Small Businesses on IRS Radar for Underreporting Cash Sales

Small businesses are on the radar of the IRS for underreporting cash sales and they are using a relatively new form to target businesses, Form 1099-K.

Since 2011, merchant card processors have been required to issue Form 1099-K to the IRS with a copy sent to business owners. The purpose of the form is to report the total amount of payments processed on behalf of a particular business.

The IRS is now beginning to leverage this data to question small business owners. As the program ramps up, the IRS indicates that it expects to send roughly 20,000 inquiry letters to business owners with more expected in the future. The IRS uses the information reported on the form to compare the amount of merchant card payments against total revenue reported on the business' tax return.

The IRS then analyzes this information and compares it against other businesses in the same industry. Businesses that show an unusually high portion of gross receipts from merchant card payments (and, therefore, a relatively low percentage of receipts from cash payments) compared to similar businesses are more likely to be selected by the IRS for inquiry.

According to 2006 IRS data, underreporting of small business income resulted in uncollected tax payments of $141 billion. The IRS is seeking to narrow this so-called tax gap, the difference between taxes owed versus actually paid, and believes this may be an effective first step. Please note that these IRS inquiry letters are simply a request for more information and are not tantamount to an audit. In the letter, taxpayers are asked to explain why their cash payments are low or why they reported less income than was shown on Form 1099-K. There is often a simple explanation for this discrepancy. Selling gift cards, collecting sales tax or offering cash back are just a few of the many reasons why revenue shown on the tax return could be more or less than that shown on Form 1099-K.

Business owners will receive their Form 1099-K by January 31st for the preceding year and should take additional time to examine the form for any inaccuracies. Addressing incorrect information early could avoid IRS questioning later.