Are You A Compliant Taxpayer?

 In IRS Problems, Tax Debt, Tax Filing

What does it mean to be a “compliant taxpayer”? A compliant taxpayer is one that is in good standing with the existing tax rules and regulations. In a general sense, this includes the following:

  1. Meeting all filing requirements
  2. Paying all amounts due and owing to taxing authorities on a timely basis
  3. Reporting all includable income
  4. Reporting only deductions that are allowed by law
  5. Responding timely and adequately to any notices received by taxing authorities

Do you think you are a compliant taxpayer?

If you are not sure, read on! Here is a hint- all 5 of these are required!

Meeting All Filing Requirements

In order for a taxpayer, be it an individual or a business, to meet all filing requirements, the taxpayer first needs to know what those filing requirements are.

  • Individual Income Tax– As a general rule, an individual with income exceeding the standard deduction for the tax year is required to file an income tax return for that year. The standard deduction is based on the taxpayer’s filing status (such as single, married filing jointly, married filing separately, head of household, or qualifying widow(er)) and is generally adjusted for inflation each year. But there are also other special situations where an individual’s income could be significantly lower than the standard deduction and the taxpayer is still required to file. A couple of examples are if the taxpayer received self-employment net profits of at least $400 or had health insurance under the Affordable Care Act (commonly known as “ACA” or “Obamacare”). So, it’s possible that a 14-year-old cutting lawns or babysitting over the summer, to earn a few extra bucks, may actually have to file a tax return.
  • Business Income Tax– For a business that reports its income on the owner’s individual tax return as a sole proprietorship (or a single-member LLC classified as such) the business is considered the same under the tax law as the individual owner.

For businesses classified under the tax law as C Corporations or S Corporations, even if the business doesn’t have any income or activity for the year, the business is still required to file. There is no “standard deduction” rule that excuses them from filing, even if the owner formed the business and never did anything more to cultivate the business or earn any income. This is a rule that many taxpayers are unaware of until years later when they receive notices assessing penalties for unfiled returns.

A Partnership may or may not have a filing requirement depending on whether there is net income attributed to the entity for that year.

  • Other Tax Returns– Keep in mind that income tax is not the only type of tax for which taxpayers must comply. Payroll and sales tax compliance are extremely important as well in cases where they apply, estate and gift tax compliance may be applicable, and excise tax could also apply in certain circumstances based on particular products and services involved.

Whether the taxpayer is an individual or a business, to achieve tax compliance, it is important to file a return, if required, and to file it on time. If for some reason the taxpayer does not have the ability to file by the original deadline, oftentimes an extension may be available by request, or in some instances it may even be automatically granted provided that all taxes are paid to the taxing authority by the original due date. But always remember that an extension of time to file is NOT an extension of time to pay! Penalties and interest will be assessed on the unpaid tax from the due date of the return until the balance is paid in full.

Paying All Amounts Due and Owing on a Timely Basis

This is probably the one that trips up the most taxpayers, especially those who are self-employed. We have a “pay-as-you-go” tax system, which means that taxpayers are expected to pay tax throughout the year as their income is earned.

  1. Income Tax for Employed Individuals– When individuals work for an employer, “paying-as-they-go” can be relatively easy, because the employer takes the money and remits it directly to the IRS, the state, or the relevant taxing authority in question. However, in some cases, even individuals who work for an employer may not be compliant taxpayers. Sometimes they claim more “allowances” than they are entitled or claim that they are “exempt” on their Form W-4, when they are not legally eligible to do so, which prevents the employer from withholding income taxes. This results in that individual underpaying taxes throughout the year, and potentially a large bill when taxes are due. Quite often it results in a large bill that the individual is unable to pay.
  2. Income Tax for Self-Employed Individuals/Business Owners– Self-employed individuals and business owners are responsible for “paying-as-they-go” on a quarterly basis. For small business owners, sometimes it can be tough to determine how much income they will have for the entire year when the first quarter’s payment is due. The good news is that there are “safe harbors” that allow the self-employed individual or business owner to avoid penalties, provided that they pay in an amount calculated based on last year’s taxes, or in some cases for a new business based on the quarterly operations of that tax year.
  3. Payroll Tax, Sales Tax, and Other Taxes– Businesses that have employees, sell goods or services subject to sales tax, or are subject to excise or other taxes are also required in many cases to pay-as-they-go, depositing the amount due to the taxing authority throughout the month or year. It is possible that a business may be an annual depositor (payer) for one type of payroll tax such as federal unemployment tax (FUTA) but be required to remit Form 941 deposits (Social Security, Medicare, and Federal Withholding taxes) on a bi-weekly basis. Sales tax remittances can also vary depending on the state, county, value of goods or services sold in the jurisdiction, exemptions under the law, and other factors.

