United States General Accounting Office GAO Report to the Chairman, Committee on Small Business, U.S. Senate August 1999 TAX ADMINISTRATION Tax Requirements of Small Businesses GAO/GGD-99-133 United States General Accounting Office General Government Division Washington, D.C. 20548 B-281009 August 24, 1999 The Honorable Christopher S. Bond Chairman, Committee on Small Business United States Senate Dear Mr. Chairman: Small businesses—a category that includes all farmers and sole 1 proprietorships and partnerships, S corporations, and corporations with assets of less than $5 million—are an important segment of taxpayers that are subject to substantial federal tax requirements. Not only do they account for nearly half of all taxes the Internal Revenue Service (IRS) collects annually, but they also have extensive interactions with IRS as they attempt to comply with their tax obligations. Because of your interest in alleviating any unnecessary burden that the federal tax system places on small businesses, you asked us to assess the magnitude of the burden that complying with tax obligations imposes for these businesses. This report is the first of a series of reports to address your concerns. As agreed with your office, our objectives for this report were to determine (1) the federal filing, reporting, and deposit requirements that apply to small businesses and (2) the actual experience of small businesses in meeting these requirements, including their involvement in IRS’ enforcement processes. Small businesses, like large businesses, are subject to multiple layers of Results in Brief filing, reporting, and deposit requirements. We identified more than 200 different IRS requirements that potentially apply to small businesses. Through such requirements, IRS administers a variety of tax policies— notably those associated with income, employment, and excise taxes. In considering the implications of the number of requirements, it is important to recognize that the requirements reflect the many decisions that have been made by Congress and the executive branch to accomplish their policy goals, including those that might benefit small businesses and other taxpayers. It is equally important to recognize that most businesses do not need to comply with all or even most of these requirements. The ones that 1 Corporations with no more than 75 shareholders can elect to be treated as S corporations for federal tax purposes if certain requirements are met. The main advantage of this election is avoidance of tax at both the corporate and shareholder level, as the income of S corporations is generally subject to tax only at the shareholder level. Page 1 GAO/GGD-99-133 Small Business Tax Requirements B-281009 apply to a particular small business would depend on how the business is organized, whether it has employees, and the nature of its business operations. Limitations in IRS’ information systems prevented us from fully determining the extent to which small businesses filed the various forms and schedules or their involvement in key stages of IRS’ enforcement processes. IRS has acknowledged that these limitations hinder its ability to effectively manage small business activities and will continue to be a serious impediment until the systems are improved. We were able to obtain and analyze limited data on small business filings of income tax forms and on some aspects of their involvement in IRS’ enforcement processes. Our analysis of IRS’ 1995 data on the most commonly filed income tax forms and schedules showed that small businesses, on average, filed one secondary form in addition to their primary income tax return, with little variation among types of businesses. Our analysis of small business audits showed that the audit rate for small businesses is higher than the rate for all taxpayers and that about two-thirds of the audits of small businesses result in recommendations for assessment of additional taxes and penalties. Businesses in the United States (including farmers) are generally Background structured in one of four forms: sole proprietorship, partnership, S 2 corporation, and corporation. Each form of business has distinctive legal characteristics and different tax consequences. Corporations are taxed as corporations, with dividends included in the owner’s income; sole proprietors are taxed as individuals; and the income earned by S corporations and partnerships is passed through to their owners and taxed at the owners’ rates. The Internal Revenue Code (IRC) distinguishes small businesses from larger businesses in a number of ways, and IRS has used different definitions of small business for different internal operating purposes. As part of its current reorganization effort, IRS has developed an agencywide definition of small business, which we used in our work. Based on that definition, small businesses include (1) all farmers and sole proprietorships and (2) partnerships, S corporations, and corporations that annually reported less than $5 million in assets. 2 Another alternative business form that has emerged is the limited liability company, which generally is classified as a partnership for tax purposes, but offers the corporate benefit of limited liability for owners. Page 2 GAO/GGD-99-133 Small Business Tax Requirements B-281009 A large majority of all businesses are small businesses. To illustrate, for tax year 1995, we used IRS data to identify approximately 23.4 million businesses that filed returns. Of this population, 94 percent of partnerships reported total assets of less than $5 million, and 98 percent of S corporations reported total assets of less than $5 million. About 97 percent of U.S. corporations reported assets of less than $5 million in 1995. Sole proprietorships accounted for approximately 16.3 million of the nearly 23.4 3 million business filers in 1995. To identify the federal filing, reporting, and deposit requirements that Scope and apply to small businesses, we examined information such as IRS forms, Methodology publications, manuals, and related IRC provisions. We also interviewed IRS officials who were cognizant of small business tax issues, including officials in IRS’ Office of Public Liaison and Small Business Affairs, Compliance Research Division, Appeals Division, and the Small 4 Business/Self-Employed/Supplemental Income Team. To help ensure completeness, we had knowledgeable IRS officials review our listing of IRS requirements. To develop a more comprehensive list of federal tax requirements that apply to small businesses, we contacted the Bureau of Alcohol, Tobacco, and Firearms (ATF) in the Department of the Treasury for information on requirements pertaining to the excise taxes that it administers. The ATF requirements apply generally to any business. To determine the actual experience of small businesses in meeting their filing, reporting, and deposit requirements, including their involvement in IRS’ enforcement processes, we (1) interviewed IRS compliance officials specializing in examination, appeals, and collection issues to ascertain how small businesses are affected by the enforcement processes and (2) obtained some computerized information from IRS databases on the filing and enforcement experience of small businesses. This included data from IRS’ Statistics of Income Division, Audit Information Management System (AIMS), and Accounts Receivable databases. Throughout this review, we drew on our previous work at IRS and on tax administration issues in general. 3 According to IRS, about half of these taxpayers received the vast majority of their income from wages, not business-related enterprises, and should be considered as “incidental” business filers. 4 The Small Business/Self-Employed/Supplemental Income Team is one of several IRS teams developing plans and blueprints to, among other things, restructure IRS into four principal operating units to better serve taxpayers. Page 3 GAO/GGD-99-133 Small Business Tax Requirements B-281009 Our work did not address IRS activities related to small businesses that had not filed returns. Also, we experienced several limitations during the course of our work because much of the data we sought were not collected in IRS’ information systems and databases or were not sufficiently reliable. To obtain and analyze the available data, we often had to rely upon sampling, matching, and ad hoc techniques. In addition, data were not available for a single year across all variables, so we had to use 5 data from different years as needed. We did not verify the reliability of the IRS data we used except for some limited checking. Appendix I describes the data limitations we experienced in more detail. We requested comments on a draft of this report from IRS. Their comments are reprinted in appendix IV. Our work was performed in accordance with generally accepted government auditing standards between September 1998 and May 1999 at IRS headquarters in Washington, D.C. Small businesses, like large businesses, are subject to multiple layers of Small Businesses Face filing, reporting, and deposit requirements that reflect how the business is Multiple Layers of Tax organized, whether it has employees, and the nature of its business 6 Requirements operations. By our count, there are more than 200 requirements—which we grouped into four layers—that may apply to small businesses as well as larger businesses and other taxpayers. The requirements are designed to implement a variety of tax policies. They provide a way not only to collect taxes from businesses, but also to use businesses to collect taxes owed by third parties (e.g., withholding employees’ personal income tax and Social Security and Medicare (FICA) taxes). It is highly unlikely that any business would need to complete all 200 requirements. This is because the forms, schedules, and other requirements that apply to a particular small business reflect how the business is organized, whether it has employees, and the nature of its business operations. Although a few of the requirements must be submitted more frequently than once a year, the vast majority are submitted annually. Appendix II provides a listing of all the requirements that we identified. They reflect the decisions of Congress and the executive branch in keeping with their policy goals and objectives. 5 We obtained the most recent data available from IRS; some were for 1995 and some for 1997. 