Are you the owner of a small or home based business? Do you report your income on Schedule C? If so, get ready for an audit. The IRS in at least two states is staffing up to perform audits on virtually all non-farm Schedule C filers. Other states are sure to follow. Here’s why.

There is a “tax gap” of around $290 Billion a year. The IRS believes a significant portion (but no where near the majority) of that is due to under reporting of income by small businesses who report using Schedule C. With the budget deficits growing and the economy shrinking the IRS is under pressure to close the “tax gap”. So why target small business? It’s a lot easier than going after the big corporations.

IRS Commissioner Mark Everson testified to the Investigative subcommittee of the U.S. Senate Homeland Security and Governmental Affairs Committee, “We have real difficulties finding out what’s going on (with large corporations),” he said. “Our challenges are acute and ever-growing. Offshore abuses are a real problem.”  In other words, small businesses are simply easier to go after since the large corporations can use such evasive tactics as offshore tax havens and other shelters not available to the small business owner.

What can you do? First of all, make sure you keep very good records of all income and deductions. You must be prepared for an audit because there is a bull’s eye painted on your chest if you file a Schedule C.

Alternatively, you can change the structure of your business from a sole proprietorship to a partnership or corporation. The likelihood of being audited drops precipitously for these other structures. Formation of a partnership is easy and inexpensive. You can do it yourself or ask your accountant or attorney to do it for you. Setting up a corporation is a bit more complex and will cost more to establish but may be the best choice depending on your personal situation. Seek professional advice from your accountant and attorney to determine what structure is most appropriate to your situation.

The good news is there are people working to help you with this challenge. The Coalition for Fairness in Tax Compliance was begun by the NFIB. The Small Business Legislative Council and the U.S. Chamber of Commerce joined with them to defend against harmful tax proposals.  They are at least sounding the alarm on our behalf. They are also suggesting to the IRS that just because large corporation’s tax liabilities are hard to determine doesn’t mean the IRS shouldn’t pursue these companies.