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Tax Compliance

Updated on January 4, 2024
Article byWallstreetmojo Team
Reviewed byDheeraj Vaidya, CFA, FRM

Tax Compliance Meaning

Tax compliance refers to the degree or extent to which organizations or individuals comply with the tax laws in a nation. It is taxpayers’ responsibility to follow the set rules and pay their taxes on time every year. Non-compliance with tax tarnishes the image of an individual or company.

Tax Compliance

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Governments set different tax laws to control tax computation, procedural requirements, and income spending requirements. Compliance, in this case, is essential as both state and federal governments earn their revenue through tax collection and utilize the funds for the nation’s development. Note that the tax laws vary from one state or country to another.

Key Takeaways

  • Tax compliance definition refers to the decision of taxpayers, including companies and individuals, for example, salaried persons, to abide by the tax laws of any given nation. 
  • The willingness of the taxpayers to follow the rules is key to ensuring that the govern has the money to fund the different welfare schemes, operate public institutions, improve the infrastructure, and develop the economy.
  • Two vital elements of this type of compliance are deadlines and documents. 
  • A key difference between tax compliance and planning is that the former does not require taxpayers’ focus all year round.

Tax Compliance Explained

Tax compliance refers to individuals’ or businesses’ willingness to comply with the tax rules of their country. This involves filing returns within the due date, declaring the total taxable income with accuracy, filing out the right income tax return forms, and claiming correct deductions. Moreover, it requires people to pay the right amount of tax owed to the government.

Adhering to all the set rules and regulations is crucial for taxpayers to steer clear of additional charges, for example, interest or penalties imposed by an organization administering and enforcing all tax laws of the country. An example of such an organization is the Internal Revenue Service (IRS).

A business or individual that complies with all the laws within a nation does not engage in tax avoidance or evasion. Note that persons must follow the law irrespective of what rules and regulations the government has set.

Organizations and individuals must look for professional advice from any trustworthy tax consultancy firm in case they are unsure how they are unsure whether they are meeting all the tax compliance requirements.

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Elements

Some key elements of this concept are as follows:

  • Payments: Individuals and organizations need to make tax payments need to pay taxes every year within a due date set by the federal or state government. Also, the amount of tax paid must be accurate. Note that in the case of underpayments, the IRS has the right to impose penalties and interest. Moreover, one must remember that if persons avoid tax intentionally, they can be subject to criminal prosecution, which can lead to imprisonment or fines.
  • Record Keeping: One must know what and how to record. This ensures that taxpayers prepare filings correctly and provide accurate information to the IRS. Moreover, if an individual or organization maintains the correct records, in the case of any tax-related problem or audit, tax lawyers can utilize the paper trail to resolve the issue and determine whether the problem was deliberate or inadvertent.
  • Documents: Businesses must accumulate documents from every worker or employee they hire. Once the tax season begins, organizations must distribute 1099s and W-2s to contractors and employees, respectively. Note that taxpayers must ensure the distribution of the right documents.
  • Filing And Reporting: Another key tax compliance requirement is that every taxpayer operating on a tax year that ends on December 31 needs to fill out a tax form to report their taxable activity for the assessment or previous year. They need to report the activity accurately in the right form.
  • Deadlines: Taxpayers have multiple due dates for payments, filings, and deposits. For instance, an individual must pay the tax amount due within a specific date. Additionally, businesses must deposit the tax withheld from their employees’ paychecks on a particular schedule. That said, the determination of the pay period takes place on the basis of the tax liability amount and the pay period utilized by the business.

Examples

Let us look at a few tax compliance examples to understand the concept better.

Example #1

Suppose Country ABC’s citizens are extremely happy with how the government is spending its revenue to offer better infrastructure, healthcare facilities, and education. Because of this, a major portion of the nation’s population fulfills all the requirements concerning tax compliance. This means the majority of businesses and individuals accurately report their income for the assessment year and make tax payments within the due date. On account of the high tax collection, the government can grow the economy at a significant rate.

Example #2

In June 2023, the United States District Court ordered Kraken, a popular crypto exchange, to provide the IRS with information related to transactions and amounts. The federal tax agency said that it required the details to find out whether the users of that exchange underreported their income.

According to the court order issued in June, Kraken needed to give information about the users involved in transactions worth more than $20,000 in a calendar year. The information had to include TINs, birthdates, names, email IDs, etc.

How To Improve?

Governments must take the following measures to improve compliance:

  • First, governments need to monitor tax compliance better. For this, they must maintain a register comprising all unregistered taxpayers and have only one Tax Identification Number (TIN) to identify a taxpayer and detect unregistered taxpayers.
  • To collect accurate taxes, governments must create and implement an effective audit plan. The plan must include the guidelines for the audit so that the government can spot evasion of tax.
  • Any government must enable electronic tax payment and filing. This will make it convenient for individuals and businesses to fulfill their tax-related obligations.
  • Governments must make changes the existing administrative practices if necessary to improve efficiency concerning tax collection.
  • Every government must allocate certain funds to develop and utilize technology for the automation of tax-related processes. Besides streamlining taxpayers’ compliance efforts, this step can help reduce errors.

Importance

One can go through the following points to understand the importance of this concept.

  • Complying with the tax laws ensures that companies or individuals do not have to pay penalties, fines, or any additional charges.
  • It enhances financial credibility.
  • When businesses and individuals pay their taxes accurately and on time, it helps in the nation’s progress.
  • It also plays a key social engineering role in various modern market democracies.

Tax Compliance vs Tax Planning

The concepts of tax compliance and planning are often confusing for individuals new to the world of finance. One can clearly understand their meaning and purpose by knowing how they differ. So, let us find a few of their critical differences highlighted in this table.

Tax ComplianceTax Planning
It refers to the degree to which a taxpayer, for example, a company or any individual, adheres to the tax-related regulations within a nation.Tax planning involves engaging in financial planning to increase tax efficiency. 
It is less complicated and involves taxpayers focusing when they need to file their tax returns. Tax planning is more complex; one needs to focus on it throughout the year.  
In this case, a few key elements are deadlines, record keeping, payments, and documents. Some crucial elements of tax planning are tax-efficient investments, adaption and evaluation, and holistic review.

Frequently Asked Questions (FAQs)

1. What is voluntary tax compliance?

It refers to a principle that a given country’s citizens will comply with the government’s tax laws, filing accurate tax returns within the set deadline. Simply put, it implies voluntary compliance with the government’s tax laws.

2. What does a tax compliance officer do?

Tax compliance officers engage in planning and carrying out investigations of taxpayers, including businesses and individuals. They are responsible for analyzing the financial condition of taxpayers along with all associated operations.

3. What are the factors that affect tax compliance?

Some noteworthy economic and non-economic factors impacting tax compliance are as follows:
– The income level of the taxpayer
– Audit probabilities
– Penalties
– Tax benefits
– Fines
– Perceived fairness
– National norms
– Tax rates
– Social norms

4. What is the level of tax compliance in the US?

According to the website of the IRS, the net compliance rate in the United States stands at 83.7% after considering late payments and enforcement.

This article has been a guide to Tax Compliance and its meaning. We explain how to improve it, its examples, importance, elements, and comparison with tax planning. You may also find some useful articles here –

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