Employed Tax Center;
• IRS Tax Calendar for Businesses and Self-Employed, available at www.irs.gov;
• e-News Subscriptions; and
• The IRS Video Portal—Small Business Video and Audio Presentations, available at www.irs.gov.

The IRS is also soliciting comments from small businesses on its Business Compliance Burden Survey.This a draft survey about the costs business taxpayers incur to amend a return or address a problem with already-filed federal income tax returns. The IRS is interested in hearing how the survey could be made better, with feedback going to michael.k.bess@irs.gov.

The Patient Protection and Affordable Care Act (PPACA), P.L. 111-148, is also adding compliance complexity, in part because of the employer shared-responsibility requirement. In response, the IRS has published a question-and-answer webpage (available at www.irs.gov). Additionally, there is information on the upcoming Affordable Care Act Information Returns (AIR) System, which is a web-based system that is modeled after Modernized e-File (MeF). To use the AIR, employers must register with e-services and then apply for an ACA IR Transmitter Control Code (TCC) to transmit PPACA information. Information returns are voluntary for the 2014 tax year but are mandatory for the 2015 tax year (for filings in 2016). The IRS has also recently published Notice 2015-17 to provide guidance on the application of Sec. 4980D to certain types of health coverage reimbursement arrangements. The notice provides transition excise tax relief for failure to satisfy market reforms in certain circumstances and reiterates the previous guidance in Notice 2013-54 that employer payment plans are group health plans that will fail to comply with the market reforms that apply to group health plans under PPACA.

To conclude, small businesses unduly bear a significant portion of federal tax compliance costs. Choosing a prudent tax adviser is essential if a business wants to benefit from the expertise necessary to reduce its overall tax burden as low as permitted. Although small business owners agree that the complexity of the tax Code is an important issue, the IRS has made many strides in providing education and guidance to these businesses. Going forward, meaningful change must be structured to make the Code less complex, decrease the administrative burdens associated with current tax law, and encourage small business growth.