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Revenue officials admit 'huge burden' of business expense reviews, offer tips for responding

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Officials from the state Department of Revenue are trying to help tax practitioners and small-business owners cope with an onslaught of tax notices sent out under a recent agency initiative applying greater scrutiny to business expenses.

The agency's efforts to offer guidance include a webinar and question-and-answer session held last week with members of the Pennsylvania Institute of Certified Public Accountants.

During the presentation revenue officials offered clarification on the kinds of documents they will accept to verify expenses, as well as best practices for communicating with the department throughout the review process.

The webinar stemmed from a fairly new Department of Revenue initiative to scrutinize expenses that some self-employed people and sole proprietors claim on forms called Schedule Cs. Business owners deduct these expenses from their business income in order to reduce their tax burden.

The revenue department recently bought software that sorts through individual claims on a filer's return and flags any expenses that exceed average costs in the filer's industry.

The department started a pilot of the program in the 2015 tax year and put it into full force this past year. The reviews resulted in an avalanche of tax notices being sent to small business owners, who often did not understand how to respond and had trouble reaching revenue officials when they tried to seek help, according to some tax professionals.

Revenue officials, meanwhile, struggled to keep up with the reviews and subsequent questions when the software flagged significantly more returns than they had anticipated.

"We recognize this was a huge burden and not necessarily what we intended," said John Kaschak, the revenue department's deputy secretary of taxation, during last week's webinar. "This sort of snowballed."

Here are some of the questions revenue department officials answered during last week's webinar:

What kinds of documents count as verification?

Questions about what counts as verification topped the list of concerns for many tax preparers trying to help their clients through reviews, which, some said, seemed to require wading through piles of receipts.

The revenue department does not need every receipt for every expense questioned in a review, officials said.

In most cases, the department will accept general ledgers, schedules, summaries, logs, canceled checks, bank statements and credit card statements - all information, officials contend, that tax practitioners would have needed access to in order to prepare the returns in the first place.

If the question is about a utility expense, business owners can, in most cases, send a few representative utility bills as verification, instead of an entire's year's worth.

What is the best way to correspond with the department if I have questions or want to send documents?

Sending information via mail, even certified mail, adds six to eight weeks to the review process - so don't do that, revenue officials said.

Instead, the department would prefer practitioners send verification documents via fax or email. Contact information is available on the revenue department's website.

Practitioners can still send responses via traditional mail - something they might choose to do if, for example, the documentation is too large for an email attachment - but their clients should know that any documents sent will not be returned.

Reviews take on average about three months to complete, revenue officials said. Anyone who sent responses to the department more than three months ago and has not yet heard a responses should resend the information or reach out, preferably via email, to find out the status of the review.

How can I help my clients reduce their chances of receiving a notice next year?

The revenue department plans to do a version of these same reviews in the next tax year. Practitioners who want to help their clients avoid going through the process can provide verification for expenses they feel might be questioned with the initial return. The department does not expect to flag any expenses filers already verified during this year's reviews.

The department also has a tip sheet for filing Schedule Cs on its website.

Determining whether an expense might trigger a review in the future, though, will remain a guessing game. The state does not plan to release the numbers it uses to decide when an expense is suspiciously high.

Why is the department doing this?

These reviews are desk reviews, which look at individual line items as opposed to full returns, and are subject to different legal guidelines than full audits. The revenue department maintains it has a legal obligation under the state tax code to "make inquiries, determinations and assessments of all the taxes imposed," and these desk reviews help them do that.

The state did not conduct these reviews in past years because it did not yet have access to the software it now uses to flag outlier expenses.

The state has yet to determine how much additional tax revenue these reviews will bring in.

Read more about the reviews here.

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Jennifer Wentz

Jennifer Wentz

Jennifer Wentz covers Lancaster County, York County, financial services, taxation and legal services. Have a tip or question for her? Email her at jwentz@cpbj.com. Follow her on Twitter, @jenni_wentz.

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