Analysis of annual business bank account deposit reporting for tax compliance and revenue

The annual reporting of business bank account deposit totals has been suggested as a potential tax revenue raiser. Upon more detailed analysis, however, it does not appear to be a cost effect method to detect un-reported income, or promote greater taxpayer compliance.

The proposal is an extension of the congressionally mandated reporting by banks and other processors of annual credit card and debit card receipts and certain other payments received by business taxpayers. Because of the contractual restrictions on their acceptance and the fees charged to use them, card processing amounts are relatively accurate indicators of the gross revenue received by a business using these methods of payment. The largest source of inaccuracy will probably be credits paid in other ways and non-revenue “cash back” amounts given back on purchases by debit cards.

Unfortunately, business checking and investment accounts are “asset” accounts and deposits made to them are not very reflective of revenue. The reporting of annual deposit totals would not provide useful information for IRS enforcement activity. Business checking accounts normally pay no interest on the funds deposited, so most successful businesses actively manage their cash assets to generate some interest income even with today’s low rates. Depending on their size and cash flows, most businesses may transfer excess funds daily or several times a week from checking accounts to savings accounts, money market accounts, brokerage investment accounts, or possibly even short term certificates of deposit. As funds are needed, investment balances are re-deposited back into a checking account. As a result, the same cash asset will be included many times in deposit totals, particularly when the deposit totals for all accounts are added. This deposit total may be 5, 10, perhaps 15 or more times the actual business revenue, and of little use to the IRS for enforcement activity, except for complete non-reporting which can be identified in other ways. Business bank deposits also include many other amounts that are not related to business gross revenues such proceeds from bank loans, private loans or capital investments, check cashing for customers or employees, etc.

If the IRS tried to use this misleading data for enforcement activity, even with major adjustments, it could lead to massive numbers of CP2000 notices, and large processing and error resolution expenses for both taxpayers and the IRS. Two businesses with the same revenue could have very different deposit totals depending on the way a business manager manages money.

Although the amount of just cash deposits might have some use as indicators of revenue, most bank deposit accounting records combine the amounts of cash and checks in each deposit, and any requirement to track them separately would be a major cost burden on the banking system. Most taxpayer records also probably don’t separate bank deposit entries by type or sources of the funds except in non-sortable memos. Any audit resolutions would probably require onsite evaluation of hundreds or thousands of accounting records for a year, and would be an ineffective use of IRS resources. Even separate accounting for cash deposits would probably have little real value to the IRS, because most intentionally unreported cash revenue probably doesn’t get deposited in bank accounts now, and it certainly wouldn’t get deposited if the taxpayer knew there would be reporting.

To confirm that deposit data would have little value to the IRS, we conducted a conference call on 07-26-10 with Faris Fink, Deputy Commissioner of the IRS Small Business – Self Employed Division (SBSE), 202-622-0600, email Faris.R.Fink@irs.gov . SBSE has the primary responsibility within IRS for information reporting, information processing in the business Masterfile system, and most business audit and enforcement activity. Deputy Commissioner Fink generally agreed with our analysis of the data validity problems of using bank deposit totals for enforcement and indicated that that he saw little value in IRS having or trying to process the data. He indicated that he would be glad to talk with Congressional staff members about the problems he sees with the proposal.

Commissioner Fink also confirmed what we had previously heard from Treasury Tax Policy and others in IRS, that they do not see positive value, in relation to costs, in the Form 1099 information reporting of goods purchases or commercial services such as transportation, accommodations, utilities, etc. He would like to see the reporting requirement return to the original Treasury proposal applying to independent service contractors regardless of their form of business entity.

Eric Blackledge and Thala Taperman Rolnick, CPA 07-25-10

National Small Business Network

P O Box 639 Corvallis, Oregon 97339-0639

Phone 541-829-0033 Email Tax@NationalSmallBusiness.net