The Bull's Eye On Business' Back

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Your sales are lousy. Your biggest customer just went bankrupt owing you a few hundred thousand dollars. Your health insurance costs are rising rapidly and you're having trouble financing your accounts receivables.

But that's not the half of it. There's an Internal Revenue Service auditor poring over your books in the conference room. A state sales tax agent has left you a phone message that he wants to come in for a visit, and city fire inspectors just dropped off a violations summons.

With government budgets sharply constrained and likely to be under pressure for years to come, businesses struggling in the recession are now facing intense and rising scrutiny from tax and regulatory authorities. Across the country, governments are ramping up their audits of businesses, increasing fines and fees, and aggressively interpreting their tax codes to maximize collections. Meanwhile, tax codes and regulations continue to grow more complex and difficult to follow, sharply increasing the cost of compliance. As the technology consulting firm Sabrix recently put it: "Make no mistake: to cash-hungry tax authorities, your business represents a revenue stream." That's blunt.

The more intense scrutiny of firms actually started at the federal level before the recession began. From 2005 through 2007, the IRS increased audits on small-to-mid-sized firms, those with revenues between $10 million and $50 million, by 41 percent, according to a study by Syracuse University. The IRS says it thinks there's substantial ‘noncompliance' among firms in that revenue range. But IRS Taxpayer Advocate says a big problem is that the tax code is too complex and many taxpayers, their tax-preparers and the IRS's auditors simply don't agree on how to interpret the code.

But the feds aren't business's only concern. Since the recession began, governments with the biggest financial woes are being the most aggressive, starting with California. Among its moves the state has been sending letters to businesses telling them to check their records for out-of-state purchases, and then instructing them to pay back taxes they owe on goods or services they've bought in another state. In the first half of the year 25,000 firms got hit with the letters, whose tone is intimidating, to say the least: "Industry studies indicate there is a likelihood that your business has purchased fixtures, equipment...or other items...outside California," the letter reads. It then advises the business that the state has the right to audit it if it doesn't self-audit.

Across the country in New York City, whose $60 billion budget is larger than most states, the growing bite on business also comes from new fees and aggressive enforcement of regulations. The city's budget this year contains a whopping $100 million in projected new fine and fee revenues, up 12.5 percent from the $800 million the city already collects. What's particularly alarming to local businesses is that most of that additional money will come from estimated increased ticketing, as if they city knows that firms and city residents will behave that much more badly this year.

Some groups applaud such initiatives because they believe that businesses are simply being forced to pay what's due and keeping government coffers full in the process. The California Tax Association, a union group that advocates for a strong public sector, commended the state's letter-writing initiative because there is "a ton of tax avoidance out there," as a spokesperson said. Meanwhile, New York's businessman Mayor, Mike Bloomberg, told the press that firms that obey the laws have nothing to worry about from new enforcement efforts.

But the reality is more complicated. In New York, city inspectors under pressure to boost revenues have resurrected obscure laws that haven't been enforced for years. Meanwhile, tax codes are getting so complicated that firms struggle to comply at huge costs, and many still run afoul of the law. A survey last year by Tallman Insights, a technology consulting firm, found that small and mid-sized businesses spend on average $327,000 a year just to conform to sales and use taxes. At the heart of those costs are constant increases in tax rates, changes in clauses of the tax code, and complex lists of what qualifies as taxable and what doesn't.

In California, for instance, retailers are supposed to collect taxes on sales of fertilizer for flower gardens, but not on fertilizer used in vegetable gardens. If a store gets confused and collects for both, customers will complain. But if the store collects for neither, it's liable for the taxes and penalties on those items that are taxable. And the penalties add up. The Tallman surveyed estimated that businesses pay on average $34,000 in penalties and interest over and above back taxes.

Many firms that do business over state lines are finding that the cost of expanding in even a minor way, such as by enlisting an independent agent to represent the firm in a new state, can lead to a big tax bite. A recent article in CFO Magazine recounted the tax woes of a small Arizona furniture manufacturer which had a sales rep who made one trip a year to Washington State to service just two clients. When the state's tax authorities surveyed the firm and found out about the business, they sent it a substantial income tax bill based on just three days of activity every year in Washington. A poll by the magazine found that the states that were most aggressive about trying to extend their tax reach in this manner to out-of-state firms were New York, California, Massachusetts, New Jersey and Texas.

The good news in all of this, I suppose, is that it's worse elsewhere, such as in Europe, because of the widespread use of the Value-Added Tax, or VAT, which is a multi-stage levy which requires firms to calculate the value they add to a product or service and then pay taxes, which are eventually passed along to the consumer.

I guess business owners can thank heaven that America doesn't have a VAT, for now at least.


Steven Malanga is an editor for RealClearMarkets and a senior fellow at the Manhattan Institute

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