By Marc Fischer, Founder and CEO, Dogtown Media
For many, our nation’s tax reform was a bittersweet victory. While small businesses create 64 percent of our country’s private sector jobs, they often face the heaviest burdens in tax compliance. The tax reforms passed last year brought some unexpected benefits for tech startups and small businesses like mine, but also posed new challenges. We have an opportunity to build upon the momentum of recent changes to our nation’s tax code to address the tax challenges and Internal Revenue Service (IRS) auditing fears that still plague American job creators.
Here’s a little background.
My company, Dogtown Media, is a Venice Beach-based mobile technology studio that incorporates artificial intelligence (AI), mHealth, and robotics into mobile solutions and develops IoT-related apps. Our company’s mission is to build innovative products that positively impact businesses around the globe. Like any startup, we were proud to see our vision resonate, and in just one year’s time, we tripled our revenues and began to explore different avenues of opportunity. However, as we shifted from startup to established company, our small business faced significant new tax considerations.
We began Dogtown Media as a limited liability corporation (LLC), joining the 90 percent of American businesses that are considered pass-through entities. Pass-through entities are ones in which a business owner pays taxes on business income through his or her personal income tax returns. In other words, my business partner and I were personally taxed on our company’s earnings. While this is a common practice for many businesses, it posed a massive burden during tax season – our company’s exponential growth incidentally pushed us into the top one percent personal income tax bracket. As individual taxpayers, we went from eating ramen on our modest tax returns to looking like we were rich – while still eating ramen. Under the previous tax regime, it took a lot of money, tax engineering, and countless hours with our certified public accountant (CPA) (all activities that took valuable time away from growing our business) to claw back some of the funds the IRS took as a result of the tax classifications of our small business.
We were curious about the changes coming from recently passed tax reform. After considerable research and many meetings with our CPA, consultants, and research and development (R&D) tax credit experts, we were pleased to discover that the new tax plan, though flawed, offered some key benefits for American small business.
- Tax reform lowered the tax rate for pass-through entities from 35 percent to 20 percent. At the end of the day, we’re able to keep more money in our company’s bank account, vital for re-investment, hiring new employees, and growing our knowledge base through research and development. All these efforts make it easier to grow our business faster and ensure business owners are not required to take out as much capital to pay company taxes.
- The new reforms also raised the dollar limit for expensing equipment to $1 million, offering new benefits for companies that must purchase equipment to conduct or grow their business. Though this change does not bring the same benefits to developers who develop intangible software, it could offer necessary capital for engineering hardware like wearable medical devices, a field that we have explored recently.
- Lastly, this administration’s tax reform offers greater payroll deductions, with massive benefits for small businesses. By providing greater payroll tax deductions, it enables us to focus on attaining the qualified employees that will help us reach the next level while mitigating the tax concerns that inevitably come with it.
While tax reform brought unexpected benefits for small businesses, challenges remain. This current tax code is equally, if not more, confusing than the previous code, and our business is more reliant than ever on tax advisors. In fact, our tax preparation expenses multiplied this year. Moreover, businesses like ours continue to face time-consuming and costly challenges posed by audits from the IRS. Companies that file business tax reforms and have an income between $200,000 and $1 million are significantly more likely to be courted by the IRS for a field audit.
Thankfully, we can look to the implications of broader tax reform, including the Preserving Taxpayers’ Rights Act, H.R. 3220, a bipartisan bill that offers much-needed protections to make the auditing process clearer, more user-friendly, and more cost-effective for small businesses and entrepreneurs in the app ecosystem.
- This bill would allow small businesses and taxpayers resolve their tax audits in the IRS Office of Appeals, without being forced to litigate their case in Tax Court. Tax litigation takes time and a significant amount of money – resources that are vital to running a business – particularly when the IRS technically allows taxpayers to challenge their audits in the “friendlier” Office of Appeals. However, there is currently no statutory law that supports a taxpayer’s right to Appeals, enabling the IRS to bypass the process and Tax Court litigation. This bill’s ability to secure the taxpayers’ legal right to challenge an IRS audit in the Office of Appeals would bring cost-saving benefits to businesses across our community.
- In addition to securing the right to resolve audits in the Office of Appeals, the Preserving Taxpayers Rights Act would place limits on the types of cases the IRS litigate in Tax Court. Under some circumstances, the IRS can bypass the usual appeals process and immediately take disputed audits to Tax Court by “designating a case” for litigation. Under current law, the IRS has wide discretion to bypass these protections under the guise of “sound tax administration,” which gives the IRS a significant advantage over taxpayers. This legislation would place reasonable limits on this authority, allowing the IRS to override a taxpayer’s right to appeal if, and only if, the taxpayer is linked to a high probability of tax avoidance. We all know that the tax code can be incredibly complicated, and many taxpayers make mistakes without ill-intent. This element of the bill would empower small businesses, and all taxpayers, to defend their rights at the IRS and protect well-intentioned taxpayers not engaged in legally-questionable transactions.
- The bipartisan bill would also bring benefits and protections to small businesses and startups by implementing clear rules on the designated summons process. As any business that has been audited knows, the IRS often leverages time in the auditing process, asking for information over several months or years without informing the taxpayer when the audit will conclude. Though there is a three-year statute of limitations that provides a natural end for an audit, the IRS can override this statute by issuing a “designated summons.” A designated summons is essentially a subpoena for information relevant to the audit that is not confined to the statute of limitations and is intended to be used only if a taxpayer is uncooperative and intentionally stonewalling the agency to run out the clock. However, the current law does not require the IRS to even allege the occurrence of uncooperative conduct to use this summons — it simply needs to meet the basic requirements of a traditional summons or subpoena. The Preserving Taxpayers’ Rights bill would protect the average taxpayer and ensure the IRS can only use designated summons on delinquent taxpayers trying to evade the statute of limitations, shifting the responsibility to the IRS to first find proof of uncooperative conduct before issuing the onerous summons.
- Lastly, the Preserving Taxpayers’ Rights Act would limit the types of sensitive tax information that may be accessed by outside firms during a tax audit. In our data sensitive world, privacy is key, and this piece of the legislation would offer added protection and security for taxpayers and businesses of all sizes. Not only would it simplify the elements of the tax audit process, it would also help preserve the integrity of taxpayers’ private, sensitive data and protect it from being used nefariously by third parties.
As a small business in the tech space, we will continue to watch the long-term impacts of tax reform and push for more improvements and simplifications to this system for the benefit of all businesses. At the end of the day, small businesses and entrepreneurs simply want to build our companies and bring economic opportunities to our communities. Anything we can do to simplify our tax process or streamline the IRS’s ability to do their job – while allowing us to do ours – is an effort we will support. We encourage the House and Senate to support the bipartisan Preserving Taxpayers’ Rights Act to improve the current tax audit system. Addressing these concerns will increase efficiency and cost-savings while adding to the improvements offered within our nation’s recent tax reform efforts.