For businesses that have locations, employees, contractors, clients, or ship goods to customers in more than one state, the compliance obligations can balloon quickly. It is extremely important for businesses that are considered to be “conducting business” in multiple states by any of these means to engage with a professional to determine the extent of their tax compliance obligations. No offense to taxpayers, but they are almost always unaware of the extent of their compliance obligations until they engage with a professional, especially with many state departments of revenue rapidly updating their tax laws.

Reporting All Includable Income

The definition of gross income under Internal Revenue Code §61 is “all income from whatever source derived” “except as otherwise provided”. What that means is that the general rule is to include everything in gross income unless it is specifically excluded elsewhere in the tax code.

There are many items includable in gross income that taxpayers are not aware of which go unreported on their taxes. For example, some common ones are forgiven credit card debt, unemployment income, gambling income, or even a state income tax refund from the previous year could be taxable.

And income tax is not the only issue. Many taxpayers do not report their full gross sales on their sales tax returns. Down the road, they get an audit notice because the state has compared the revenue that the taxpayer reported for income tax to the revenue that the taxpayer reported for sales tax, and the numbers do not agree. It is an easy catch for the state since it has both sets of data.

The IRS has increased its reporting requirements with regard to third parties to such a degree that underreporting income can oftentimes be detected without even involving a person! The IRS’s computers are able to compare the Forms W-2, 1099 series forms, 1098 series forms, and other third-party reporting forms to what is being reported on an individual’s return or the absence of a filed return, and easily catch many discrepancies or underreported income. They can also catch excessive deductions via third-party reporting as well in some cases.

Important to keep in mind though is that even if income is not reported on a W-2, 1099, or other third-party forms if it is includable in income under IRC §61, you should report it on your return. You can then determine if there are ways to offset that income with deductions to reduce the amount of tax you might be obligated to pay.

Reporting Only Deductions Which Are Allowed by Law

It is important for taxpayers to realize that there are generally no “automatic deductions” other than those allowed under the law, such as the standard deduction for federal income tax, and potentially personal exemptions on a state income tax return.

For example, some taxpayers think there is an “automatic” $500 charitable contribution deduction for anyone who wants to claim one, or there is an “automatic” amount of your house payment or apartment rent that you can use as a home office, or there is an “automatic” amount of mileage that you can deduct as business miles. Those are fallacies. If the deduction is not allowed under the Internal Revenue Code, then it should not be deducted on the return.

During the preparation of the tax return, it is important for the taxpayer to discuss with his or her preparer any deductions which he or she feels may be appropriate or concerns about those which may be questionable. It is not the preparer’s job to catch every wrongfully claimed deduction on a tax return; it is the taxpayer’s job, and all items on the tax return are the taxpayer’s representations.

Responding Timely and Adequately to Any Notices Received

Did you know that taxpayers have an obligation to open their mail? Believe it or not, if the IRS or other taxing authority sends you mail and you do not respond after sufficient time passes, they are within their rights to assess whatever tax, penalties, and interest are included in that envelope. After more time passes, they can start levying whatever assets they can get their proverbial hands on. The taxpayer definitely is entitled to due process and can object, but the longer the taxpayer waits to do anything about the notice received, the worse off the taxpayer will be. If you retain only one thing in this article, retain this: 1) open your mail and 2) contact a qualified representative (Attorney, CPA, or EA) if you receive a notice, as early in the process as possible! Okay, that’s two things, but you get the point.

After reading this, if you have determined that you as an individual, or a business you own is not a compliant taxpayer, no worries! Simply fill out the form for a free consultation, and my firm would be happy to help you along your road to achieving compliance.

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