S Corps under IRS Microscope As Agency Launches New Audit Study
IR-2005-76
The phenomenal growth of S corps over the past 20 years hasnt gone
unnoticed by the IRS. The agency is getting ready to measure S corp and
shareholder compliance by auditing 5,000 randomly selected S corp
returns from tax years 2003 and 2004.
The use of S corps has exploded, IRS Commissioner Mark Everson said.
The IRS needs a better understanding of what this means for tax
compliance. This research is critical for achieving our strategic goal
of ensuring that corporations and high income individuals are paying
their fair share.
- Comment. The S corp audit study is part of a larger compliance research initiative. It will be carried out under the National Research Program.
20 years of growth
The last extensive IRS study of S corps examined 10,000 S corp.
returns from 1984. In the 21 years since, S corps have grown to the
most common form of doing business in the U.S.
In 1985, there were approximately 725,000 S corps in the U.S. By 2002,
the most recent year for which information is available, the number of
S corps jumped to 3.1 million. Almost 60 percent of all corporate tax
returns were filed by S corps in 2002.
Two million S corps reported net income of nearly $250 billion in 2002.
About one million S corps reported net losses of approximately $63
billion.
- Comment. Taking a closer look at S corps reveals that growth has been strongest among larger S corps. S corps with more than $10 million in assets jumped from just about 2,000 in 1985 to 26,000 in 2002.
- Comment. The many similarities between S corps and traditional C corps may explain the popularity of S corps. Taxpayers accustomed to operating their businesses as C corps have found switching to S corp. form easy. Last years big tax cut, the American Jobs Creation Act of 2004 (2004 Jobs Act)made S corps even more attractive. The new law raised the number of permissible S corp shareholders from 75 to 100. It also allows family members to elect to be treated as one shareholder.
Measuring compliance
The 5,000 audits of S corps are expected to begin later this year. Although this number is just one-half of the 10,000 S corps audited in the 1984 study, the IRS reported that the smaller size will not make that much difference because of how the study will be conducted.
- Comment. While the 10,000 returns tested back in 1984 represented 0.75 percent of all S returns filed that year, the 5,000 returns about to be examined represent only 0.06 percent of the current S corp population.
The IRS predicts that the study will enable it to identify which S corp
returns should be pulled for audit because of greater compliance risk.
The results of the study will be used to more accurately gauge the
extent to which the income, deductions and credits from S corps are
properly reported on returns filed by the corporations and their
shareholders, the IRS explained.
- Comment. According to the 2004 IRS Data Book, Publication 55B, released in March, the number of returns filed by S corps that were examined decreased to 6,402 in FY 2004 from 9,695 in FY 2003. The general audit rate for S corps declined to 0.19 percent in FY 2004 from 0.30 percent in FY 2003. Nevertheless, the general audit rate for small businesses should rise in the coming years, since the IRS has identified the small business/self-employed sector as a major area of noncompliance. Schedule K-1 matching is a particularly fertile area that the IRS plans to farm more diligently.
- Comment. The National Federation of Independent Businesses (NFIB) told CCH INCORPORATED that according to NFIB small-business owners, federal taxes on business ranked number five out of 75 problems facing small business owners. About 75 percent of small employers file taxes as individuals, for example as S corp owners, partners or sole proprietors. If you add all the people who work for themselves, but dont employ anyone else, the figure moves to about 90 percent, NFIB Research Foundation Executive Director Denny Dennis noted.