6 For the purpose of this report, requirements are the filing of a tax form or schedule and making deposits. Schedules that were embedded in a primary return were not counted as a separate requirement. Page 4 GAO/GGD-99-133 Small Business Tax Requirements B-281009 Primary Income Tax The requirements with which a small business must comply depend upon how it is organized—sole proprietorship, partnership, S corporation, and Returns Represent One corporation. Each business type has its own primary income tax return, Layer of Requirements some of which include a set of schedules embedded in the form. For example, the primary corporate income tax return, Form 1120, U.S. Corporation Income Tax Return, contains eight embedded schedules. To support their primary income tax return, certain types of businesses and individuals with business income must also attach a mandatory schedule to their return. (See table 1.) For example, sole proprietorships must file Form 1040, U.S. Individual Income Tax Return, and Schedule C, Profit or 7 Loss From Business. As pass-through entities, partnerships and S corporations each have two separate sets of returns–one for the entity and one for its owners. In addition to the primary income tax return filed by the entity, each owner must file a Form 1040 and a Schedule E, 8 Supplemental Income and Loss. Table 1: Primary Income Tax Returns a and Mandatory Schedules Business category Primary income tax return Mandatory schedule Sole proprietorship Form 1040 Schedule C Farmer Form 1040 Schedule F Partnership Form 1065 Schedule K-1 Partner Form 1040 Schedule E S corporation Form 1120S Schedule K-1 Shareholder Form 1040 Schedule E Corporation Form 1120 None Legend Form 1040, U.S. Individual Income Tax Return Form 1065, U.S. Partnership Return of Income Form 1120, U.S. Corporation Income Tax Return Form 1120S, U.S. Income Tax Return for an S Corporation Schedule C, Profit or Loss From Business Schedule E, Supplemental Income and Loss Schedule F, Profit or Loss From Farming Schedule K-1, (form 1065) Partner’s Share of Income Schedule K-1, (form 1120S) Shareholder’s Share of Income a Schedules that are required to be filed with the primary return. Source: IRS. 7 Related to income tax, estimated tax is another important requirement that applies to many small businesses. Many sole proprietorships, partners, and S corporation shareholders must pay estimated taxes quarterly for income and self-employment tax. In making these payments, they must estimate their income for the coming year and the amount of income, Social Security, and Medicare taxes that will be owed on this income. Corporations must also make installment payments of estimated tax on their income, while S corporations must pay estimated tax only on certain tax liabilities. 8 Form 1040 and Schedule E are not generally considered to be business returns. Page 5 GAO/GGD-99-133 Small Business Tax Requirements B-281009 Employment Tax Adds A small business’ decision to hire employees adds a second layer of tax requirements. We identified 10 different federal employment tax deposit Another Layer of Tax requirements that potentially apply to small businesses. The number of Requirements employment tax filings and deposits depends on the number of employees and the resulting employment tax liability owed at a particular time. (See table 2 and table II.2 in app. II.) For each employee, a small business is generally responsible for collecting and remitting several federal taxes with varying frequency stipulations–withholding for employees’ personal income tax and the employee’s share of FICA, the employer’s share of FICA, and federal unemployment tax (FUTA). Table 2: Key Employment Tax Requirements Type of employment tax Primary return Deposit requirements Personal income Form 941, Employer’s Quarterly Quarterly if liability is less than and FICA tax Federal Tax Return $1,000 per quarter withheld and Monthly if $50,000 or less in the a employer’s share lookback period of FICA Semiweekly if more than $50,000 in the lookback period Next day if $100,000 or more accumulated on any day during a deposit period Form 943, Employer’s Annual Tax Annually if liability is less than Return for Agricultural Employees $1,000 per year Monthly if $50,000 or less in the b lookback period Semiweekly if more than $50,000 in the lookback period Next day if $100,000 or more accumulated on any day during a deposit period Deposits made by mail using Form 8109 or electronically using Electronic Federal Tax Payment System FUTA tax Form 940, Employer’s Annual Deposit quarterly by mail using Unemployment Tax Return (if Form 8109 or electronically using liability is greater than $100 in a Electronic Federal Tax Payment tax year) System a The Form 941 lookback period for 1999 covers four quarters, beginning July 1, 1997, and ending June 30, 1998. b The Form 943 lookback period is the second calendar year preceding the current calendar year. Source: IRS. A small business employer must report quarterly the amount of personal income tax withheld and FICA taxes paid for employees on Form 941, Employer’s Quarterly Federal Tax Return. The employer must deposit Page 6 GAO/GGD-99-133 Small Business Tax Requirements B-281009 employee income tax and FICA taxes withheld and the employer’s share of FICA taxes by mail or electronically either quarterly, monthly, semiweekly, or the next business day, depending on the employers’ tax liability. If total deposits of withheld income and FICA taxes were more than $50,000 in the second year preceding the current year, the employer must make electronic deposits using the Electronic Federal Tax Payment System 9 (EFTPS). In addition, a small business employer must annually report and quarterly deposit FUTA taxes separately from FICA and withheld income tax. Lastly, an employer must send a federal Form W-2, Wage and Earnings Statement, to each of its employees and file federal Forms W-3, Transmittal of Wage and Tax Statements, and W-2 with the Social Security Administration. In sum, hiring employees—even just one employee—is a critical decision for small businesses in terms of their tax liability and the 10 complexities of the tax administration processes that they face. Offering Employee Benefits The decision to offer employee pension, fringe, and welfare benefit plans adds another layer of requirements for a small business. Some benefit Adds a Third Layer of plans may substantially increase the number of filing requirements that Requirements small businesses face, while others are simplified and entail few, if any, filing requirements. We counted over 10 filing and reporting requirements pertaining to benefit plans, including requirements like the Form 5500 series and related schedules. Certain pension plans are tailored to small businesses and self-employed individuals, offering them a tax-favored way to save for retirement. Simplified Employee Pensions (SEP), Savings Incentive Match Plans for Employees (SIMPLE), and Keogh plans offer small employers and self- employed individuals a deduction for contributions to the plan and deferral of tax on income of the plan. Generally, SEP and SIMPLE plans are less complex than Keogh plans, and while businesses must maintain records about the plans, they do not have any separate filing or reporting requirements with IRS. Keogh plans offer certain benefits not offered by SEP and SIMPLE, but they tend to be more complex and entail substantial filing and reporting requirements with IRS using Form 5500 and related 11 schedules. In addition, most fringe and welfare benefit plans entail filing 9 IRS has waived penalties for most smaller businesses required to use EFTPS that make timely deposits using paper deposit coupons. The penalty relief applies through December 31,1999, to all taxpayers currently required to use EFTPS if they did not make aggregate tax deposits of more than $200,000 during the year. In addition, new regulations increase the threshold amount from $50,000 (withheld income and FICA taxes) to $200,000 (aggregated of the federal tax deposits). 10 Employment Taxes and Small Business (GAO/T-GGD-97-21, Nov. 8, 1996), p. 7. 11 IRS, Department of Labor, and Pension Benefit Guaranty Corporation have consolidated their returns and report forms to minimize the filing burden for plan administrators and employers. Page 7 GAO/GGD-99-133 Small Business Tax Requirements B-281009 and reporting requirements with IRS using the Form 5500 series. (For a complete list, see table II.3 in app. II.) Other Business Operations The remaining tax requirements that potentially apply to small businesses depend upon the nature of the business activities. A few of these Add a Fourth Layer of requirements are specific to a type of business, but most are generally Requirements applicable to all businesses. For example, there are requirements that pertain to the depreciation of assets, the sale of business property, and claims for a credit to increase research activities. These requirements, of which there are nearly 140, range across income taxes, excise taxes, and information reporting. (For a complete list, see tables II.4, II.5, and II.6 in app. II.) Some of these requirements are used to implement provisions in the Internal Revenue Code that can benefit small (and other) businesses. For example, businesses must complete Form 8861, Welfare-to-Work Credit, to receive a tax credit for hiring long-term family assistance recipients. Also, businesses must complete Form 4562 to claim deductions for depreciation and amortization of business assets or to make the election to immediately expense the cost of certain property. The election to expense property allows the taxpayer to take an immediate deduction instead of using the depreciation schedules to recover a portion of the costs annually over the property’s useful life. (The total cost that may be expensed is $18,500 for 1998.) Among excise taxes alone, we identified about 70 requirements that potentially apply to small businesses. (For a complete list, see tables II.5 and II.6 in app. II.) Generally, though, most small businesses are not responsible for filing excise taxes. According to IRS, fewer than 800,000 small businesses filed excise tax returns in 1997. IRS and ATF administer many of the federal excise taxes. The excise taxes administered by IRS consist of several broad categories, including environmental taxes, communications taxes, fuel taxes, retail sale of heavy trucks and trailers, luxury taxes on passenger cars, and manufacturers’ taxes