The IRS Special Enforcement Program (SEP) Explained

Understanding the IRS Special Enforcement Program

The IRS Special Enforcement Program, or SEP, is a special program within the IRS that focuses on auditing certain taxpayers. SEP aims to make sure taxpayers are reporting all of their income and paying the right amount of tax. This article will explain what SEP is, who it targets, and what happens during a SEP audit.

What is SEP?

SEP stands for Special Enforcement Program. It is a division within the IRS Small Business/Self-Employed Operating Division.

SEP focuses on auditing taxpayers who the IRS believes may be hiding income or not reporting all of their income. The goal is to find unreported income and make sure taxpayers pay what they owe.

Who does SEP target?

SEP targets taxpayers who the IRS thinks may have unreported income. This often includes small business owners, self-employed people, and cash-based businesses.

Some examples of who SEP audits include:

• Restaurants
• Bars
• Hair salons
• Construction companies
• Landscapers
• Small retail stores
• Sole proprietors

These types of businesses deal in a lot of cash, so the IRS worries they may not report all of their income.

What triggers a SEP audit?

There are a few red flags that may trigger the IRS to open a SEP audit on a taxpayer:

• Reporting income that seems unusually low for the taxpayer’s business
• Not reporting enough income to cover business expenses
• Big swings in income from year to year
• Transactions that seem questionable or suspicious

For example, if a restaurant owner claimed they only made $30,000 last year, but claimed expenses of $50,000, the IRS would likely investigate.

What happens during a SEP audit?

A SEP audit aims to uncover any unreported income the taxpayer may have. The IRS agent will:

• Ask for records of all income sources
• Compare income to similar businesses
• Look for large, questionable, or unusual transactions
• Try to identify any income that wasn’t reported

For example, the agent may look at bank records to identify deposits that were not claimed on tax returns. Or they may interview vendors and suppliers to ask about payments made.

What are the penalties?

If unreported income is found, the taxpayer will have to pay back taxes on it. They will also face penalties such as:

• Failure to file penalty: 5% per month of unpaid taxes
• Failure to pay penalty: 0.5% per month of unpaid taxes
• Accuracy penalties: 20% of underpaid tax
• Civil fraud penalty: 75% of underpaid tax

In extreme cases if tax evasion is proven, the taxpayer could face criminal prosecution. This could mean prison time.

How can taxpayers prepare?

The best way to prepare for a potential SEP audit is to report all income accurately. Business owners should save detailed records such as:

• Bank statements
• Income and expense logs
• Receipts
• Invoices

Having organized records helps taxpayers prove the income they reported if audited. Hiring a tax professional can also help navigate an audit.

Conclusion

The IRS Special Enforcement Program uses audits to find unreported income, especially among cash businesses. If selected for a SEP audit, taxpayers need to provide complete records to support their tax return. Those who accurately report their taxes have nothing to fear from a SEP audit.

References

IRS Special Enforcement Program Overview

SEP Audit Process

SEP Regulations

IRS Enforcement Budget and Resources

IRS Criminal Investigation Division

IRS Strategic Plan