Small business audits often find no more taxes due-IRS watchdog

WASHINGTON, July 25 Thu Jul 26, 2012 2:04am IST

WASHINGTON, July 25 (Reuters) - The U.S. Internal Revenue Service's watchdog criticized the agency for doing a high number of small business, "S-corporation" audits without finding additional taxes owed.

Treasury Inspector General for Tax Administration Russell George, chief watchdog for the IRS, said on Tuesday the findings were troubling because they may show "the agency is spending a significant amount of resources on unproductive audits."

S-corps are flow-through company structures in which profits go directly to the owners, who pay income taxes on them. In C-corporations, which include most publicly traded businesses, profits are taxed twice, first as corporate income and again as income to investors who get dividends.

Since the 1986 tax code reform widened the differential between individual and corporate tax rates, the S-corp set-up has become increasingly popular among U.S. businesses, along with other flow-through structures.

More than 98 percent of all S-corps have $10 million or less in assets, according to George's group, known as TIGTA.

In a sample of S-corps of that size, George's unit found for the fiscal year ended Sept. 30 that 62 percent of audits were completed without any recommendation of tax changes.

It was unclear how much money in additional taxes was collected as a result of S-corp audits, TIGTA said, acknowledging that S-corp audits can be tricky.

Still, the group recommended, the IRS should do better at scrutinizing S-corp filings to uncover owed taxes.

The IRS, in a letter acknowledging the TIGTA report, said it agreed with the watchdog's recommendations.

S-corp tax returns have surged in recent years, even as C-corp returns have plummeted in number. S-corps will file nearly 5.7 million returns in 2015, up 26 percent from 2011, IRS said.

Democratic President Barack Obama has expressed interest in possibly taxing S-corps as C-corps, though Republicans have balked at this idea. (Reporting by Patrick Temple-West; Editing by Kevin Drawbaugh and Tim Dobbyn)