on a variety of different products. ATF administers excise taxes on the production, sale, or import of guns, tobacco, or alcohol products or the manufacture of equipment for their production. Page 8 GAO/GGD-99-133 Small Business Tax Requirements B-281009 Limitations in IRS’ information systems prevented us from fully Small Businesses’ determining the extent to which small businesses actually filed various Experience in Filing required forms and schedules and which businesses made deposits or the and Enforcement extent of small businesses’ involvement in IRS’ enforcement processes. We were, however, able to obtain and analyze limited data on small Processes Could Not businesses’ filing of income tax forms and on some aspects of small Be Fully Determined businesses’ involvement in IRS’ enforcement processes. The data limitations currently hinder IRS’ ability to effectively manage its activities and serve small businesses and, as IRS has acknowledged, will continue to be a serious impediment until the systems are improved. (For a more detailed discussion of IRS’ data limitations, see app. I.) Filing Experience of Small Businesses Income Tax Although we weren’t able to obtain data on most types of requirements, we were able to obtain information pertaining to small business income tax requirements. Our analysis of 1995 IRS data for approximately 44 forms and 46 related schedules that IRS believes are those most commonly filed showed that small businesses, on average, filed one secondary form in addition to their primary income tax return, with little variation among the different types of business. The most commonly filed secondary income tax form among the 44 was Form 4562, Depreciation and Amortization. Approximately 74 percent of farmers, 62 percent of partnerships, 69 percent of S corporations, and 73 percent of corporations filed the depreciation and amortization form in 1995. The returns for sole proprietorships were lower, with slightly less than 40 percent filing the depreciation and amortization form in 1995. The number of schedules small businesses submitted varied, depending on the type of business. This includes the mandatory schedules filed with the primary return by certain business types and individuals with business income as well as secondary schedules and other schedules embedded in the primary tax return. On average, sole proprietorships and corporations filed approximately three schedules, while farmers filed slightly less than 12 three. Partnerships and S corporations filed more schedules than other types of businesses. Partnerships filed approximately 11 schedules, and S 12 The results for sole proprietorships and farmers include schedules pertaining to nonbusiness income (e.g., wages). Page 9 GAO/GGD-99-133 Small Business Tax Requirements B-281009 corporations filed approximately 6 schedules, on average, in 1995. The filing results are higher for partnerships and S corporations because of their unique structure as pass-through entities. Partnerships and S corporations must file a Schedule K-1, Partner’s or Shareholder’s Share of Income, with IRS for each partner or shareholder. As a result, Schedule K-1 filings accounted for a significant proportion of the multiple schedules filed by partnerships and S corporations in that year. Employment Tax and Pensions IRS did have information on federal employment taxes, but it could not be broken out by small businesses. Further, IRS did not have sufficient, reliable data on the number of small businesses that filed pension forms in 1995. We were able to obtain very limited disaggregated data on the number of pension forms filed in 1995. However, the results could not be projected to the larger population of small businesses. We worked with IRS’ Employee Plans/Exempt Organizations Division to obtain a sample of the number of small businesses that filed Form 5500, using an employer identification number match. From a sample of 65,701 small business employer identification numbers, we matched 11,585 that filed Form 5500. The data indicated that 1,090 sole proprietorships, 824 partnerships, and 9,671 corporations filed forms from the Form 5500 series in 1995. Enforcement Experience of IRS had limited data on the extent to which small businesses are involved in both examination and collection activities. We obtained limited data on Small Businesses audit rates; duration; recommendations, such as refunds, no change, or changes recommended by IRS examiners; and appeals and petitions. When IRS has indications that a small business may have failed to meet one or more of the aforementioned requirements, the business can become involved in IRS’ enforcement processes. These processes are basically the same for small businesses as for other taxpayers. They involve examining returns for potential errors or compliance problems, notifying taxpayers of suspected discrepancies, settling disputes over additional taxes 13 recommended, and collecting taxes assessed. (App. III provides a simplified picture of IRS’ audit and dispute resolution process.) 13 See Tax Administration: IRS’ Return Selection Process (GAO/GGD-99-30, Feb. 22, 1999) and Tax Administration: IRS Measures Could Provide a More Balanced Picture of Audit Results and Costs (GAO/GGD-98-128, June 23, 1998). Page 10 GAO/GGD-99-133 Small Business Tax Requirements B-281009 Audits IRS’ primary technique for assessing compliance with tax laws is to 14 examine the accuracy of the tax reported on filed tax returns. In selecting returns to be audited, IRS attempts to focus on those it believes are most likely to have compliance problems. IRS data showed that about 2.3 percent of the income tax returns filed by small businesses in 1997 were 15 audited, generally through audits conducted by IRS’ district offices. By contrast, IRS audited 1.3 percent of all returns filed in 1997. The audit rate for sole proprietors (individuals filing Schedule C) was 3.2 percent, 16 compared to 1.2 percent for individuals not filing Schedule C. According to IRS officials, the audit rate for small business taxpayers is higher than the overall rate because small businesses tend to have more compliance problems than other taxpayers. A common kind of problem that small businesses can face is in the area of employment tax compliance. A small business can fall short of operating capital, and as a consequence, it may divert some or all of its estimated tax deposits or employment tax withholdings to make up the shortfall, hoping to pay IRS at a later date. According to IRS officials, the amount of these unpaid taxes, penalties, and interest can pyramid quickly. The danger is that a business that must rely on these funds for working capital is likely to have other liabilities and delinquencies that reflect financial problems so severe 17 that it cannot recover. Table 3 provides detailed information on the audit rates in 1997 for the four types of small businesses and farmers. 14 IRS audits do not include all taxpayer contacts that can result in recommended assessments of additional tax. In particular, notices resulting from IRS’ information matching math-error programs are generally not counted as audits, according to IRS officials. In 1997, IRS’ information matching program generated about 2.8 million notices, resulting in assessments totaling about $1.5 billion. We could not identify any readily available data on how much was assessed to small businesses. 15 IRS data on audits of Schedule C filers is limited to those who derive most of their income from their business activities rather than from wages. These audits, when conducted by IRS’ service centers, generally involve aspects of the Form 1040 or self-employment tax return, rather than Schedule C. Also, the AIMS data do not take into account audits of Schedule E filers, particularly the individual owners of partnerships or S corporations. 16 The data showed audit rates of 4.1 percent and 3.6 percent for Schedule C filers in 1995 and 1996, respectively, compared to 1.5 percent in both years for individuals not filing Schedule C. 17 See Unpaid Payroll Taxes: Billions in Delinquent Taxes and Penalty Assessments Are Owed (GAO/AIMD/GGD-99-211, Aug. 2, 1999), which discusses employment tax compliance. Page 11 GAO/GGD-99-133 Small Business Tax Requirements B-281009 Table 3: Audit Rates Across Small Business Types Type of business Size Audit rate Sole proprietorship Gross receipts < $25,000 3.2% Gross receipts $25,000 < 100,000 2.6 Gross receipts $100,000 and more 4.1 All sole proprietorships 3.2 Farmer Gross receipts < $100,000 1.3 Gross receipts $100,000 and more 2.8 All farmers 1.8 a Partnership All partnerships 0.6 a S corporation All S corporations 1.0 Corporation Assets < $250,000 1.2 Assets $ 250,000 < $1 million 3.5 Assets $1 million < $5 million 7.8 All corporations 2.1 a About 94 percent of partnerships and 98 percent of S corporations were small businesses in 1995 (i.e., they had less than $5 million in assets, based on GAO’s analysis of IRS’ Statistics of Income data). Source: IRS Data Book (Publication 55B), 1997. IRS has little data on the burden imposed by its audits of small businesses 18 and other taxpayers. IRS’ AIMS database does include information on the length of audits from an administrative perspective—that is, the number of days from when IRS’ auditors first begin working on a case until the case is 19 closed. This information, although not a complete indicator of the burden that IRS audits imposed on small businesses, does provide some insight on the time it takes to go through the audit process. During an audit, a taxpayer is likely to spend some time searching for documentation, responding to IRS’ inquiries, and meeting with IRS examiners. However, over the course of the audit, there are also periods of time when the taxpayer is not actively involved, such as while IRS is evaluating records and researching issues, or when IRS examiners are temporarily reassigned to other cases or activities. Table 4 provides data on the average length of small business IRS audits that were closed in 1995. 18 As of May 1999, IRS was working with a consultant on a multiyear project to develop better estimates of tax compliance burden, including the burdens associated with audits. 