IRS Underreported Business Income Letters – What Now?

They’re at it again. Last year, around this time, the IRS was sending mass mailings to small businesses questioning their accuracy in reporting income. Just like last year, the IRS is again sending Letter 5036 and 5039 which questions the accuracy of the businesses reported income. The letters are the result of the IRS matching the information reported on 1099-K’s from credit card processors for businesses with merchant accounts against the businesses reported income. If you receive one of these letters, don’t panic and keep the following things in mind:

  1. This is not a demand for payment or notice of tax deficiency. It is simply an inquiry based on preliminary information and does NOT mean that the IRS is onto something.
  2. The requested response is an explanation as to why the credit card receipts and the reported gross income do not correspond. There are many reasons why this might be the case and explaining it is sufficient to resolve the inquiry.
  3. If there is a discrepancy in the amount reported and you need to make an adjustment, DO NOT simply send in the correction to the income. It’s likely that you also underreported your expenses. So before you provide the IRS with only half the picture, get with your tax professional and make sure the entire return (income AND expenses) is corrected so that you don’t overpay on the resulting income.
  4. Don’t ignore the letter. If it asks for a response, provide one, or have your tax professional provide one. Dealing with the IRS is not enjoyable, but ignoring the inquiry will normally make it worse.
  5. Remember that there are things you can do to significantly reduce your chance of getting these types of letters. Check with your tax professional for details.

The IRS has rarely been an asset to small businesses and most would agree that the current focus from the IRS on the small business community is not only unwarranted, but unwelcome. However, it is a necessary element of business and until the focus goes elsewhere, simply address it and move on.

By: Evan A. Nielsen (Licensed in California)

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