You must understand the “tax gap” because…

As a small business owner, it’s absolutely critical that you understand what’s meant by the “tax gap,” so today I’ll do my best to explain what it means and why it’s important.

What’s the tax gap?

The tax gap is the difference between what the IRS thinks taxpayers should be paying in Federal income taxes and the amount which taxpayers actually report as their tax liability.

What causes the tax gap?

Taxpayers don’t report all the income they receive
Taxpayers take deductions they aren’t entitles to or can’t prove
Some taxpayers don’t even file a return

Why should business owners care?

The IRS recently estimated that $148 billion of the tax gap is due to unreported income earned by unincorporated businesses and the resulting unpaid self-employment tax.

What’s the IRS doing about it?

In 2010 the IRS examined over 270,000 returns which included Schedule C and recovered an average of $9000 in additional taxes per audit.

How does the IRS choose which returns to audit?

There are many different ways your return could be selected for audit. One that gets used a lot is the 1099 matching process. You know, those pesky slips of paper called 1099-MISC you get from clients in January every year. You don’t have to send them in with your tax return, so maybe you don’t pay much attention to them.

But the IRS does!

The folks who send them to you are required to send copies to the IRS. And the IRS simply loves 1099s. Why? Because they show how much you’ve been paid which usually results in income you should be reporting.

What exactly is the 1099 matching process?

It’s the best way the IRS has to identify under reporting of income. If they get copies of 1099s from your customers that total MORE than the amount of gross income you’ve reported on your Schedule C, you’re likely to get a letter questioning the accuracy of your return.

What if you think your 1099 is wrong and the amount reported on it is too high?

Your natural inclination is probably to report the correct (lower) amount, but that’s not a good idea because it will result in a mismatch.

You must understand the “tax gap” because…

You don’t want to be a part of it.

For more information, click here .