19 Audit cases are closed in various circumstances, such as when the case results in no changes, the taxpayer appeals the case, or IRS officials refer the case to the collection unit to collect the outstanding tax liability. Thus, when audit cases are referred to either the appeals or collection unit, IRS considers that the audit has concluded, and the case is closed in its Examination Division. However, as IRS opens a new case in either its appeals or collection unit, a taxpayer may perceive this as simply a continuation of the audit. Page 12 GAO/GGD-99-133 Small Business Tax Requirements B-281009 Table 4: Average Length of Small a Business Audits Duration Average length Less than 6 6-12 More than Type of business (in days) months months 12 months Sole proprietorship 273 45.7% 32.5% 21.7% Farm 221 69.1 17.1 13.8 b d Partnership 754 30.1 16.9 52.9 c d S corporation 308 44.2 28.7 27.1 Corporation 335 45.8 27.2 27.0 Average for all businesses 288 46.2 31.0 22.8 Note: Excludes audits recorded in IRS’ database merely because a business was partially or totally owned by a large business subject to IRS’ Coordinated Examination Program, in which IRS conducts lengthy audits of the very largest corporations. a Total percent for some business categories does not equal 100 due to rounding. b Includes all partnerships because IRS’ AIMS database does not differentiate partnerships with less than $5 million in assets. c Includes S corporations with less than $10 million in assets because IRS’ AIMS database does not differentiate S corporations with less than $5 million in assets. d According to IRS, partnership and S corporation audits assigned to service centers remain open in the AIMS database even after they are appealed. Excluding service center audits reduces the average length of partnership audits to 472 days, with 41.8 percent lasting more than 12 months, and S corporation audits to 289 days, with 25.5 percent lasting more than 12 months. Source: GAO analysis of IRS’ AIMS data. As shown in the table, on average, the audits lasted less than 1 year, and nearly half closed in less than 6 months. Still, some audits—especially those of partnerships—lasted much longer. For example, more than half of the audits of partnerships lasted more than 1 year, as did nearly 30 percent of those for S corporations and corporations. Also, although not shown in the table, 16 percent of partnership audits and from 1 to 3 percent of the 20 audits for other types of small businesses continued beyond 4 years. According to IRS’ Examination Division officials, a variety of factors can lengthen the time it takes to complete a business audit. Examples cited included (1) difficulties in scheduling appointments with taxpayers, (2) the time required for a taxpayer to assemble needed information, and (3) the fact that some audits involve highly complex business tax issues requiring extensive research and investigation. With respect to audits of partnerships in particular, the officials said that the audits tend to take longer because IRS must secure and examine each partner’s return in addition to the partnership return. An audit of a partnership’s return remains open as long as any partner is in disagreement with any audit 21 issue. Also, audits of partnerships often require special procedures and 20 With certain exceptions, an assessment must be made within 3 years after a return has been filed. 21 Under IRC section 6229, special rules apply to the period of limitations on the assessment of partnership items. Page 13 GAO/GGD-99-133 Small Business Tax Requirements B-281009 analyses, such as reviewing the linkages between the returns filed by the partnership and each of the partners and checking the application of complex tax laws affecting partnerships in some circumstances. Recommended Additional Taxes Small business audits often result in recommendations for the assessment and Penalties of additional taxes and penalties. For the small business audits closed in 1995, 67 percent resulted in a recommended change to the reported tax liability or refundable credits, while about 33 percent resulted in no such changes. Some audits resulting in no change to the reported tax liability did result in changes to other return items deemed significant by IRS examiners. For example, net loss, which can be carried forward and claimed in future years, may have been overstated on the return and adjusted by IRS. Table 5 provides more detailed information on IRS examiners’ recommendations on audits closed in 1995. In considering the information presented, it is important to note that the audit recommendations do not equate to final audit outcomes. For example, recommendations may be partially or fully overturned in IRS appeals or in court decisions. Table 5: Audit Recommendations for Small Business Audits Audits recommending Audits recommending change no change Type of Total Additional taxes No a b business audits and penalties Refund Adjustment adjustment Sole proprietorship 298,609 63.8% 4.4% 15.7% 16.1% Farmer 13,381 59.0 6.7 10.3 23.9 Corporation 35,011 52.4 5.8 17.0 24.8 All businesses 347,001 62.4 4.6 15.6 17.3 Note: For audits closed in 1995. a Partnerships and S corporations were excluded because audit results generally pass through to the individual business owners. b Includes audits that resulted in adjustments not affecting the taxpayer’s liability for the current year, such as adjustments to reported net losses. Also includes delinquent returns secured by IRS auditors where reported tax liability was considered accurate. Source: GAO analysis of IRS’ AIMS data. IRS’ 1995 data show that small businesses appealed to IRS or filed court petitions in 8 percent of the audits where it recommended additional tax and penalties. Table 6 provides more detailed information on audits that were appealed and petitioned by each small business category. According to IRS Appeals officials, the lower appeals rates for sole proprietorships and farms may reflect the fact that their returns generally involve less complex tax issues, which leads to fewer potential tax Page 14 GAO/GGD-99-133 Small Business Tax Requirements B-281009 disagreements. Similarly, the officials attribute the much higher appeals rate for partnerships to the complexity of the tax laws affecting partnerships and their returns. Table 6: Number of Small Business Audits Appealed or Petitioned to the Audit appeals and petitions Courts As percent of audits As percent of recommending additional a Type of business Number total audits taxes and penalties Sole proprietorship 11,739 3.9 6.2 Farm 557 4.2 7.1 b Partnership 1,031 14.6 31.7 c S Corporation 1249 7.2 15.7 Corporation 3,615 10.3 19.9 All businesses 18,216 4.9 8.0 Note: For audits closed in 1995. a Limited to appeals of audits that recommended additional taxes and penalties. b Includes all partnerships because IRS’ AIMS database does not differentiate partnerships with less than $5 million in assets. c Includes S corporations with less than $10 million in assets because IRS’ AIMS database does not differentiate S corporations with less than $5 million in assets. Source: GAO analysis of IRS’ AIMS data. Collections IRS’ collection process starts at the point IRS identifies a taxpayer as not 22 having paid the amount of tax due as determined by the tax assessment. First, IRS is to send a notice (or series of notices) to the taxpayers 23 informing them of the amount owed. If the amount is not paid, IRS is authorized to employ enforcement powers to collect what is owed. IRS can refer the delinquency to an automated collection system call site, where an employee calls the taxpayer by telephone and asks for payment. The payment arrangements may include installment agreements or an offer-in-compromise from the taxpayers if the full amount owed cannot be paid. Information about large and chronic tax delinquencies can be referred directly to one of IRS’ 33 district offices, where IRS revenue officers may contact the taxpayer in person. According to IRS officials, small business audits that involve employment taxes are often referred directly to district offices. In addition to liens and levies, IRS collection officials have 22 As we have reported, IRS has had difficulty collecting assessments from many taxpayers, including small businesses. (See GAO/GGD-98-128, June 23, 1998.) 23 Collectively, these notices are to provide the taxpayer with statutory notification of the tax liability, IRS’ intent to levy assets if necessary, and information on the taxpayer’s rights. Page 15 GAO/GGD-99-133 Small Business Tax Requirements B-281009 authority to seize and sell taxpayers’ property, such as cars or real estate. Seizure is generally a last resort to get payment of the amount owed, and the IRS Restructuring and Reform Act now requires a district director’s approval. IRS could not provide information on the number of small businesses undergoing enforced collection actions (i.e., liens, levies, or seizures). However, recent IRS information shows that enforced collections, in general, have declined dramatically since 1997. For example, in fiscal year 1997, IRS made about 10,000 seizures compared to about 2,300 in fiscal year 1998, and fewer than 200 in fiscal year 1999. We requested comments on a draft of this report from the Commissioner Agency Comments of Internal Revenue. On July 23, 1999, we received IRS’ written comments, which discuss IRS’ plans and actions to assist small businesses with their filing and reporting burdens. The comments are reprinted in appendix IV. We also met with IRS officials, including the Deputy National Director of the Public Liaison and Small Business Affairs Office and the Assistant Commissioner for Forms and Submission Processing, to discuss their technical comments, which we incorporated where appropriate. We are sending copies of this report to Senator John Kerry, Ranking Minority Member of your Committee; Senator William V. Roth, Jr., Chairman, and Senator Daniel P. Moynihan, Ranking Minority Member, Senate Committee on Finance, and Representative Bill Archer, Chairman, and Representative Charles B. Rangel, Ranking Minority Member, House Committee on Ways and Means. Copies will also be sent to the Honorable Lawrence H. Summers, Secretary of the Treasury; the Honorable Charles O. Rossotti, Commissioner of Internal Revenue; and the Honorable Jacob Lew, Director, Office of Management and Budget. Copies will be made available to others upon request. Page 16 GAO/GGD-99-133 Small Business Tax Requirements B-281009 If you or your staff have any questions concerning this report, please contact me or Charlie W. Daniel on (202) 512-9110. Key contributors to this report were Robert