Despite the IRS’s own figures revealing that, in general, only 1- or 2-percent of all taxpayers actually have their returns audited each year, one of the more nerve-wracking aspects of taxes for many shooting sports equipment business owners and managers continues to be the possibility of being audited.

In reality, however, what was once a large and inefficient federal bureaucracy, the IRS is changing to become more streamlined and, most importantly, catching more tax offenders. Today, the IRS enforces the tax law in a number of ways, including the increasingly more common correspondence (examination by mail) audits and the dreaded field (face-to-face audit) examinations.  

Agents in back offices are being replaced by computers using complex algorithms that cast a wide net, one that pulls many law-abiding people into the chaos of an audit. The result is that many businesses are being scrutinized far more often than the numbers seem to indicate. 

According to the latest figures, the IRS audited almost 1.1 million tax returns, approximately 0.5 percent of all returns filed in 2016. The majority of audits conducted during 2017, 70.8 percent, were via correspondence. The remaining 29.2 percent were field audits. Of course, of the more than 1.1 million audits, almost 34,000 resulted in additional refunds totaling more than $6.6 billion.

A Smaller Target

Computers are less forgiving than humans. Any tactical shooting products and accessories shop owner or manager who hopes to survive and thrive under the new algorithm-based IRS should follow a few guidelines.

1. Always be prepared for scrutiny. Understanding the tax rules and potential red flags is essential to knowing what information should be saved and for how long. 
2. Be prepared to move quickly. Information Document Requests (IDRs) and face-to-face audits now move on a shockingly fast timeline, so have a plan of action. Build a relationship with an accountant who can step in quickly when the dreaded IRS audit notice is received.
3. Consistency is key. Inconsistencies in paperwork happen even to honest people when the accounting is not handled professionally. The IRS, however, is increasingly seeing discrepancies as fraud until proven otherwise.
4. Expect no mercy. IRS agents are being allowed no wiggle room and no grace. This attitude is being passed on to the businesses they deal with.

Employment Tax Bug-A-Boos

According to the latest available figures, as of December 2016, 1.4 million employers owed approximately $45.6 billion in unpaid employment taxes, interest and penalties. The IRS, as well as lawmakers, are aware that noncompliance with employment taxes, such as withheld income taxes, Social Security and Medicare taxes, is a growing problem. 

Employment taxes, including withheld income, Social Security and Medicare taxes, account for nearly 70 percent of taxes collected by the IRS. The Trust Fund Recovery Penalty is a weapon that allows the IRS to assess a civil penalty against any “responsible person who willfully fails to pay over a business” withheld employment taxes. It also makes it a crime to willfully fail to collect or pay over those taxes.

In addition to employment taxes being a large target for IRS auditors, the taxable wages of misclassified workers and fringe benefits were among the most frequently misreported, leading to the highest wage adjustment amounts on average. Worker classification issues arise when employers misclassify employees as independent contractors or other nonemployees and fail to withhold and pay employment taxes. Fringe benefits issues involve property, a service or cash received that should be treated as taxable wages but are not.

The IRS’s 2016 Data Book indicates a greater than 40 percent increase in all employment tax civil penalties assessed in 2016 from those in 2015. This appears to signal a greater focus on employment tax enforcement that continues to this day.

Partnerships Versus Partners

Thanks to the Bipartisan Budget Act of 2015, the rules governing partnership audits were replaced with a new centralized program that, in general, assesses and collects tax at the partnership level. Under the new rules that kicked in this year, any adjustment to partnership income, gain, loss, deduction or credit, as well as any partner distributive share of these adjusted items is treated at the partnership level. In other words, any income tax resulting from an adjustment is assessed and collected at the partnership level – not from the partners. It is a similar story with any penalty, addition to tax or additional amount related to an adjustment that is determined at the partnership level.

The new rules outline the procedure a shooting sports equipment partnership can choose to elect out of the centralized partnership audit program.  Only an eligible partnership, one that has 100 or fewer “eligible” partners, may elect out of the centralized partnership audit regime.

An eligible partner is any person who is an individual, regular, “C” corporation, eligible foreign entity, “S” corporation or the estate of a deceased partner.  Unlike other sections of the tax law, a husband and wife are not treated as a single partner for these purposes.

Poor Documentation Is A Death Sentence

Many retail managers and shop owners, even those with no intent to commit fraud, can fall short when it comes to documentation and paperwork. The IRS appears increasingly determined to find and audit these businesses. Once sent only to those suspected of failing to comply with the tax laws, IDRs are being sent out in record numbers as a screening tool.  Even if the shooting sports equipment business pays its taxes dutifully, it may be penalized for lacking documentation. After all, the law requires every taxpayer to retain the records used when preparing the tax returns. Those records generally should be kept for three years from the date the return is filed. 

The IRS will usually provide a written request for the specific records needed. If records are kept electronically, the IRS may request those in lieu of or in addition to other types of records.  

Taxpayer Rights

The Taxpayers Bill of Rights, part of the IRS Restructuring and Reform Act of 1998, requires the IRS to provide a written statement detailing the taxpayer’s rights and the IRS’s obligations during the audit, appeals, refund and collection processes.

Those rights include:

1. A right to professional and courteous treatment by IRS employees.
2. A right to privacy and confidentiality about tax matters.
3. A right to know why the IRS is asking for information, how the IRS will use it and what will happen if the requested information is not provided.
4. A right to appeal disagreements, both within the IRS and before the courts.

Among the most important of the rights given every taxpayer whose returns are targeted for an audit is whether to be represented by a tax professional, or whether to attempt to answer the IRS’s questions alone.  Another important consideration for everyone and every business owner and manager being audited is where to hold that meeting.

Should the meeting be in the accountant’s office where all of the working documents are easily accessible? Should it be at the firearms retailer’s place of business, the place where all the records are kept, to demonstrate to the IRS auditor that there is nothing to hide and that the products and accessories operation is a legitimate one?  Or, should the manager, shop owner and/or the operation’s representative trudge down to the IRS office armed only with the specific documents and information requested by the IRS auditor?  Not too surprisingly, there is no one right answer.

Hurry And Get It Over

The increased emphasis on small business tax audits comes hot on the heels of an IRS announcement that it hopes to speed up the audit process with something called the Fast Track Settlement (FTS) program.

The IRS’s Small Business/Self-Employed Fast Track Settlement Program (SB/SE FFS) was created to provide an expedited process for resolving disputes with small businesses and professional practices. Small business or self-employed taxpayers that currently have unagreed factual or legal issues in at least one open year under examination can work together with SB/SE and the Office of Appeals to resolve outstanding disputed issues while their case is still within the SB/SE’s jurisdiction. Once an application is accepted, the goal is resolution within 60 days.

Having The Last Word

Until a retailer agrees with the IRS, the appeals process remains open. Most importantly, from the initial screening for accuracy each return receives up to the final appeal that has been exhausted, mistakes in the favor of the taxpayer are discovered in about 25 percent of all cases.

The IRS is usually quite sympathetic to honest mistakes and more than willing to discuss underpayments of taxes that may result from the many so-called “gray” areas of our tax rules.  

They’ll frequently negotiate the amount of tax due on occasion. But they don’t like fraud.

Honesty and clarity go a long way toward preventing, dealing with and surviving an IRS audit. Naturally, every shooting sports equipment retailer should have a strategy for avoiding audits as well as for dealing with an IRS auditor. A fallback position if those strategies fail should also be in place.