SB/SE (Small Business and Self-Employed) audits consist of several preliminary tests for unreported income, or “minimum income probes,” which begin with the Financial Status Analysis, or Cash-T analysis. Using the Cash-T probe, IRS examiners compare the balance sheet and income statements from the year under audit with prior/subsequent year data. TIGTA reported in September 2010 that for FY 2008 it had sampled 227 sole proprietor audits and found the Cash-T stage of the income testing to be lacking. In several cases, examiners did not consider the taxpayer’s personal living expense (PLE) data or determine whether the reported income was sufficient to pay both for the business expenses deducted on the tax return as well as the taxpayer’s basic rent, food, clothing, and other living expenses not included on the tax return.
In a 2010 report, TIGTA (Treasury Inspector General for Tax Administration) recommended the IRS should increase examiner accountability for their audits by instructing group managers to provide written feedback to their examiners on their application of the minimum income probes. They should also incorporate that feedback into the examiners’ progress reports and annual appraisals. Finally, TIGTA recommended that IRS examiners consider PLE data in their Cash-T analyses.
In another 2010 report, TIGTA report estimated that the tax gap for unreported income earned by unincorporated businesses and unpaid self-employment tax was still $148 billion. While this represents a marked improvement over the figure from 2001 contained in the GAO report, TIGTA would still like the IRS to improve small business audit performance. TIGTA plans to release reports on S corporation and passthrough entity audits with similar findings later in the fiscal year.