Read Part 1 of THE TAX GAP

For anyone who fears being audited,  you’ll be happy to learn that one of the IRS’s long-term goals is  to move away from traditional audits to more of a “trust but verify”  environment.  The Service has observed that the tax gap is greatly reduced in  areas where there is third party verification, such as W-2s to report wages,  1098’s to report mortgage interest, or Social Security numbers for dependents. 

In the past, however, a big challenge for the government is to find a source of third party  verification that covers small businesses and self-employed individuals.   Well, effective for 2012, the IRS has introduced a new form called theForm 1099-K  to provide income verification for this group of taxpayers.

According to the instructions to  this form, “You have received this form because you have accepted merchant cards  for payments, or because you received payments through a third party network that (1) exceeded $20,000 in  gross total reportable payment transactions and (2) the total number of those  transactions exceeded 200 for the calendar year.” 

With fewer people purchasing goods  and services  with cash,  and a higher percent of all transactions being completed with debit or credit cards,  the IRS will use this third party verification of merchant card payments as a  tool to get a better sense of the revenue that many small businesses receive each  year.  Take a look at Line 1a of theRevised  Schedule C, Profit or Loss From Business, and you’ll see that you’ll be  required to separately report all of the income reflected on the Form 1099-K’s  starting in2012.

Audit Stats

Currently, the IRS is auditing the  following groups of taxpayers each year:

Category of taxpayer Audit Rate
Individuals with income greater than $1 million


Individuals with income greater than $200k but less than $1 million 4%
Everyone else


More Audits and Better Audits

Until the tax gap is brought under  control, expect the IRS to rely on audits as a deterrent against non-compliance  with the current tax laws. It will be interesting to see what happens with the  Tax Gap once merchant card activity reported on 1099-K’s is implemented starting in 2012.

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