Floren and Daniel Lynch. Sincerely yours, Margaret T. Wrightson Associate Director, Tax Policy and Administration Issues Page 17 GAO/GGD-99-133 Small Business Tax Requirements Contents Letter 1 Appendix I 20 IRS’ Information Systems Limit Availability of Data on Small Businesses Appendix II 23 Tax Requirements That Potentially Apply to Small Businesses Appendix III 35 Simplified Audit and Dispute Resolution Processes Appendix IV 38 Comments From the Internal Revenue Service Tables Table 1: Primary Income Tax Returns and Mandatory 5 Schedules Table 2: Key Employment Tax Requirements 6 Table 3: Audit Rates Across Small Business Types 12 Table 4: Average Length of Small Business Audits 13 Table 5: Audit Recommendations for Small Business 14 Audits Table 6: Number of Small Business Audits Appealed or 15 Petitioned to the Courts Table II.1: Layer One–Primary Income Tax Returns and 23 Related Schedules Table II.2: Layer Two–Employment Tax Requirements 25 Page 18 GAO/GGD-99-133 Small Business Tax Requirements Contents Table II.3: Layer Three–Employee Benefit Plan 26 Requirements Table II.4: Layer Four–Requirements That Depend on 27 Business Operations Table II.5: Layer Four–Excise Tax Requirements 32 Administered by IRS Table II.6: Layer Four–Excise Taxes Administered by 33 ATF Figures Figure III.1: Simplified Audit and Dispute Resolution 36 Processes 37 Abbreviations AIMS Audit Information Management System ATF Bureau of Alcohol, Tobacco, and Firearms EFTPS Electronic Federal Tax Payment System FICA Federal Insurance Compensation Act FUTA Federal Unemployment Tax Act IRC Internal Revenue Code IRS Internal Revenue Service SEP simplified employee pensions SIMPLE savings incentive match plans for employees Page 19 GAO/GGD-99-133 Small Business Tax Requirements Appendix I IRS’ Information Systems Limit Availability of Data on Small Businesses In general, the Internal Revenue Service’s (IRS) numerous information systems do not collect or store information by taxpayer groups, such as small businesses. Rather, IRS’ current data systems reflect the agency’s stovepipe structure and transaction-based business approach. Even if IRS’ information systems maintained data by taxpayer groups, obtaining complete account information for a taxpayer would not be easy because IRS’ systems are not linked together. Historically, IRS has operated through functions, such as Examination or Collection, and information about taxpayers tended to be developed to serve each function’s specific needs and its specific interactions with taxpayers rather than IRS’ overall needs or taxpayers’ needs. As a result, IRS’ various and discrete databases provide information pertaining to certain transactions, such as seizures or the filing of income tax returns. The structure of IRS’ information systems does not easily allow for a complete assessment of a small business taxpayer’s interactions—from filing to postfiling—with IRS. IRS maintains information about taxpayers’ filing and compliance histories in masterfile accounts, currently housed in Martinsburg, WV. The majority of the information about taxpayers’ filing and compliance histories is stored in two masterfiles—the individual masterfile and the business masterfile. Neither of these files is coded to distinguish small businesses from other taxpayers. To further complicate matters, data on filings and payments by small businesses may be divided between the individual and business masterfile. Data from Schedule C (sole proprietorship), Schedule E (partnership and S corporation shareholder), and Schedule F (farmer) are posted to the individual masterfile. Data from Schedule 1120 for corporations, including S corporations, are posted to the business masterfile. In addition, all employment and excise tax data are posted to the business masterfile. As a result, certain small businesses may have data on both masterfiles. A similar situation exists with postfiling data, such as that pertaining to examination and collection activities. The data are scattered across numerous information systems and are not coded to distinguish small businesses from other taxpayers. The business masterfile accounts are especially complicated, having multiple reporting requirements and being more difficult for IRS to maintain without error or to use to access data. Also, the information on the masterfiles is not complete because other databases may have other related information. For example, income received about the business from a bank or other payer that has been reported to IRS on an information return is not included in the masterfiles. Page 20 GAO/GGD-99-133 Small Business Tax Requirements Appendix I IRS’ Information Systems Limit Availability of Data on Small Businesses Further, IRS updates the masterfiles weekly, after the transactions have taken place. Most of IRS’ compliance systems (e.g., Collection) operate off uploads and downloads of selected taxpayer account information on the masterfiles. These systems are used on-line by IRS employees to assist taxpayers or assess their compliance. But the account information on the systems is limited to the intended purpose, and updates are not reflected until the masterfiles are updated on weekends. The limitations in IRS’ information systems prevented us from fully determining the extent to which small businesses actually filed various required forms and schedules and made deposits. The limitations also prevented us from fully determining the extent of small businesses’ involvement in IRS’ enforcement processes. Many of the IRS databases do not allow for a detailed analysis of the information they contain. We were unable to separate out the four types of small businesses in some of the databases. For example, the Form 941 that employers are to use to file their employment taxes does not have information on business assets or gross receipts that would have allowed us to categorize employers by size. Without this information, our alternative was to use information from the business masterfile. Accessing the appropriate tax module in that file might have made it possible to capture information on assets. However, extracting masterfile data is a time- and resource-intensive undertaking that is prone to errors and data reliability problems. It involves requesting IRS’ Information Services to provide an extract from various masterfiles, working with the files to validate them, and then merging the data into one that would be suitable for analysis. IRS receives many internal and external requests for data, and each request must await its turn in the queue. IRS’ resources are limited, and the request could have taken many months for the agency to complete. Thus, we decided not to ask IRS to make the extractions for us. Some of the information we sought was not readily available from IRS’ compliance databases. For example, IRS’ Audit Information Management System (AIMS) database does not identify some small business taxpayers or adequately distinguish small businesses from other businesses. Because AIMS does not include the asset size of partnerships or S corporations, it cannot distinguish between small and other partnerships or S corporations. AIMS does, however, include asset data for sole proprietorships and corporations. Page 21 GAO/GGD-99-133 Small Business Tax Requirements Appendix I IRS’ Information Systems Limit Availability of Data on Small Businesses IRS’ audits do not include all taxpayer contacts that can result in recommended assessments of additional tax. In particular, notices resulting from IRS’ information matching math-error programs are generally not counted as audits, according to IRS officials. In 1997, IRS’ information matching program generated about 2.8 million notices, resulting in assessments totaling about $1.5 billion. We could not identify any readily available data on the proportion of these assessments directed at small businesses. IRS is taking interim steps to address some of its data problems. IRS expects to develop a way of linking a customer identifier to the case information in 35 of its most important information systems. When this “workaround” is complete, IRS managers and frontline workers should know whether the return or information report data they might be using are for a small sole proprietor, partnership, S corporation, or corporation. However, the interim solution will not provide real-time information about the full range of transactions currently ongoing for a particular taxpayer. Neither will the interim solution link IRS’ systems to provide comprehensive information about taxpayers’ interactions with the agency. IRS has acknowledged that its systems limitations hinder its ability to effectively manage its activities and serve small businesses and plans to continue making information systems improvements as part of its ongoing modernization and restructuring efforts. Page 22 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses Table II.1: Layer One–Primary Income Tax Returns and Related Schedules Frequency Type of (annually unless a business Tax form otherwise noted) Explanation Sole Form 1040, U.S. Individual Income Tax If reporting income from a sole proprietorship (or other proprietorship Return individual income) Schedule C, Profit or Loss from a If incurred profit or loss as owner of a sole proprietorship Business (Sole Proprietor) Schedule C-EZ, Net Profit from Business If expenses are $2,500 or less, may use Schedule C-EZ as alternative to Schedule C Form 1040 E, Estimated Tax for Quarterly If income and self-employment taxes expected to be Individuals $1,000 or more and withholding and credits are expected to be less than the smaller of 90 percent of the tax on the current year return or 100 percent of the tax shown on return for the previous year. Form 2210, Underpayment of Estimated If estimated tax filer wants to perform their own penalty Tax by Individuals, Estates, and Trusts calculations instead of allowing IRS to make the calculations for them Farmer Form 1040, U.S. Individual Income Tax If reporting income from a farm as an individual taxpayer Return Form 1065, U.S. Partnership Return of If reporting income from a farm and organized as a Income partnership Schedule F, Profit or Loss from Farming If incurred farm income or expenses Schedule J, Farm Income Averaging If electing to figure tax liability by averaging income over past 3 years Form 990C, Farmers' Cooperative If a farmers' associations operated on a cooperative Association