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5 Reasons the IRS's New Focus on Small Businesses Is Ridiculously Egregious

The Internal Revenue Service reportedly is targeting tens of thousands of small businesses around the country, sending letters asking if they are underreporting revenue.

The goal of the letters, according to The Wall Street Journal, is to fight what the IRS sees as a “widespread problem: failure by businesses, including mom-and-pops, to report all cash sales in order to minimize tax bills.” Specifically, the IRS is asking businesses whether they are underreporting cash receipts, which have a less reliable paper trail than credit-card sales.

While the IRS claims the letters don’t constitute an audit, they certainly run the risk of creating a chilling effect on thousands of American businesses. “There’s an emotional thing when you get a pretty ominous-looking letter from the IRS, [saying] you might have done bad things,” Tom Reese, owner of a hearing-aid retailer in Tennessee, told the Journal.

It’s more than emotional. Here are five reasons why the IRS’s campaign against small businesses is particularly egregious:

1. The burden of proof is on you, not on the IRS.
The IRS is saying you have to prove you didn’t break the law. The letters begin with the premise that businesses could be guilty: “Your gross receipts may have been underreported.” It is up to the businesses to go through the time and expense of proving they did nothing wrong. In fact, given that these letters are being sent to tens of thousands of businesses, and they are all form letters, means that there is very little “proof” of wrongdoing anyway. Businesses have to hire accountants and lawyers. All the IRS had to do was pay for postage.

2. The IRS is targeting the most vulnerable.
The Wall Street Journal specifically mentioned “mom-and-pops” as a target of the IRS letters. These kinds of companies -- the local store, the independent contractor, the professional-services office -- make up the majority of businesses in the country, yet, given their size, they can least afford to pay the accounting and legal expense to fight back. Large corporations have legal and tax departments. Smaller businesses don’t. Billable hours related to what is essentially an IRS fishing expedition saps profits, which could otherwise be re-invested in the business.

3. The campaign could be a job-killer.
By targeting small businesses, the government is focusing on the kinds of companies that have actually put people to work since the financial crisis. Small businesses accounted for 82,000 of the 200,000 private-sector payrolls added in July, according to the ADP National Employment Report. Routinely, small businesses have accounted for the plurality -- and, in some months, the majority -- of the jobs created in this nation. Businesses of this size hire based on profit-and-loss. Cut into those profits, and you lose jobs.

4. The IRS isn’t transparent.
Want to know how the IRS has determined that your business might be underreporting cash sales? Tough. Clearly there is an algorithm based on reporting from banks and credit-card companies, but the IRS isn’t offering the extent that data is used. In fact, it is offering very little. It only says that the businesses receiving the letters have reported cash sales that are “unusually low.” It is difficult to refute any accusation when you don’t know what information went into it in the first place. Is it based just on the percentage of cash sales? Does the algorithm take into account the average size of a transaction? Are some sectors being targeted more than others? Business owners know nothing about why they are getting these letters.

5. It will only get worse from here.
Right now, the IRS has sent letters to roughly 20,000 small businesses, but the Journal notes that the agency expects that number to grow in the coming months. Expanding the program, though, doesn’t fit with the IRS’s assurance that it is “working diligently to minimize burden on both taxpayers and tax professionals.” If the IRS casts a wider net, it will only increase the burden on businesses. Every dollar spent fighting what could be unfounded allegations is a dollar not reinvested in the economy. Add the list of targets, and there could be a palpable economic impact -- at a time when the country can least afford it. 

Ray Hennessey is Editorial Director of Entrepreneur.com.

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