Small Business Tax Cheats: A $122 Billion Problem
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The Fiscal Times
January 18, 2012

When large companies like General Electric and Bank of America are 'outed' over their microscopic tax payments to the federal government, the press and the public pile on in outrage.   But they may be shooting at the wrong target.  Recently updated IRS data shows large corporations are not the only ones gaming the tax system.  Although big companies expertly maneuver the tax code to whittle down their bills legally, small businesses are actually evading taxes en masse.

The nation’s tax gap—or the difference between what the IRS is owed and what it collects—grew from $290 billion in 2001 to $385 billion in 2006.  Businesses that log income on individual returns, which are largely small businesses and farms, accounted for the single largest portion of that: $122 billion. 

As lawmakers struggle to agree on ways to control the nation’s $1.3 trillion deficit, while funding a vast array of domestic programs, it stands to reason that collecting that missing revenue would be a top priority.   But an increasingly tricky web of politics and logistics surrounding small business tax matters virtually eliminates any likelihood of a serious crackdown on these diverse entities.  

The political rhetoric on both sides of the aisle hails small business as the primary engine of job creation and economic growth, even though that  notion is highly debatable.  As a result, making any policy change that might burden or disrupt small businesses has become taboo.  President Obama joined the chorus last week, calling for the Small Business Administration to be elevated from agency-level to cabinet-level “to make sure that small-business owners have their own seat at the table.”

"If you underreport your income [in a large corporation] it’s right there. But for small business, it’s like the Wild West."

While there’s no denying that America’s million small businesses are a seismic, often beneficial force within the U.S. economy, a large proportion of owners successfully under-report their income to dodge taxes.   “There really is money there, but you are talking about getting millions of influential citizens angry at you if you say or do anything that’s perceived as stifling small business,” said Martin Sullivan, a contributing editor at Tax Analysts and a former Treasury official.

It’s much easier for small business owners to conceal income from the IRS, since they aren’t required to report their income on a W-2 form, don’t have taxes automatically withheld from their wages, and certainly don’t have IRS agents stationed in their workplace looking over their shoulder, as is the case with large corporations such like Boeing.  “Corporate employees receive regular paychecks, and it’s the easiest thing in the world for the IRS to find out if you underreport your income because it’s right there,” Sullivan said.  “But for small business, it’s like the Wild West.”

Small businesses can structure themselves as subchapter S corporations,  partnerships or pass-through entities (LLCs) , or sole proprietorships —the most common classification which accounts for about three-quarters of small businesses.  The total number of small businesses under these categories combined has shot up to 27 million in 2007 from 18.4 million in 1997, according to the Census Bureau.  Currently, more than 21 million of the country’s 27 million small businesses have no employees other than the owner.