RNI's October 2007 Newslink Newsletter
A large percentage of sole proprietors underestimated their income and overestimated their business deductions, resulting in over $93 billion dollars in unpaid taxes for 2001.
This is the conclusion of a July 2007 report, "Tax Gap: A Strategy for Reducing the Gap Should Income Options for Addressing Sole Proprietor Noncompliance" issued by the Government Accounting Office for the US Senate.
This fact is probably behind the increase in IRS audits of family child care providers and is likely to continue.
The report said that an estimated 39 percent of sole proprietors who file a Schedule C underreported their business income, 73 percent overreported their business expenses, and 61 percent underreported their net income.
The misreporting of expenses on Schedule C occurred across all expense categories, but the biggest errors were found in four categories: car and truck (50% of returns with an error), depreciation (42%), supplies (41%), and the Other expense line (55%).
We don't know how many of these errors were accidental and how many were deliberate. However, the number of errors identified in this report is staggering. The IRS and Congress are considering what actions to take to close this tax gap, but no single course of action seems imminent.
For family child care providers, this report could spell trouble. There has been an increase in the number of IRS audits of family child care providers over the past year, and this report could put more pressure to increase them further. From my experience, the four expense categories identified above are often scrutinized in family child care audits. To protect themselves, providers should pay particular attention to keeping accurate records for these expenses. If providers use a tax preparer, they should ask about the amounts shown on these lines of their Schedule C to make sure they are correct.