Income Tax Return basis Form 1040 ES, Estimated Tax for Quarterly See explanation above. Qualified farmers pay annually; Individuals nonqualified farmers pay quarterly. Form 2210F, Underpayment of Estimated If farmers or fishermen want to perform their own penalty Tax by Farmers and Fisherman calculations for estimated tax instead of allowing IRS to make the calculations for them Partnership Form 1065, U.S. Partnership Return If organized as a partnership, unless received no income (information return) and incurred no expenses treated as deductions or credits for federal income tax purposes Schedule K-1, (form 1065) Partner’s If organized as a partnership with income or deductions; Share of Income, Credits, Deductions copy filed with IRS for each partner etc. Partner Form 1040, U.S. Individual Income Tax See explanation above Return Schedule E, Supplemental Income and If a partner in a partnership (even if no income received) Loss (part II) to report share of partnership income or loss Form 1040 ES, Estimated Tax for Quarterly See explanation above Individuals Form 2210, Underpayment of Estimated See explanation above Tax by Individuals, Estates, and Trusts S corporation Form 1120S, U.S. Income Tax Return for If elected to be an S corporation to report income, gains, an S Corporation losses, etc. (continued) Page 23 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses Frequency Type of (annually unless a business Tax form otherwise noted) Explanation S corporation Schedule K-1 (form 1120S), If an S corporation, copy filed with IRS for each Shareholder's Share of Income, Credits, shareholder Deductions Estimated Tax, Form 8109, Tax Deposit Quarterly If tax expected to be $500 or more for certain specified Coupon or EFTPS taxes Shareholder Form 1040, U.S. Individual Income Tax See explanation above Return Schedule E, Supplemental Income and If a shareholder in an S corporation (even if no income Loss (part II) received) to report share of S corporation income or losses Form 1040 ES, Estimated Tax for Quarterly See explanation above Individuals Form 2210, Underpayment of Estimated See explanation above Tax by Individuals, Estates, and Trusts Corporation Form 1120, U.S. Corporation Income Tax If a domestic corporation, regardless of taxable income, Return unless meeting requirements for specialized forms or exempt under section 501 Form 1120-A, U.S. Corporation Short If gross receipts, total income, and total assets each Form Income Tax Return under $500,000 and certain other requirements met Estimated Tax, Form 8109, Tax Deposit Quarterly If income tax expected to be $500 or more Coupon or EFTPS Form 2220, Underpayment of Estimated If corporation is using annualized income installment Tax by Corporations method or adjusted seasonal installment method or a large corporation figuring first required installment based on prior year’s tax Other Form 1120-H, Income Tax Return for If a qualified homeowners association and form 1120-H corporation Homeowners Associations (attach to yields lower tax than form 1120 returns 1120) Form 1120-IC-DISC, Interest Charge If at least 95 percent of gross receipts during the tax year Domestic International Sales Corporation are qualified export receipts and certain other Return (also must file three Schedules– requirements met K, P, and Q, form 1120-IC-DISC) Form 1120-L, U.S. Life Insurance If a domestic life insurance company (or a foreign Company Income Tax Return corporation that would qualify as a life insurance company if it were a U.S. corporation) Form 1120-PC, U.S. Property and If a domestic nonlife insurance company (or a foreign Casualty Insurance Company Income corporation that would qualify as a nonlife insurance Tax Return company if it were a U.S. corporation) Form 1120-REIT, U.S. Income Tax If a corporation, trust or association meeting specified Return for Real Estate Investment Trusts conditions and electing to be treated as a Real Estate Investment Trust Form 1120-RIC, U.S. Income Tax Return If a domestic corporation that elects to be treated as an for Regulated Investment Companies Regulated Investment Company Form 1120-SF, U.S. Income Tax Return If structured as a section 468B designated and qualified for Settlement Funds settlement fund a We did not count schedules that are embedded in a primary return as separate requirements. Source: GAO compilation of IRS information. Page 24 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses Table II.2: Layer Two–Employment Tax Requirements Type of tax Tax form Frequency Explanation Withheld Form 941, Employer's Quarterly Federal Tax Quarterly If business has employees they are to report income Return withheld taxes and FICA Schedule B (form 941), Employer's Record As required: quarterly, If business has employees of Federal Tax Liability (attach to 941) monthly, semiweekly Form 941C, Supporting Statement to Correct As needed to correct If business has employees Information withholding errors from prior quarters Form 941–M, Employer's Monthly Federal Monthly If business has employees Tax Return Deposit (form 941 payments), by mail using Quarterly if liability < If business has employees and withholds taxes. Form 8109, Federal Tax Deposit Coupon, or $1,000 per quarter; Electronic deposit if annual liability greater than by EFTPS monthly if < $50,000 $50,000 a in lookback period; semiweekly if > $50,000 in lookback period; or next day if > $100,000 undeposited Form 943, Employer’s Annual Tax Return for Annually If withheld income and employment taxes on Agricultural Employees wages paid to agricultural employees Deposit (form 943 payments), by mail Annually if liability < Same as above using Form 8109, Federal Tax Deposit $1000 for the year; Coupon, or by EFTPS monthly if < $50,000 b in lookback period; semiweekly if > $50,000 in lookback period; next day if > $100,000 undeposited Form 945, Annual Return of Withheld Annually If income tax withheld from nonpayroll payments Federal Income Tax FUTA Form 940, Employer's Annual Federal Annually If business has employees and liability is greater Unemployment Tax Return than $100 in tax year Form 940EZ Annually If business has employees and if certain conditions are met for state unemployment taxes Deposit (Form 940 payments) Form 8109, Quarterly If liability greater than $100 in tax year Federal Tax Deposit Coupon or EFTPS Information Form W-2, Wages and Compensation Paid Annually If business has employees (must file on magnetic returns to Employees media if 250 or more Form W-2s) Form W–3, transmittal of W–2s Annually If business has employees (shows totals from Form W2s, same filing as W2) Self- Schedule SE, Self-Employment Tax Annually If received net earnings of $400 or more from self- employment employment a The Form 941 lookback period for 1999 covers four quarters, beginning July 1, 1997 and ending June 30, 1998. b The Form 943 lookback period is the second calendar year preceding the current calendar year. Source: GAO compilation of IRS information. Page 25 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses Table II.3: Layer Three–Employee Benefit Plan Requirements Tax form Frequency Explanation Form 5500, Annual Return/Report of Employee Annually If plan has 100 or more participants Benefit Plan Form 5500-EZ, Annual Return/Report of One- Annually If only one participant and certain other conditions met Participant Retirement Plan Form 5500-C/R, Annual Return/Report of Employee Annually If fewer than 100 participants Benefit Plan Schedule A (form 5500), Insurance Information Annually If any plan benefits provided by insurance company Schedule B (form 5500), Actuarial Information Annually If plan set up as "defined benefit" rather than "defined contribution" and subject to minimum funding standard Schedule C (form 5500), Service Provider and Annually If compensation paid to any trustee or others providing services to Trustee Information the plan exceeds a certain threshold, generally $5,000 per year Schedule E (form 5500), Employee Stock Ownership Annually If an employer with a pension benefit plan that contains ESOP Plan (ESOP) Annual Information benefits Schedule F (form 5500), Fringe Benefit Plan Annual Annually If an employer with a cafeteria plan, educational assistance Information Return program, or adoption assistance program Schedule G (form 5500), Financial Schedules Annually If filing form 5500 Schedule P (form 5500), Annual Return of Fiduciary Annually If a trustee of a trust created as part of an employee benefit plan of Employee Benefit Trust or a custodian of a custodial account Schedule SSA (form 5500), Annual Registration Annually If filing form 5500, to report participants with vested benefits who Statement Identifying Separated Participants With were separated from the company during the year Deferred Vested Benefits Source: GAO compilation of IRS information. Page 26 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses Table II.4: Layer Four–Requirements That Depend on Business Operations Frequency Form (annually unless applicability Tax form otherwise noted) Explanation Potentially any Schedule D, Capital Gains and Losses If business sold or exchanged capital assets business Form 1116, Foreign Tax Credit If filing as an individual, estate, or trust and paid certain foreign taxes to a foreign country or U.S. possession Form 3468, Investment Credit If claiming investment in building rehabilitation, alternative energy, or reforestation Form 3800, General Business Credit If more than one type business credit claimed Form 4255, Recapture of Investment Credit If required to refigure investment credit (e.g., when investment credit property sold) Form 4562, Depreciation and Amortization If depreciating, amortizing, or expensing certain business property Form 4684, Casualties and Thefts If deducting losses due to fire, storm, theft, or other casualty Form 4797, Sales of Business Property If sold or exchanged business property Form 4952, Investment Interest Expense If filing as an individual, estate, or trust and claiming Deduction deduction for investment interest expense Form 5884, Work Opportunity Credit If claiming the work opportunity credit for wages paid to targeted groups of employees Form 6198, At-Risk Limitations If incurred loss from specified "at risk activities" (e.g., farming, exploring for oil, others) Form 6251, AMT Individuals If tax on alternative minimum tax income is greater than tax reported on form 1040 Form 6252, Installment Sale