Business Faculty Publications


The Latest Audit Risks for Small Businesses and the Caution Needed for Passthrough Filers

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Journal of Tax Practice & Procedure


Accounting | Business


In today’s business world, there has been an increasing number of closely held small business employers, such as C corporations, S corporations, partnerships and sole proprietorships. Many of these are passthrough entities that are businesses that don’t pay income taxes directly. Instead, their income is passed through to their owners who pay taxes on it on their individual returns under
Schedule C. Both small and large passthrough businesses have become the economic powerhouse in the United States because they earn more net business income than C corporations (although C corporations surpass passthroughs in gross receipts), employ over half the workforce in the United States, and are often taxed at top individual tax rates. An IRS study reveals the organization’s
interest and increasing focus on passthrough businesses, in terms of both its structure and priorities, have tripled in size since 1980.1 From the approximate 92,000 IRS employees, about 47,000 of them work in the small business/ self-employed unit, one of four operating units in the IRS. 2 However, the IRS currently audits Schedule C filers 18.5 times more than partnerships or S corporations. Therefore, passthrough filers are much more susceptible to being
audited which makes it even more important to understand processes and the triggers for being audited as well as what the IRS has in store for the future. In addition, your audit chances increase the better you are doing. For example,
in 2014, Schedule C filers without Earned Income Tax Credit (EITC) were audited at a rate of 7.4% (all income groups combined) versus the 0.4% for partnerships and 0.4% for S corporations.3



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