Does It pay to be honest?

Filing an income tax return is a great litmus test of a person’s honesty. Do you report all of your income, some of your income, or none of your income?

A constant theme of the IRS is the multi-billion dollar tax gap caused by the failure of people who either don’t report their income or under report their income thereby under paying their true income tax liability. The most current estimate of the tax gap reported by the IRS equals $485 billion. The largest group contributing to this problem are sole-proprietors who underreport their business income to reduce their assessed income and self-employment taxes. The IRS estimates this category accounts for $179 billion of the tax gap.

So who are these “tax cheats” who don’t pay their taxes? It’s your plumber, your electrician, your handyman, your lawn care service and for church going people, sometimes your preacher. It is ordinary people trying to get by and pay their bills. But why would they behave this way?

They behave this way because of the high cost required to be honest. They struggle to pay their bills, to provide opportunities for their children, and to reinvest in their business. They justify their moral lapse because of the lack of fairness in the tax laws and the government’s redistribution of wealth from their household to less deserving endeavors.

Once in a while a business owner comes to me with the desire to move from noncompliance to compliance, from skirting the laws and regulations to following the rules.

I explain to them what changes are needed. My explanation goes something like this: “You will have to pay self-employment tax of 15.3% on your net income in addition to income tax. Your income tax rate will be 15%. Whoops, I forgot to add the 7% Arkansas tax rate. You will need to quit paying your workers cash. Oh, you pay them with a check? Then you will need to send the IRS 1099s to report how much you paid them. Ask for their Social Security number and address so you can complete the 1099s.

“They don’t have Social Security numbers? Hmmm, that’s not good. You’re not supposed to hire illegal immigrants. When you have legal workers, you need to treat them as employees rather than independent contractors. You will need to pay one-half of your employees Social Security tax at the rate of 7.65% plus federal and state unemployment taxes.

“Don’t forget to get workers compensation insurance. Just estimate your labor cost will increase by 15% to 20% when you add both employment taxes and worker compensation insurance premiums together. Have you been collecting and paying your sales tax? You need to get your sales tax permit then. Well, you’re in business, you have to keep a set of books.”

Generally I don’t see this business owner again after this initial meeting. If I do see him again, the next conversation is to answer his questions created by his fear of taxing authorities incarcerating him for not complying with the laws in the past. I reassure them that they seldom put people in jail, they just take your money and assets. It can be expensive to be honest.

I work hard to keep my clients from paying a dime more of income tax than legally required, but I work within the framework of the Internal Revenue Code and other applicable laws and regulations.

I report my income and pay my taxes. If I wanted to cheat on my own income tax return, I could. As a CPA with 33 years of experience I know how to cheat with a low probability of being caught. I just don’t. I maintain my own integrity and I encourage my clients to be honest. The benefits of being truthful are greater than the cost of paying taxes.

If you are not honest, how do you view yourself? How you view yourself can affect your integrity in other areas of your life. How you think of yourself can impact your level of success in life and in business.

If your employees are aware what you do, you are training them to be dishonest. Do you want dishonest people working for you? A growing business needs honest employees. That should be self-evident.

There are many other downsides for businesses that underreport income. If you need to borrow money from the bank, underreporting your income can reduce your chance for a loan approval. When you need to sell your business, underreporting your income will make your business look less profitable and cost you significant money by reducing what a buyer will pay for your business. And the reasons go on.

Our government will create all sorts of obstacles for small businesses to overcome, but businesses could not operate profitably in an environment without laws and regulations. Laws and regulations can protect you from an element of people who are dishonest to the core. They do exist.

If you are a small business owner finding it difficult to rise to legitimacy, keep looking for the path to compliance. When you write your check to the IRS, I will turn my head and spit on the ground with you. I don’t like the way our government spends our money either. But don’t let our government’s lack of morality and lack of perceived fairness motivate you to compromise your integrity. It’s not worth it.

I hope you have a great night’s sleep tonight.