Small businesses are drivers of economic growth, bringing innovation and creating opportunities. However, when it comes to tax compliance, it’s an entirely different story. Despite the Internal Revenue Service (IRS) stating that small business is not an enforcement priority, the numbers tell a different tale. The 2021 tax gap estimates reveal significant non-compliance among small businesses, with over half of the underreporting tax gap attributed to them.
As the tax season approaches, as a small business owner, you have a role to play in closing this compliance gap and ensuring that your business meets its tax obligations. Fulfilling these responsibilities doesn’t just keep you compliant; it opens doors to maximizing your business impact and building a stronger, fairer economic system.
Throughout this article, we’ll go over the tax gap estimates and their components, the challenges small businesses face, the consequences of non-compliance, and more.
- Understanding the Tax Gap and Small Business Non-Compliance
- Small Business Compliance Challenges
- Why You Should Diligently and Honestly Report and Pay Your Taxes
- Bridging the Tax Gap: The Role of Small Businesses
Understanding the Tax Gap and Small Business Non-Compliance
So, what exactly is the federal tax gap? It’s the disparity between the taxes owed to the government and the actual amount paid on time. This gap has three sources: non-filing, underreporting, and underpayment.
According to the IRS’s most recent publication, the tax gap for 2021 is approximately $688 billion, broken down into:
- Non-filing: $77 billion, which refers to the failure to file a required tax return.
- Underreporting: $542 billion, resulting from inaccurate tax returns.
- Underpayment: $68 billion, arising from failure to pay taxes owed.
Small businesses make up 50% of the $542 billion attributed to underreporting. This can be further broken down as follows:
- Individual business income tax: $182 billion
- Small corporation income tax: $21 billion
- Self-employment tax: $68 billion
However, it’s important to note that these numbers may underestimate the true extent of non-compliance. The figures exclude certain data, such as corporate income tax, income from flow-through entities, foreign or illegal activities, digital assets, and pandemic credits. Therefore, the actual tax gap could potentially be higher than the estimated amount.
Small Business Compliance Challenges
Overcoming compliance challenges allows small businesses to operate while upholding their responsibilities within the tax system. But it really is easier said than done. So, let’s start by recognizing these challenges:
1. Poor Record-Keeping
When businesses fail to keep accurate and organized financial records, it becomes difficult to report income, expenses, and deductions accurately. These compliance failures contribute to the tax gap, as businesses may unknowingly understate their income or fail to report expenses accurately. Also, poor record-keeping not only hinders proper tax reporting but also makes it challenging for tax authorities to verify the accuracy of filed returns.
To overcome this, adopt effective record-keeping practices. This includes utilizing accounting software, hiring a professional bookkeeper, regularly reconciling accounts, and conducting internal audits for accuracy.
2. Misclassification of Business
Another significant tax compliance challenge small businesses face is misclassifying their business entity. Since different entities may be subject to other tax liabilities, inaccurate classification can lead to underpayment or overpayment of taxes, contributing to distortions in the tax system and widening the tax gap. Also, you might miss out on tax credits and deductions, which you would’ve qualified for had your business been correctly classified.
Seeking professional advice from tax accountants or attorneys can help you pinpoint the correct classification and avoid misreported taxes. Regularly reviewing and reassessing the business structure is essential to ensure ongoing compliance.
3. Complex tax regulations and obligations
The intricate nature of tax laws, rules, deadlines, and reporting requirements increases the chances of unintentional non-compliance, inadvertently contributing to the tax gap. You must understand various tax obligations, including tax filings, estimated tax payments, employee payroll taxes, and more.
Furthermore, tax rules are subject to regular updates and amendments. Staying on top of these changes can be overwhelming, especially for small business owners with numerous responsibilities. Here’s how we can be of help. Be the first to know about new tax obligations and industry trends. The MBE CPAs App keeps you informed with proactive push notifications for breaking news that matters to your business. Customize your news feed further and receive immediate alerts on relevant tax regulations and development, allowing you to adapt your compliance strategy swiftly.
Why You Should Diligently and Honestly Report and Pay Your Taxes
Skimping on taxes? Think again. Unreported income and unpaid dues ripple through your business and the economy. Let’s dissect the far-reaching consequences.
Penalties and Fines Imposed by Tax Authorities
Tax authorities can impose penalties and fines for failure to comply with tax obligations. These penalties can be substantial and quickly accumulate, adding financial strain to your business. The severity of the penalties may vary depending on the nature and extent of non-compliance. You can avoid these penalties and maintain financial stability by diligently fulfilling tax obligations.
Reputational Damage and Loss of Customer Trust
Customers may perceive non-compliance as a lack of integrity, trustworthiness, and commitment to ethical practices. As a result, businesses may experience a decline in their customer base and market share, affecting their overall growth and long-term viability. You can uphold your reputation and retain customers’ trust by consistently and honestly fulfilling tax obligations.
Restricted Access to Government Programs and Contracts
Many government programs and contracts require businesses to demonstrate compliance with tax regulations. Non-compliance can disqualify small businesses from participating in these programs and accessing lucrative government contracts. This restriction can limit growth opportunities and impede the business’s potential to participate effectively in the marketplace. By diligently meeting tax obligations, small businesses can maintain eligibility for government programs and contracts, enabling them to benefit from these opportunities.
Impact on the Overall Economy and Public Services
The tax revenue from businesses contributes to funding public infrastructure, education, healthcare, and other essential services. When businesses underreport or evade taxes, it strains the economy and leads to cuts in public services.
Bridging the Tax Gap: The Role of Small Businesses
Small businesses like yours are the backbone of our economy. Your commitment to tax compliance helps fund essential public services, supports government initiatives, and stimulates economic progress. Your efforts in bridging the tax gap are not only beneficial to your business but also to the broader community. As small business owners, you can shape the economy and contribute to its long-term sustainability. By maintaining your tax compliance, you can be vital in ensuring a robust future for your business and the communities you serve.
As you move forward, it’s crucial to implement strategies that prioritize meticulous record-keeping and staying updated on tax regulations and changes. In addition to utilizing resources, small businesses should consider seeking professional help when navigating complex tax regulations. Collaborating with a qualified tax professional can provide expert guidance and ensure compliance with tax obligations. At MBE CPAs, we have industry-specific experts who can guide you through tax regulations and compliance and identify potential tax relief opportunities for your business.
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