Keeping pace with the ever-changing tax regulatory landscape can be difficult and time consuming. Noncompliance can result in hefty fees, penalties, and audits.
According to new data released in October 2022 by the IRS, tax gap estimates are on the rise. The IRS defines the gross tax gap as “the difference between estimated “true” tax liability for a given period and the amount of tax that is paid on time.”
Based on IRS projections for 2017-2019, the estimated average gross tax gap is projected to be $540 billion per year. After a projection of enforced and other late payments totaling $70 billion, the net tax gap projection is $470 billion.
In an effort to narrow the tax gap, the IRS stated that it collected more than $4 trillion in taxes, penalties, interest and user fees in 2021, the latest year for which data is available.
Given the findings, one can only expect the IRS will continue to ramp up its compliance efforts. This is especially true in light of the 2022 Inflation Reduction Act.
One of the provisions of this legislation allotted an additional $79.6 billion in funding to the IRS. The news quickly raised eyebrows as word spread that a large portion of the funding would be spent on compliance enforcement.
Ensuring tax regulatory compliance has always been critical, but, given the recent developments, it is now more important than ever.
What is tax regulatory compliance?
Tax regulatory compliance is when a taxpayer (business or individual) complies with federal, international, and state tax laws in a timely fashion.
This may seem straight forward, however, staying compliant in today’s complex tax environment can become challenging. This is especially true for small businesses given the numerous tax implications they face.
What are the main types of tax regulations?
The are three main types of tax regulations, which describe the type of rule or law as either procedural, legislative, or interpretive regulations. Let’s take a closer look at each.
1. Procedural regulation
A procedural regulation would be where Congress gives the IRS authority to administer the tax law through rules the IRS creates for ease of administration. For instance, who must file a tax return and when those returns are due, how to file an extension, what must be included on the tax return etc.
To further illustrate, consider the following example:
When President Trump was elected, he ran on a political ticket that he was going to simplify the individual income tax return so that computing individual income taxes was so easy it could fit on a postcard. He signed something very similar to this post-card-type-individual income tax return into law under the Tax Cuts and Jobs Act and IRS created regulations to support that Act. This is a type of procedural tax law change because it provides guidance on how to report individual income and deductions and how the IRS should accept that information.
2. Legislative regulation
A legislative regulation is typically what can be taxed and what is deductible or includible in income. When the government wants to incentivize individuals and businesses, they may create a tax credit to entice people to behave a certain way or make certain purchases.
For example, President Biden ran on a ticket to reduce greenhouse gases and incentivize businesses and families to go green by creating tax credits that induce people to reduce their carbon footprint. This can now be seen in the CHIPs and Science Act and in the Inflation Reduction Act. We are seeing new IRS regulations on credits for going solar or purchasing an electric vehicle, credits that incentivize businesses to begin manufacturing semiconductor chips here in the United States, and that incentivize STEM education programs and jobs.
3. Interpretive regulation
Interpretive regulations help administrative agencies clarify the rules. An IRS Notice is an example of an interpretive rule because notices don’t attempt to change the laws passed by Congress — rather, they provide clarity if any ambiguity exists.
The IRS will issue temporary regulations or proposed regulations and give taxpayers a time period to read the regulations and provide feedback on whether the regulation aligns with Congress’ intent. Receiving comments helps the IRS provide interpretive guidance in Notices to clarify areas of the law where it is needed.
What is a tax compliance measurement audit?
A tax compliance measurement audit is typically a line-by-line audit of everything presented in the individual or business tax return.
An auditor will contact the taxpayer and request documentation or evidence supporting the items on the return. If the auditor finds there is an error in the amount of tax due, the auditor will educate the taxpayer and will assess the correct amount of tax that should’ve been paid. Often there is interest due on underreported tax based on when that tax should’ve been paid. Sometimes there are penalties if there is a gross misstatement in taxes due or a finding of willful evasion of tax due.
A compliance measurement audit is different than a desk audit or letter audit, in which the taxing authority (IRS or state) may want clarity or evidence supporting just one transaction or one line item on the return. In this instance, the taxpayer generally won’t meet an IRS or state auditor to close this type of audit.
What is an example of tax compliance?
On the federal tax side, an example of tax compliance for individuals is properly reporting any income or accession to wealth in a calendar year. Individuals typically receive W-2 forms reporting income they received from their employer, or if they run a small business, they need to file forms to report their business income received (less allowable ordinary and necessary business expenses paid). Taxpayers are in compliance if they file an accurate return by the return due date, which is April 15th each year, not including extensions.
What are the common pitfalls within tax compliance?
Common pitfalls within tax compliance are human error, or not getting all the information from the business owner or individual. This can result in missed deductions or miscalculations. Even when all of the information is present, humans make mistakes with mathematical errors and transpositions of numbers.
What are the best sources to stay up to date with tax regulations?
Tax and accounting professionals must ensure they are leveraging the tools and resources needed to stay up to date with tax regulations. These include:
- Networking: Run workshops for tax teams to share their knowledge and experience of a particular tax area.
- Individuals can also subscribe to list serves on the IRS website and state department of revenue websites and receive email updates in their email inbox with tax news and new regulations.
- Webcasts and Events: Browse events, including upcoming and on-demand webcasts, hosted by leading tax, audit, and accounting experts to stay up to date.
- Technology: Leverage tools like tax and regulatory alerts to get proposals, new laws, and regulatory updates as they unfold. Ideally, such alerts can also be drafted for social media or for your clients.
How do you ensure compliance with tax requirements?
It depends on the complexity of the taxpayer’s financial situation, but usually using a reputable and competent CPA, IRS enrolled agent-tax preparer, or tax attorney is the best way to ensure compliance with tax requirements.
However, most individuals that only have W-2 income from their employer can rely on reputable tax return software that will guide them through an online tax interview to properly determine their income tax liability.
Ensuring tax compliance can be difficult, but it doesn’t have to be. Tax and accounting professionals can keep clients in the know with the right tools and technology. Take action today to ensure compliance.
To learn more about other problems in the accounting industry, read “Top accounting issues in 2023”.