IRS LAUNCHES STUDY OF
S CORPORATION
REPORTING COMPLIANCE

The phenomenal growth of S corporations over the past 20 years has not gone unnoticed by the IRS. The agency has announced that it is getting ready to measure S corporation-and shareholder-compliance by auditing 5,000 randomly selected S corporation returns from tax years 2003 and 2004.

"The use of S corporations has exploded," IRS Commissioner Mark Everson said. "The IRS needs a better understanding of what this means for tax compliance. This research is critical for achieving our strategic goal of ensuring that corporations and high income individuals are paying their fair share."

The last extensive IRS study of S corporations examined 10,000 S corporation returns from 1984. In the 21 years since, S corporations have grown to become the most common form of doing business in the United States.

In 1985, there were approximately 725,000 S corporations in the United States. By 2002, the most recent year for which information is available, the number of S corporations jumped to 3.1 million. S corporations filed almost 60 percent of all corporate tax returns in 2002. Two million S corporations reported net income of nearly $250 billion in 2002. About one million S corporations reported net losses of approximately $63 billion.

The many similarities between S corporations and traditional C corporations may explain the popularity of S corporations. Taxpayers accustomed to operating their businesses as C corporations have found switching to S corporation form easy. Last year's big tax cut, the American Jobs Creation Act of 2004, made S corporations even more attractive. The new law raised the number of permissible S corporation shareholders from 75 to 100. It also allows family members to elect to be treated as one shareholder.

The 5,000 audits of S corporations are expected to begin later this year. Although this number is just one-half of the 10,000 S corporations audited in the 1984 study, the IRS reported that the smaller size would not make that much difference because of how the study will be conducted.

The IRS predicts that the study will enable it to identify which S corporation returns should be pulled for audit because of greater compliance risk. "The results of the study will be used to more accurately gauge the extent to which the income, deductions and credits from S corporations are properly reported on returns filed by the corporations and their shareholders," the IRS explained.

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