Importance of Reporting All Income to the IRS
by Simplice Essou | October 13, 2023
Business ownership can be very rewarding. However, it comes with many responsibilities. One of these responsibilities include the filing of the annual income tax return due by April 15 for businesses. Tax return preparation can be a long and time-consuming process that does not add to the bottom line. However, it is required to stay in compliance and avoid penalties. Income tax preparation and reporting requires the revenue and expenses to be calculated and reported accurately. Failure to report income accurately (underreporting) can lead to fines, penalties and in some case jail time.
Who needs to report business income?
Businesses need to prepare and file annual income tax or information return in case of partnerships. The information return is used to notify government agencies and the Internal Revenue System (IRS) and provide information regarding the owners and the company. This tax return reports business transactions during the year. These include income, gains, deductions, credits, losses. This is also important for determining the income tax liability of the business.
How does the IRS know a business is underreporting its income?
The IRS verifies the income taxpayers report on their returns by comparing the data businesses and other organizations report on Form 1099s, Form W2 and others. This data is gathered when they pay contractors, employees, and other payees. In cases where there are differences between the two reports, the IRS will ask the taxpayer to explain the discrepancies. The IRS will send that request on Form CP2000, Notice of Underreported Income. This notice is also referred to as the Notice of Proposed Adjustment for Underpayment/Overpayment and is the most common notice sent out by the IRS.
What happens when you underreport your income?
When the IRS discovers that a business has underreported income, whether it is intentionally or unintentionally, the business is exposed to tax penalties and possibly criminal prosecution.
According to the IRS, taxpayers who intentionally fail to accurately report their income, may face the following severe consequences:
- Be charged with a felony
- Five years in jail and/or a fine up to $250,000 or $500,000 for corporations
- Civil penalties
- Increase likelihood of being audited by the IRS
Steps to accurately report your income to the IRS
Businesses need to ensure there is a system in place to accurately track and report income and expenses by using the following steps:
- Open a business account: It is crucial to open a business account to ensure proper segregation of personal finance and business finance.
- Select an accounting method: Before starting to track the income and expenses, business owners need to select one of the two main accounting methods: cash basis or accrual basis.
a. Cash basis: When the cash basis is used, sales and expenses are recorded when the cash is received for sales and payments are made for expenses.
b. Accrual basis: When the accrual basis is used, income and expenses are recorded when they are incurred. - Select an accounting system: An accounting system such as QuickBooks online can help reduce the risks of underreporting your business income.
Overall, businesses should be aware that underreporting their income could come with harsh consequences, therefore, ensuring an accurate tracking system is in place is crucial for the life of the business.
Author: Simplice Essou
