In response to a request by Senate Finance Committee Chair Max Baucus (D-Mont.) and Ranking Member Charles Grassley (R-Iowa), the Government Accountability Office (GAO) spent the last year looking into tax compliance by the S corporation community. The GAO recently released a comprehensive review of the challenges S corporation face when calculating their taxes.    

 The GAO examined various questions including why some businesses choose to be S corporations, analyzed the types of S corporation non-compliance, what the Internal Revenue Service (IRS) has done to address noncompliance and what are the options for improving S corporation compliance. To answers these questions, the GAO interviewed numerous stakeholders, including NSBA.

According to IRS data, roughly 68 percent of S corporation returns filed for tax years 2003 and 2004 (the years that data were available) misreported at least one item. Approximately 80 percent of the time, misreporting provided a tax advantage to the corporation or shareholder. The most frequent errors involved deducting ineligible expenses, which decreased S corporation shareholder tax liabilities.

Even though a majority of S corporations used paid preparers, 71 percent of those that did were non-compliant. Stakeholder representatives said that preparer mistakes may be due to the lack of preparer standards as well as their misunderstanding of the tax rules.

Shareholders of S corporations also made mistakes in calculating basis—their ownership share of the corporation—when taking losses passed to them from the corporation, potentially decreasing their total taxes. According to the report, IRS officials said that calculating and tracking basis was one of the biggest challenges for shareholders, and that S corporations themselves were in a better position in most cases to calculate basis for their shareholders.

The GAO report concludes and recommends that Congress should require S corporations to calculate and report basis for their shareholders’ shares. The report also recommended that the IRS research options for improving the performance of professional tax preparers, provide additional guidance to new S corporations on calculating basis and compensation, require examiners to document their analysis of compensation, and provide more guidance on compensation. The IRS generally agreed with the GAO’s recommendations.