Testimony of Thala Taperman Rolnick, CPA

House of Representatives – Committee on Small Business

September 21, 2005

Mr. Chairman Manzullo, Ranking Member Velazquez and members of the Committee,

My name is Thala Taperman Rolnick. I am a CPA from Phoenix Arizona.

I would like to thank you for listening to my concerns and reservations regarding the Internal Revenue’s plan to carry out a National Research Program to randomly audit 5,000 S-corporations. Commission Everson stated that “This research is critical for achieving our strategic goal of ensuring that corporations and high-income individuals are paying their fair share.”

Shortly after this program was announced, The Treasury Inspector General for Tax Administration released its report on the affect of corporate Return Examination Coverage.

The TIGTA audit focused on examinations done by the IRS of small corporations and S corporations with less than $10 million in assets between the years 2001 through 2004.

The IRS audited approximately 27,450 S-corporation returns over this 4 year period. While the number of returns did decrease from year to year, it was still almost an average of 5500 a year or the number of NRP returns they currently want to audit. Of those returns, 42% or over 11,500 returns resulted in no change. Only 1,317 of those returns resulted in what the Service called ”no change with adjustments.” This means that there may have been an adjustment to a shareholder return resulting in some change to the shareholders’ personal tax liability.

These examinations accounted for 286 direct compliance years. Each compliance year is composed of 2000 hours of direct examination time. This means 286 auditors spent their full time on these 27,450 audits. In other words, an auditor spent almost 21 hours of direct time on each audit.

The report stated that this many no change returns indicates that the IRS is doing a poor job of selecting returns. The Service will say, that is why they need the NRP audits – the information they discover from these audits will allow them to better select returns in the future. They tell us that the last time they did a similar audit was back in the 1980’s. I counter with, why can’t they determine what they need to know from the audits they have complete? Why can’t they analysis the information they have obtained from these audits? What can they learn from new audits that they can’t learn from these?

While this is the only S-Corporation audit program that the IRS has publicly identified, there is another S-Corporation audit program and a Schedule C audit program affecting my clients, small business clients. I am speaking from resent experience. The first of these additional programs is the audit of 1^st and 2^nd year S-Corporations. The second program is the audit of individual returns where there is wage income and a Schedule C loss. When I asked the agent why they would want to audit a brand new business, her answer was “to make sure new businesses are doing it right.”

I would like to refer to another TIGTA audit that determined that TEC, the IRS Taxpayer, Education and Communications section has made significant progress in working to educate small business regarding their tax and compliance issues. I would like to thank Congress for providing the additional funds to keep this division and SPEC open. It provides an outstanding service. I believe that, TEC instead of an audit agent should be visiting my first and second year client to assist them in “doing it right.”

I referred to an S-corporation audit I am currently working on. The taxpayer actually made a small profit in her first year. She received a salary and took minimal distributions that were not subject to payroll taxes. In other words, she did everything right. We determine that IF ,and I believe it is a very unlikely, the agent were to find $20,000 of adjustments, the net result would be an additional $3,000 of taxes. Where is the cost benefit here? How can this help the small business? This audit is taking her time away from her start up business and I anticipate our fees to be $5,000.

I mentioned a Schedule C audit program earlier. This is another unannounced audit program. The client I represented is a start up dentist. She had wages and a Schedule C loss in the year of the audit. In the following year, she had no wages and a small amount of profit. By the current year, she is making a nice profit. Anyone looking at the whole picture and who understands business could see the progression.

After 4 full days of the auditor’s time, we received a no change audit. If he was allowed to look at the whole picture, limit his audit scope based on the circumstances and test only a few items, like the taxpayers working capital loan that helped her survive in the first year, he could have closed the audit in a quarter of the time. All he really needed to do was to take a look at the beginning life cycle of a business.

What complicated this audit even further was that the agent requested information the taxpayer was prevented from providing do to HIPAA rules. Every receipt of income, every lab expense had to be sanitized before we could present it to the agent. The client sheets filled a 4 inch binder. We finally got him to agree to reviewing one month. The time it took her to sanitize the data was time she had to take away from her practice.

When I discussed this audit with a friend of mine his response was “as a taxpayer, I am a shareholder in the IRS and this does not sound like a good return on my investment.”

I am a CPA who makes her living doing compliance work, but very soon I will also be a small business. Small business is the back bone of our country’s economy. All three of these programs hurt small business. These audits cost those most unable to afford them the highest percentage of their income. They must take time away from their businesses to prepare for and attend the audit. In most cases, they must pay someone, like me, to represent them. These are additional costs that most small businesses can not afford.

Internal Revenue Service believes that examination of income tax returns is an important to encourage voluntary compliance. I agree. I also believe that the Service needs find better methods of selecting returns of taxpayers that are not complying with our tax laws and are not paying their rightful share of our taxes and I believe they already have that data to work with.

Thank you for allowing me this time to share my concerns on these issues that affect small business.