Income If reporting income from casual sales (other than inventory) where payments received in a tax year after the year of sale Form 6478, Alcohol Used as Fuel Credit If claiming the credit for alcohol used as fuel Form 6765, Increasing Research Credit If claiming the credit for increasing research activities Form 6781, Gains and Losses from Section If claiming gains or losses from (1) section 1256 1256 Contracts and Straddles contracts under the marked-to-market rules (such as regulated futures contracts) or (2) straddles (offsetting positions that decrease the risk of loss) Form 8275, Disclosure Statement If disclosing items that are otherwise not adequately disclosed for the purpose of avoiding penalties Form 8275-R, Regulation Disclosure If disclosing positions taken on a tax return that are Statement contrary to Treasury regulations Form 8404, Interest Charge on DISC- If a shareholder in a Interest Charge Domestic Related Deferred Tax Liability International Sales Corporation and receiving deferred DISC income that increases taxable income Form 8582, Passive Activity Loss If reporting a net loss from "passive activities" (e.g., Limitations most real estate investments) Form 8586, Low Income Housing Credit If an owner of certain low-income housing projects and claiming credit Form 8594, Asset Acquisition Statement If bought or sold a trade or business and goodwill or going-concern value attaches or could attach to assets (continued) Page 27 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses Frequency Form (annually unless applicability Tax form otherwise noted) Explanation Potentially any Form 8609, Low-Income Housing Credit If obtaining a housing credit allocation in order to claim business Allocation Certification low-income housing credit Form 8697, Interest Computation under the If required to figure interest on certain long-term Look-Back Method for Completed Long- contracts under the "lookback" method of section term Contracts 460(b)(2) Form 8801, Credit for Prior Year Minimum If filing as individual, estate, or trust and claiming the Tax minimum tax credit for alternative minimum tax incurred in a prior year Form 8816, Special Loss Discount Account If an insurance company and electing an additional and Special Estimated Tax Payments for deduction under section 847 Insurance Companies Form 8817, Allocation of Patronage and If organized as a cooperative and reporting income or Nonpatronage Income and Deductions deductions from patronage or nonpatronage sources Form 8820, Orphan Drug Credit If claiming an orphan drug credit Form 8824, Like-kind Exchanges If exchanged business or investment property for property that is of a like kind Form 8826, Disabled Access Credit If an eligible small business (with not more than $1 million in gross receipts or 30 employees) and claiming the Disabled Access Credit Form 8830, Enhanced Oil Recovery Credit If claiming the enhanced oil recovery credit Form 8834, Qualified Electric Vehicle Credit If claiming the credit for a qualified electric vehicle placed in service during the tax year Form 8835, Renewable Electricity If claiming the renewable electricity production credit Production Credit Form 8844, Empowerment Zone If claiming the empowerment zone employment credit Employment Credit for qualified wages and other expenses paid or incurred on behalf of any qualified zone employee Form 8845, Indian Employment Credit If employed American Indian(s) meeting certain criteria Form 8846, Credit for Employer Social If claiming credit for Social Security and Medicare Security and Medicare Taxes Paid on taxes incurred on employees' tip income Certain Employee Tips Form 8847, Credit for Contributions to If claiming the credit for contributions to a selected Selected Community Development Corps Community Development Corporation Form 8850, Pre-Screening Notice and No later than 21 If an employer and claiming the Work Opportunity Certification Request for the Work days after job Credit or the Welfare-to-Work Credit Opportunity and Welfare-to-Work Credits applicant begins working Form 8861, Welfare-to-Work Credit If an employer and claiming the welfare-to-work credit for wages paid or incurred to long-term family assistance recipients Form 1096, Annual Summary and If certain information returns filed, including paper Transmittal of Information Returns forms 1099 Form 1098, Mortgage Interest Statement If business receives $600 or more in mortgage interest from any person(s) Form 1099-A, Acquisition or Abandonment If acquired property as security for loan of Secured Property Form 1099-B, Proceeds from Broker or If business operates as a broker or barter exchange, it Barter Exchange Transactions must report proceeds from transactions (continued) Page 28 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses Frequency Form (annually unless applicability Tax form otherwise noted) Explanation Potentially any If certain financial institutions cancel debt of $600 or business Form 1099-C, Cancellation of Debt more Form 1099-DIV, Dividends and If paid dividends or made certain other distributions of Distributions stock Form 1099-INT, Interest Income If paid interest income exceeding specified amounts; also shows backup withholding Form 1099-LTC, Long-Term Care and If an insurance company or other payer of long-term Accelerated Death Benefits care benefits Form 1099-MISC, Miscellaneous Income If made certain payments in the course of a trade or business, e.g., payments to independent contractors Form 1099-MSA, Distributions From If made distributions from employees’ medical savings Medical Savings Accounts accounts Form 1099-OID, Original Issue Discount If issued debt instrument with $10 or more of original issue discount Form 1099-PATR, Taxable Distributions If a consumer cooperative and issued patronage Received From Cooperatives dividends of $10 or more Form 1099-R, Distributions From Pensions, If business distributed $10 or more from retirement or Annuities, Profit Sharing and Retirement profit-sharing plan Plans, etc. Form 1099-S, Proceeds From Real Estate If received proceeds from the sale or exchange of real Transactions estate Form 4789, Currency Transaction Report No later than 15 If customer of financial institution enters transaction of days after $10,000 or more in currency transaction Form 5498, IRA Contribution Information If maintained IRAs for any person(s) Form 5498, MSA Information If maintained a medical savings account for any person(s) Form 8027, Employer's Annual Information If a food and beverage establishment with more than Return of Tip Income and Allocated Tips 10 employees who work a total of more than 8 business hours on a typical business day (and tipping is a customary practice) Form 8281, Information Return for Publicly Within 30 days of If issued publicly offered debt instrument having Offered Original Issue Discount Instruments issuance of OID original issue discount instrument Form 8282, Donee Information Return 125 days after If a donee organization that sells or otherwise disposes disposition of of certain charitable deduction property within 2 years charitable after the date of receipt property Form 8271, Investor Reporting of Tax If claiming a tax benefit or reporting income from a Shelter Registration Number "registration-required" tax shelter Form 8300, Report of Cash Payments Over No later than 15 If business received cash payment of $10,000 or more $10,000 Received in a Trade or Business days after in one transaction transaction Form 8329, Lender's Information Return for If made a loan that is a certified indebtedness amount Mortgage Credit Certificates on any mortgage credit certificate Form 8362, Currency Transaction Report Daily If a casino in the U.S. with annual gross gaming by Casinos revenues in excess of $1 million, to report currency transactions of $10,000 or more (continued) Page 29 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses Frequency Form (annually unless applicability Tax form otherwise noted) Explanation Potentially any Form 8703, Annual Certification of a business Residential Rental Project If operating a qualified residential rental project Form 8852, Currency Transaction Report 15th day after the If a Nevada casino with annual gross gaming revenue by Casinos–Nevada transaction of more than $10 million to report currency transactions of $10,000 or more Form 926, Return by a U.S. Transferor of Day of transfer If transferred property to a foreign corporation, estate, Property to a Foreign Corporation trust, or partnership Farmers Form 4835, Farm Rental Income and If a landowning farmer reporting farm rental income Expenses based on crops or livestock produced by tenant Partnerships Schedule D (Form 1065), Capital Gains If sale of capital assets allocated to partnership, not and S and Losses partners corporations Schedule D (Form 1120S), Capital Gains If sold or exchanged capital assets and to report gains and Losses and Built-in Gain on distributions to shareholders of appreciated capital assets; also used to report any built in gains tax Form 8308, Report of a Sale or Exchange If sold or exchanged a partner's interest in a section of Certain Partnership Interests 751a exchange Form 8621, Return by a Shareholder of a If an owner or shareholder of a passive foreign Passive Foreign Investment Company or investment company Qualified Electing Fund Form 8752, Required Payment or Refund If elected to have an alternate tax year Under Section 7519 Form 8825, Rental Real Estate Income and If business had income or deductible expenses from Expenses of a Partnership or an S rental real estate activities Corporation Partners and Form 4952, Investment Interest Expense If a partner or other individual, estate or trust claiming shareholders Deduction a deduction for investment interest expense, unless certain conditions apply Form 8082, Notice of Inconsistent If items treated differently on schedule E and form Treatment or Administrative Adjustment 1065 or form 1120S Request Corporations Schedule D (Form 1120), Capital Gains If sold or exchanged capital assets and have gains on and Losses distributions to shareholders of appreciated capital assets Schedule H (form 1120), Section 280H If a personal service corporation did not meet certain Limitations for a Personal Service distribution requirements Corporation Schedule PH (form 1120), U.S. Personal If a personal holding company Holding Company Tax Form 1118, Foreign Tax Credit (form 1120); If