As a follow-up to its broader “Tax Gap” study completed earlier this year, the IRS yesterday announced it will engage in a multi-year study of about 5000 taxpayers reporting S corporation income or losses. According to the IRS release (see below), the study “will be used to more accurately gauge the extent to which the income, deductions and credits from S corporations are properly reported on returns filed by the flow through corporations and their shareholders.”

The S Corporation Alliance strongly supports appropriate IRS administration of the tax code, but numerous questions arise from the IRS’s announcement, including why the IRS chose to focus solely on S corporations, rather than all business types: C corporations, LLCs and other partnerships, and sole proprietorships. We’ll provide more information as it becomes available.

HILL MEETING UPDATE

Over the past two weeks, we’ve met with tax counsels for Senate Majority Leader Frist and Senators Lott and Lincoln. All three indicated that timing on a Senate Finance Committee Social Security reform proposal is still uncertain, but that it is helpful that we are out there educating staff about the harmful nature of the tax increase proposal. There seems to be a consistent refrain that this issue is very much alive (witness the new IRS study) and an ongoing focus of the tax writers.

TREASURY NOMINEES QUESTIONED

Remember the Treasury Inspector General for Tax Policy’s recommendation to greatly and unfairly increase the application of payroll taxes on S corporation income, regardless of whether the income is due to capital investment or evenly distributed. Senator Lincoln, a long-time friend to small and family-owned businesses, has helpfully submitted questions to pending Treasury nominees, asking them if this is indeed the position of President Bush’s Department of Treasury.  Eagerly anticipated answer to follow…

S CORPORATION ALLIANCE LETTER UPDATE

The S Corporation Alliance is still working to get additional signatures on our letter opposing the proposed payroll tax increase on S Corporations. We are currently at 38 signatures but there is always room for a couple more. Keep up the good work and keep those names coming!

TAX REFORM PANEL HOSTS 10th MEETING; DECISIONS REVEALED

The President’s tax reform panel met last week to make some baseline decisions in anticipation of their September 30th report deadline. According to the documents released during the meeting, Chairman Mack has divided his panel into four separate working groups, each tackling the tax code from a different perspective:

  • Complete replacement of the current tax code;
  • Partial replacement of the current tax code;
  • Fundamental reform of the current code;
  • and Major simplification and reform of the current tax code.

While Senator Mack suggested these titles don’t necessarily foreshadow the final recommendations of the panel, they certainly provide a strong clue where the panel is headed. Moreover, discussions during the panel meeting left the strong impression the panel, even with its more moderate reform recommendations, is considering consolidating business structures within the tax code into a single business type. Friends of S corporations, LLC’s, and sole proprietorships take note. The S Corp Association will continue to monitor the panel’s progress.

IRS Launches Study of S Corporation Reporting Compliance
IR-2005-76, July 25, 2005

WASHINGTON – Internal Revenue Service officials announced today the launch of a study to assess the reporting compliance of S corporations. The study, carried out under the National Research Program (NRP), will examine 5,000 randomly selected S corporation returns from tax years 2003 and 2004.

S corporations are entities whose income and deductions pass through the corporate structure to the shareholders. Since the mid-1980s, the number of S corporations has risen rapidly, growing from 724,749 in 1985 to 3,154,377 in 2002.

The growth rate has been even faster among S corporations with more than $10 million in assets. From 1985 to 2002, the number of these larger S corporations grew more than ten-fold, from 2,305 to 26,096.

“The use of S corporations has exploded,” said IRS Commissioner Mark W. Everson. “The IRS needs a better understanding of what this means for tax compliance. This research is critical for achieving our strategic goal of ensuring that corporations and high-income individuals are paying their fair share.”

S corporations are now the most common corporate entity. In 2002, the latest year for which data is available, S corporation returns accounted for 59 percent of all corporate returns filed for that tax year. Two million S corporations reported net income of about $248 billion and 1.2 million S corporations reported net losses of about $63 billion.

Numerous restrictions and requirements apply to S corporations. For example, an S corporation can have no more than 75 shareholders and none of these can be another corporation or non-resident alien. Program officials expect these audits to begin later this year. The last reporting compliance study of S corporations involved about 10,000 returns from tax year 1984, prior to the tax law changes that spurred the growth in S corporations. The new NRP initiative will use a study approach designed to reach statistically valid conclusions regarding compliance behavior, while using a smaller sample of returns than in the past.

The results of the NRP study will be used to more accurately gauge the extent to which the income, deductions and credits from S corporations are properly reported on returns filed by the flow through corporations and their shareholders. When completed, this research will assist the IRS in selecting and auditing S corporation returns with greater compliance risk.

The research program on S corporations is a complement to the study of individual reporting compliance completed last year. The preliminary results from that study, announced in March, indicated that the gross tax gap is more than $300 billion each year. IRS collection and compliance efforts reduce this gap by about $50 billion each year.
The NRP, created in 2000, is a comprehensive effort by the IRS to measure payment, filing and reporting compliance for different types of taxes and various set of taxpayers.

Administering a tax system that serves America’s taxpayers by promoting fairness and operating efficiency and effectiveness is dependent on the agency’s ability to measure and distinguish between the many factors that impact compliance with tax laws.

“This research effort provides us the knowledge we need to both improve compliance and reduce unnecessary taxpayer burden,” said Everson.

Without reliable measures, the IRS faces major challenges in enhancing its ability to detect noncompliance, improve overall compliance and develop methods for allocating resources more effectively.

From Washington Post Thursday, July 14th:
GOP Presses Case for Prosperity
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House Majority Leader Tom DeLay (R-Tex.) and Rep. Todd Tiahrt (R-Kan.) today will launch a House Economic Competitive Caucus (EC{+2}), which will focus on reducing barriers to job creation. DeLay plans to point to “a chance to empower small businesses, consumers, students, individual employees, investors, and families.”
Worried about Congress’s standing in polls, Republicans are stressing devotion to promoting prosperity. House Republican Conference Chair Deborah Pryce (Ohio) and House Majority Whip Roy Blunt (Mo.) held a news conference to claim that, as Blunt put it, the plans by Bush and the Congress “to grow this economy have worked, and they’re paying big dividends.” Half the questions were about Karl Rove. None was about the economy.