Not every business owner can be a tax accountant, of course—and should not try to be. But without awareness and attention to what tax compliance requires, your business can’t even provide the information and documentation that your tax professionals need to do their job.
Without tax compliance knowledge, some pivotal business decisions, including the structure of a new business and its filing schedule, for example, will not be fully informed. And tax compliance guidance is different for a small business, a sole proprietorship, a professional or other partnership, or a corporation.
At the foundation of all compliance is adequate record-keeping of information like:
- Employee or partner hours
- Expenses and their documentation
- Income sources including billing records, and tax payments
- Filing these records and payments by various categories
A well prepared business is one that keeps compliance front of mind by utilizing applications to accurately (and regularly) record information so when tax time arrives you don’t find yourself buried in a sea of paperwork.
Some important issues for tax compliance
Let’s look at some of the aspects of tax compliance important to every business. The last tax reform enacted by Congress modified some aspects of the tax code, including compliance and, partly in response, some states changed their own tax regulations. In fact, the Tax Foundation reported that 23 states and the District of Columbia had significant tax changes that took effect July 1, 2019. The Tax Foundation provides a list of the most significant in each state. For example, Massachusetts and the District of Columbia added new payroll taxes to support family leave programs.
Compliance costs are significant—and can be reduced. For any business, the cost of complying with tax laws and regulations is going to be significant. U.S. businesses file more than 10 million tax returns each year at an estimated cost of $4.4 billion in compliance costs. We are talking about 240 million hours spent filing returns. That is separate from the payment of taxes–but costs are costs. This means the issue deserves attention not only to reduce taxes and avoid fines, but also to cut costs.
How you start can make all the difference. The largest businesses will organize as corporations, and have to accept what is called “double taxation” on income earned by C corporations: the corporate income tax (federal and sometimes state and local) and also taxes on salaries and wages paid out of those corporate earnings. The tax treatment of “small business” traditionally has been more favorable. A sole proprietorship, partnership, or limited liability corporation pays tax only on the earnings of the owner or owners. And by the way, today what is considered a “small business” may have up to 500 employees and $7 million in revenue depending upon the industry (and many “exceptions” are even larger).
Underpaying taxes, even without intending to do so, you can jack up compliance costs and potential fines and other penalties. Businesses that handle a lot of cash seem most at risk for underpaying income and overstating expenses. But, in fact, the issue is front and center for all businesses, including professional partnerships. The answer is tracking and record-keeping systems that provide you with ongoing summaries of all the information you need on both income and expenses.
Partnerships have special challenges in tax filing. For a partnership to file a federal tax return, for example, you will need your year-end profit and loss statement, plus details and totals about all sources of income and types of expenses paid by the partnership throughout the year. One of the top “triggers” for an IRS audit is the failure to track business expenses related to travel, gifts, entertainment and meals to distinguish between those that qualify as a deduction and those that do not. This is a matter of accurate tracking of expense reporting and billing. In addition to your income statement, you will need your balance sheet on property purchased and depreciation expenses. And you will have to list shares of each partner and how profits and losses are divided up by the partners. Partnerships from architectural firms to legal practices to medical practices can ensure that record-keeping by partners is current, consistent, and complete by installing a state-of-the-art time-tracking and billing system.
Be aware of changes and expirations. You should be sure that you keep up to date, with the help of your tax professionals, with changes in tax law. For example, recent federal tax reform, important to mid-sized businesses, changed “Section 179” to increase limits on write-offs on new property. As for expirations, by the end of 2019 the work opportunity credit and employer credit for paid family and medical leaves expire. Other changes affect renewable energy investment payments related to controlled foreign corporations. In fact, every year through at least 2024, there are other expiring provisions.
Your decision on cash vs. accrual. The timing of your tax obligations will be different, as a corporation, depending upon whether you elected the cash or accrual accounting method. The IRS gives corporations leeway in choosing which system to use, but once you have chosen a system you are required to stick with it. On a cash basis, you record income as you receive payment and expenses when you pay them. With accrual, you report both as they are incurred, not when actual money comes or goes. A good information tracking system can handle either approach, of course, but the timing must be understood.
Accurate and timely withholding and payment of employment taxes avoids trouble. Assuming you are a business with regular employees, employment tax requirements apply. Make sure you are withholding the right amount of taxes (e.g., federal, Social Security, Medicare) from each employee’s pay. And keep systematic track of your payments on behalf of those employees. This is treated very seriously by the IRS, so carelessness can get you audited and possibly fined or otherwise penalized.
If your business deals with hired contractors it imposes requirements on tax compliance. You don’t have to withhold, since they are not employees, but you need a system that keeps accurate, timely records of expenditures for contractors, including, of course, compensation, and then once a year fill out and send Form 1099 to the contractor and the IRS. The IRS stays alert to possible misuse of the contractor vs. employee distinction so make sure you are following the rules.
Another benefit of effective automated records is timely filing. Being late in providing something required by the IRS is an automatic compliance problem. There must be clear lines of responsibility in your business for knowing the many tax deadlines. If you operate on a fiscal year instead of a calendar year, deadlines for the types of forms and payment will be on different dates. At a minimum for purposes of federal compliance, your relevant dates are January 31, March 15, April 17, and quarterly payments of estimated taxes usually the middle of April, June September, and January.
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