Small businesses bear a significant portion of federal tax compliance cost.

• Author: Davis, Frederick E., Jr.

Judge Learned Hand famously wrote that "[a]nyone may so arrange his affairs that his taxes shall be as low as possible; he is not bound to choose that pattern which will best pay the Treasury" (Gregory v. Helvering, 69 F.2d 809, 810 (2d Cir. 1934)). For this reason, choosing a prudent tax adviser is essential to benefit from available deductions and credits and to avoid tax penalties.

However, while using a prudent tax adviser is economical for some, it is a luxury for others, particularly for U.S. small businesses. This item focuses on small businesses that are independently owned, with gross receipts of less than $10 million.

The National Federation of Independent Business's (NFIB's) Small Business Problems &? Priorities Poll in 2012 found that tax complexity was the second most severe tax-related issue that small business owners faced. According to testimony at the most recent House Committee on Small Business hearing on "The Biggest Tax Problems for Small Businesses," small businesses with less than $1 million in gross receipts disproportionately bear almost two-thirds of tax compliance costs, relative to revenues or assets of large firms (Marron, "Tax Issues Facing Small Business," testimony before the House Committee on Small Business, p. 1 (4/9/14)).

Tax compliance costs are measured either quantitatively or qualitatively. Quantitative measures include out-of-pocket costs for paid professional tax services, opportunity costs, and other monetary costs of recordkeeping, tax planning, and payroll. Qualitative tax compliance cost includes behavior(s), i.e., good corporate citizen, reputation risks, or industry norms. Underlying all of these factors is the complexity of the tax Code. In fact, tax complexity ranks seventh out of the 75 top issues for small businesses in the NFIB's 2012 survey. The hours spent complying with the Code, or responding to notices or an audit, exacerbate the existing tax compliance burden small businesses must face. For example, the instructions to Form 1120S, U.S. Income Tax Return for an S Corporation, provide that the time needed to complete Form 1120S is approximately 56 hours, learning about the form is estimated to average 30 hours, and copying, assembling, and sending the form to the IRS averages almost seven hours. While the instructions estimate the time for recordkeeping related to the form averages approximately 62 hours, depending on the circumstances, the hours it takes could easily be more than the...