IRS LOOKS CLOSELY AT E-COMMERCE

Last month, the IRS updated its Audit Techniques Guide (ATG) for cash-intensive businesses to help its agents understand the complexities of e-commerce – the selling, purchasing and/or paying for products and services, mostly online. The IRS’ interest in this area is part of its compliance efforts aimed at closing the tax gap, which is the difference between taxes owed and taxes actually paid. Small businesses are among the largest contributors to this $450 billion a year tax gap, and as they increasingly do business online, the IRS has become more interested. In 2012, the IRS will continue a nationwide Compliance Initiative Project for emerging issues related to e-commerce. The IRS will look at unreported income involving e-commerce business activity, and in particular, the following issues:

·                 Online sales and customer payments for goods and services

·                 Advertising income

·                 Internet auctions and bartering

·                 Online “tip jars” used by visitors to support websites

·                 Sale of customer lists

·                 Referral fees from list sharing

Compliance tools

Last year, Congress gave the IRS more information statements aimed at helping with e-commerce underreporting – namely, Form 1099-K, merchant card and third-party network payment reporting. These reporting requirements are aimed at businesses that conduct e-commerce through credit and debit card payments and third-party network payment providers, such as PayPal. The resulting Forms 1099-K will be a cornerstone to a future business income-matching program that does not exist today.

Last year, the IRS completed a significant update to its Internal Revenue Manual audit procedures, and many of the changes focus on unreported income in e-commerce activity. The IRS added instructions for auditors on how to examine businesses with e-commerce activities, including several techniques to question whether all income is reported on a tax return and additional guidance on audit trails to pursue. Agents are instructed to:

·                 Reconcile merchant card payments to bank deposits, books and records, and         the tax return.

·                 Investigate website traffic and volume that could be indicative of a high volume of       business.

·                 Review websites for historical activity using www.archive.org to determine                 e-commerce activity for the year under examination. Practitioners should be             prepared for IRS agents to ask these questions in their examinations:

·                 Does your client do business online?

·                 What payment methods are accepted through the website?

·                 What products, services and other items can be purchased on your client’s             website or through email marketing?

·                 What websites does your client own? How does your client account for this             income on the return?

·                 Does your client sell advertising on the Internet?

·                 Does your client sell products and services through other online providers?

·                 Does your client’s site make sales to customers in foreign countries?

·                 Does your client sell products and services from other business partners?

What’s next?

In the next several years, expect the IRS to look closer into e-commerce as a comprehensive strategy to address small business noncompliance and narrow the largest segment of the tax gap. The IRS thinks that there is substantial noncompliance in the following e-commerce areas, which it will target in compliance initiatives going forward:

·                 Unreported income on sales of goods, including sales from home-based online         businesses

·                 Unreported income on the sale of appreciable assets, such as collectibles and         antiques

·                 Offshore activity, including unreported income from foreign customers

·                 Abuse of the home office deduction

·                 Abusive home-based business tax avoidance schemes that deduct personal,           living or family expenses

·                 Internet businesses that generate losses but are actually hobbies

Prevention is always best. To proactively protect your client’s small business, prepare a complete and accurate return. During return preparation due diligence, closely review your client’s small business and reconcile your client’s income, including any Forms 1099-K received. If your client conducts business online and is selected for audit, use the issues and questions outlined above, which are all based on IRS internal guidelines for e-commerce examinations, to prepare for the audit and avoid unforeseen issues and questions.