You need to file your taxes each year, but have you ever stopped to think about why? Or what would happen if you didn’t follow all the applicable tax laws? Beyond the trouble that could ensue if the IRS discovered you did not file your taxes, there are moral and ethical reasons to care about filing your taxes correctly, otherwise known as tax compliance.
Read on to learn more about what tax compliance means, how to know if you are in compliance, and why individuals and businesses should care.
What Is Tax Compliance?
Tax compliance means following all the laws regarding taxes. Tax compliance can apply at the state level, federal level or both.
Tax compliance issues are often unintentional. People simply may not know that a rule that applied to them has changed, with new implications for their tax liability. However, even an accidental oversight comes with negative consequences, should it be discovered.
Individuals and businesses can use legal strategies to lower their tax liability. One common example is putting money into tax-advantaged retirement accounts to lower tax liability in the present year. What’s not allowed is tax evasion or using illegal strategies to avoid paying taxes you actually owe!
How to Handle Tax Compliance
Within the US, the IRS is the agency that handles taxation issues. The IRS reviews tax returns and either approves them or flags them for a review, called an audit.
While individual taxes tend to be straightforward, businesses have a more complex tax situation.
To ensure that all appropriate laws are followed, businesses and business owners often retain tax experts. These may include a CPA to prepare taxes, a tax lawyer to consult on recent changes to tax laws and a tax compliance company to ensure that everything is in the correct order.
Before we look more at when to consider working with a tax compliance company, let’s look at why businesses should make tax compliance a priority.
The moral case for this is simple. Businesses and individuals all have a tax liability, and it is our duty to pay it.
Those who receive tax refunds aren’t getting free money. They overpaid their taxes and are receiving what is rightfully theirs. Likewise, those who owe money underpaid and must correct the situation.
From a legal perspective, it’s against the law to evade taxes. Failing to file your taxes, under-reporting income and other tax evasion strategies are against the law. If you are caught, you face financial penalties.
For a business, there may be a loss in reputation associated with tax evasion. Imagine that your business is audited and found to have underpaid taxes: Newspaper headlines report on your misstep; customers lose confidence in your business; they switch to a competitor because they don’t want to give their business to a company they perceive as cheating. Not only have you lost your reputation, but you’ve also lost money.
How to Ensure Tax Compliance
Given the complexities of tax laws and different standards for state and federal taxation, it’s no wonder that many people seek expert help when it comes to tax compliance.
Even if you seek help from a tax expert, you should still understand the different areas associated with tax compliance. This background information can help you when it comes to gathering documentation and working with your CPA or other tax expert.
The following issues are all part of tax compliance:
April 15 is the standard deadline for tax filing — but it isn’t the only deadline to know.
For businesses, the IRS maintains deadlines on employee tax forms, such as tax withholding. Businesses that hire contractors must follow deadlines regarding 1099 forms as well.
You can get an extension on your taxes if you are unable to file by April 15, but you will need to formally apply for an extension, and it isn’t granted automatically. In fact, failure to fill out the paperwork requesting an extension can lead to fines and penalties.
It’s important to note that those who owe money will accrue interest on their debt from the standard tax filing date onwards, even if an extension is granted. If you owe money, it’s in your financial interest to file on time if you can. Otherwise, you are delaying the cost of a payment that increases the longer you wait.
Estimated taxes are due on income that is not subject to withholding, such as stock dividend income or self-employment income. Failure to pay this comes with penalties and fines.
Individuals and businesses need to worry about tax record-keeping. Documents are needed to prepare taxes. They may be needed if the IRS requests more information about an item on a return.
Business owners are allowed to claim expenses, such as the cost of leasing an office. However, they must have the records to prove this expense should the IRS come knocking. In this example, a lease agreement would prove the expense was legitimate.
The IRS recommends keeping records for three years from the date the taxes were filed. However, there are times when a document should be retained for longer. For example, businesses with employees must retain their employment tax records for four years.
Disposing of documentation too early comes with financial penalties if it’s discovered.
Individuals and businesses certify that their taxes are complete and accurate. However, mistakes can happen, and so can intentional tax underpayment, as discussed above.
If the IRS determines that you haven’t paid enough taxes, they can collect what you owe, plus interest and penalties. The IRS can act aggressively to recover these funds, for example by placing liens on business property. In a worst-case scenario, individuals could face criminal prosecution for deliberate underpayment of taxes.
Tax laws are complex and always changing. Most people do not have the time or interest in keeping up with applicable changes. Instead, they rely on tax professionals to ensure compliance on their behalf. With tax season coming up, make a plan for tax filing that covers compliance.