electing to claim the foreign tax credit; separate (attached to form 1118 are Schedule I, forms 1118 must be filed for each of nine limitation Reduction of Oil and Gas Extraction Taxes categories that apply and Schedule J, Separate Limitation Loss Allocations) Form 2438, Undistributed Capital Gains If a Regulated Investment Company or Real Estate (attach to form 1120-RIC or 1120-REIT) Investment Trust and had undistributed capital gains (continued) Page 30 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses Frequency Form (annually unless applicability Tax form otherwise noted) Explanation Corporations If taxable income or loss before the net operating loss Form 4626, Alternative Minimum Tax: deduction, plus adjustments and preferences, totals Corporations (file with form 1120) more than $40,000 Form 5735, Possessions Corporation Tax If a domestic corporation engaged in a trade or Credit business within a U.S. possession on Oct. 13, 1995 and elected the benefits of the possessions credit Form 8810, Corporate Passive Activity If a personal service corporation or closely held Loss and Credit Limitations corporation with losses or credits from passive activities Form 8827, Credit for Prior Minimum Tax If incurred an AMT liability in previous year and meet (file with form 1120) certain criteria Form 8860, Qualified Zone Academy Bond If a bank, insurance company, or other corporation that Credit lends money and an eligible holder of qualified zone academy bonds Form 5452, Corporate Report of If made nondividend distributions to shareholders Nondividend Distributions Form 5472, Information Return of a 25% If had a reportable transaction with a foreign or Foreign-Owned U.S. Corporation or a domestic related party foreign corporation engaged in a U.S. trade or business Form 8842, Election to Use Different If electing to use an annualization option under the Annualization Periods for Corporate annualized income installment method to figure Estimated Tax estimated tax payments Form W-2G, Certain Gambling Winnings If business paid out reportable gambling winnings Source: GAO compilation of IRS information. Page 31 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses Table II.5: Layer Four–Excise Tax Requirements Administered by IRS Tax form Frequency Explanation Form 637, Application for Registration As needed If engaging in activities with excise taxes, entity must register Form 720, Quarterly Federal Excise Tax Return Quarterly If engaging in activities with excise taxes; Form 720 covers most excise taxes (environmental, communications, air transport, fuel, retail, luxury, manufacturing, foreign insurance) Form 11-C, Occupational Tax and Registration Annually If principal operator or employee-agent of businesses that accept Return for Wagering wagers Form 730, Tax on Wagering Monthly for the If involved in the business of accepting wagers or conducting periods reporting wagering pools or lotteries taxable wagers Form 1363, Export Exemption Certificate As needed If exporting property by continuous movement must file to claim exemption from the tax on transportation of property by air Form 2290, Heavy Vehicle Use Tax Return Annually (unless Any entity with a taxable highway motor vehicle, vehicles greater used for a partial than 55,000 pounds year) Form 4136, Credit for Federal Tax Paid on Fuels Annually If claiming the credit for federal excise tax paid on fuels; generally partnerships cannot file this form Form 5330, Return of Excise Taxes Related to Annually If there were nondeductible contributions or prohibited Employee Benefit Plans transactions or failure to meet certain other employee benefit plan requirements Form 6197, Gas Guzzler Tax (attach to form 720) Quarterly as If manufacturer and importers (including individuals) that sell or needed use automobiles that do not meet fuel economy standards Form 6627, Environmental Taxes (attach to Form Quarterly as If manufacturers or importer of ozone-depleting chemicals 720) needed (ODCs) and entities that hold for sale or sell those products Form 8849, Claim for Refund of Excise Taxes As needed If business paid excise taxes Source: GAO compilation of IRS information. Page 32 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses Table II.6: Layer Four–Excise Taxes Administered by ATF a Form number Title F 5000.19 Tax Information Authorization F 5000.24 Excise Tax Return F 5000.25 Excise Tax Return–Alcohol and Tobacco (Puerto Rico) F 5000.25A Excise Tax Return–Alcohol and Tobacco (Puerto Rico) F 5100.12 Specific Transportation Bond-Distilled Spirits or Wines Withdrawn for Transportation to Manufacturing Bonded Warehouse–Class Six F 5100.25 Specific Export Bond–Distilled Spirits or Wine F 5110.31 Application and Permit to Ship Puerto Rico Spirits to the United States Without Payment of Tax F 5120.20 Certification of Tax Determination–Wine F 5120.24 Drawback on Wine Exported F 5130.6 Drawback on Beer Exported F 5130.12 Beer for Exportation F 5170.7 Application and Permit to Ship Liquors and Articles of Puerto Rico Manufacture Tax Paid to the United States F 5200.17 Bond, Drawback of Tax on Tobacco Products, Cigarette Papers,or Tubes F 5210.5 Monthly Report – Manufacturer of Tobacco Products F 5210.8 Computation of Tax Agreement to Pay Tax on Puerto Rican Cigars or Cigarettes F 5210.9 Inventory–Manufacturer of Tobacco Products F 5300.27 Federal Firearms and Ammunition Excise Tax Deposit F 5620.7 Claim for Drawback of Tax on Tobacco Products, Cigarette Papers, or Cigarette Tubes F 5620.8 Claim–Alcohol, Tobacco, and Firearms Taxes F 5630.5 Special Tax Registration and Return (Alcohol and Tobacco) F 5320.4 Application for Tax Paid transfer and Registration of a Firearm F 5320.5 Application for Tax-Exempt Transfer and Registration of a Firearm F 1610.2 Special Occupational Tax Printing Request F 5100.30 Continuing Export Bond–Distilled Spirits and Wine F 5110.67 Continuing Transportation Bond Distilled Spirits Or Wines Withdrawn for Transportation to Manufacturing Bonded Warehouse –Class Six F 5110.68 Drawback Bond–Distilled Spirits and Wine F 5130.16 Tax Deferral Bond–Beer (Puerto Rico) F 5200.9 Certification of Prepayment of Tax on Puerto Rico Cigars, Cigarettes, Cigarette Papers, or Cigarette Tubes Report of Multiple Sales or Other Disposition of Pistols and Revolvers F 5300.9 Firearms Transaction Record Part I–Over-the-Counter F 5300.24 Firearms Transaction Record Part I–Low Volume–Over-the-Counter F 5300.9 Firearms Transaction Record Part I–Intra-State Over-the-Counter (English-Spanish) F 5300.9 Firearms Transaction Record Part II–Non-Over-the-Counter F 5300.9 Firearms Transaction Record Part II–Low Volumne–Intra-State Non-Over-the-Counter F 5000.28 Floor Stocks Tax Return F 5000.28T 1993 Floor Stocks Tax Return (Cigarettes) F 5100.4 Certificate of Taxpaid Alcohol F 5110.3 Drawback on Distilled Spirits Exported F 5110.5 Tax Deferred Bond–Distilled Spirits F 5200.23 Floor Stocks Tax Return–Pipe Tobacco F 5300.26 Federal Firearms and Ammunition Excise Tax Return F 5300.28 Application for Registration for Tax Free Transactions Under 26 USC 4221 (Firearms and Ammunition) F 55600.8 Statement of Adjustment to the Puerto Rico or Virgin Islands Tax Account (continued) Page 33 GAO/GGD-99-133 Small Business Tax Requirements Appendix II Tax Requirements That Potentially Apply to Small Businesses a Form number Title F 5600.26 Tax Collection Waiver F5600.33 Certification of Ultimate Vendor for Use in Tax Refund Claim Under Section 6416 (b) (2) of the Internal Revenue Code (27 CFR 53.179 (b) (iii)) F 5600.34 Purchaser’s Certificate of Tax-Free Purchase for Use as Supplies for Vessels and Aircraft (27 CFR 53.134 (d) (2)) F 5600.35 Purchaser’s Certificate of Tax-Free Purchase for State or Local Government Use (27 CFR 53.135 (c) (1)) F 5600.36 Vendor’s Certificate of Tax-Free Purchase for Resale for Export (27 CFR 53.133 (d) (2)) F 5600.37 Vendor’s Certificate of Tax-Free Purchase for Resale for Further Manufacture (27 CFR 53.132 (c) (2)) F 5600.38 Application for Extension of Time for Payment of Excise Tax F 5610.6 Consent to Extend the Time to Assess ATF Excise Tax F 5630.5R Special Tax “Renewal” Registration and Return F 5630.5RC Special Tax Location Registration Listing F 5630.6A Special Tax Stamp F 5630.7 Special Tax Registration and Return National Firearms Act (NFA) F 5632.1 Special Occupational Tax Inquiry Letter F 5640.5 IRC Guideline/Worksheet for Late Excise Payment/Deposit or Tax Return F 5150.35 Bond for Spirits or Distilled Spirits or Rum Brought Into the US Free of Tax (used by Virgin Islands) F 5150.36 Bond for Articles Brought Into the U.S. Free of Tax (used by Virgin Islands) a We did not compile information regarding the applicability or frequency of ATF excise tax requirements. Source: GAO compilation of IRS information. Page 34 GAO/GGD-99-133 Small Business Tax Requirements Appendix III Simplified Audit and Dispute Resolution Processes This appendix illustrates a simplified process for auditing tax returns, resolving disputed taxes, and collecting taxes owed. For the small percentage of returns that are audited, most tax issues are resolved during the audit process. However, some audited taxpayers dispute their additional taxes to Appeals, and a few seek to resolve their disputes with IRS in the courts. Page 35 GAO/GGD-99-133 Small Business Tax Requirements Appendix III Simplified Audit and Dispute Resolution Processes Figure III.1: Simplified Audit and Dispute Resolution Processes Page 36 GAO/GGD-99-133 Small Business Tax Requirements Appendix III Simplified Audit and Dispute Resolution Processes Page 37 GAO/GGD-99-133 Small Business Tax Requirements Appendix IV Comments From the Internal Revenue Service Page 38 GAO/GGD-99-133 Small Business Tax Requirements Appendix IV Comments From the Internal Revenue Service Page 39 GAO/GGD-99-133 Small Business Tax Requirements Page 40 GAO/GGD-99-133 Small Business Tax Requirements Ordering Information The first copy of each GAO report and testimony is free. Additional copies are $2 each. Orders should be sent to the following address, accompanied by a check or money order made out to the Superintendent of Documents, when necessary. VISA and MasterCard credit cards are accepted, also. 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Tax Administration: Tax Requirements of Small Businesses
Published by the Government Accountability Office on 1999-08-24.
Below is a raw (and likely hideous) rendition of the original report. (PDF)