Why do businesses get penalized by the IRS?

April 06, 2021

Find out why your business can get penalized by the IRS and avoid and legal issues

Paying your business taxes can be a pain, but it’s required by law to give a percentage of your income to the IRS to support various government-run programs and infrastructure. Forgetting to file your taxes on time or neglecting the process entirely can spell financial trouble for your company or lead to jail time. However, most businesses tend to receive penalties for minor infractions.

Penalty 1: Tax avoidance and tax evasion

It goes without saying that businesses should never willfully commit tax evasion because you’ll inevitably shoot yourself in the foot. When the IRS reviews your tax documents, they try to match up your declared income with your supported recites. If you fail to include income or file a tax return, you commit a sin of omission while avoiding to pay is a sin of commission.

A sin of omission isn’t as severe as a sin of commission and often results in a warning or an audit, depending on how serious the discrepancy is. It’s possible for a judge to rule a sin of omission as a sin of commission if the discrepancy seems intentional.

Tax avoidance is common because businesses may avoid doing taxes for months or make too many inaccurate deductions. If these deductions are supported by documentation, you commit tax avoidance. Your business will receive an audit if you file incorrectly. If you’re concerned you’ll commit tax avoidance, use a template, like an online W2 form, or consult a tax specialist.


Penalty 2: Over reporting income

One of the biggest positives of being a business is the ability to deduct expenses. However, some companies over-report because they expect that the expense will be deducted despite evidence of the contrary. A tax specialist can determine what you can deduct and if you can make said deduction without proper documentation. Avoid these common mistakes:

  • Reporting personal expenses as business expenses. 
  • Deducting a higher percentage of office space.
  • Claiming for friends/spouses who join the business owner during travel.

Penalty 3: Under reporting income

Under-reporting comes with a higher penalty than over-reporting because it’s impossible for the IRS to locate that income. You’d need to add more documentation to your tax return after the due date, which leads to late filing regardless if you filed before April 15th. Report all income and back them up with documentation. Always include cash transactions, even if they’re under $10,000 because they’re considered a business expense by the IRS.

    Penalty 4: Lifestyle doesn’t match with expenses

    The IRS will grow suspicious of your reported income if they notice you’re living a lavish lifestyle even though you claimed bankruptcy or have little debt. Both financial extremes will scream to the IRS that you’re hiding something. Ignorance of the law won’t hold up in court, so report all of your income and avoid the embarrassment of the government seizing your assets.

    Penalty 5: Not reporting sales tax or other taxes

    Taxes are placed on most goods and services in the United States, and the purchaser is required to pay for them. Some businesses will tax their customers but pocket the tax and not report it. The IRS almost always considers this tax fraud because businesses will use those funds to pay into their company, so be sure to separate all tax from your goods or services before filling.

    General fraud and tax fraud

    Most of the above penalties are under the umbrella of “general fraud” unless the business commits a willful act. Sometimes it’s difficult for the court to determine a willful act, but the judge may consider an act willful if an unwillful act seems fraudulent. Fines can’t exceed $100,000 for small businesses, but corporations could be fined up to $500,000. Penalties can include jail time.

    Tax avoidance is unlikely to bankrupt your business. Unwillful fraud usually receives a slap on the wrist by the IRS, and they’re likely to set you up with a payment plan. It’s better to avoid legal issues, so ensure you file correctly or consult an accountant.

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