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Voluntary Compliance

The principle for which all the taxpayers will file an honest and accurate annual return autonomously

What is Voluntary Compliance?

Voluntary compliance is an assumption under which the U.S. tax system operates. It is the principle for which all the taxpayers will cooperate with the tax system, filing an honest and accurate annual return autonomously.

 

Voluntary Compliance

 

Voluntary compliance does not mean that there are no tax-related laws or rules. It means that every worker is expected to file his taxes correctly without the intervention of the government.

 

How It Works

The Internal Revenue Service (IRS) plays a major role in the U.S. tax system. It is the federal agency in charge of enforcing tax-related laws. One of the agency’s main tasks is to implement income tax law for both individuals and corporations.

Every entity with an income (individuals and companies) needs to fill a form every year that declares his gross income in the past year. Based on this declaration, the entity will incur a debit or a credit with the government. It means that two situations can arise at the end of the income declaration:

  • The entity is in credit with the government, and it is entitled to get some taxes back; or
  • The entity is in debit with the government, and it needs to pay more taxes.

 

Filing taxes for all the taxpayers is too much work for the IRS itself. Checking that every taxpayer is declaring the truth will not be easy as well. In this context, voluntary compliance is introduced.

Not being able to control every taxpayer’s declaration, the U.S. tax system is working on the assumption that taxpayers will behave honestly, declaring the truth about their income, paying the right amount of taxes.

The key point to understand is that voluntary compliance does not refer to the act of filling the tax return, but it lies on the belief that the taxpayer will do it in a proper manner.

To file the tax return in an honest and correct way, taxpayers need to follow rules and laws presented and explained in the tax code. As often happens, the principles in the tax code are many, and they can be misleading or very hard to understand. For this reason, the IRS provides taxpayers with an easier form to fill in and easier guidelines.

At this point, when the time of tax return filling comes, the taxpayers can follow the guidelines and fill the provided form. Yet, it is up to each taxpayer to do it honestly, declaring their true income, and to claim deductions just if they are entitled to receive it.

 

Practical Example

To better understand how voluntary compliance works, let’s make an example. Let’s suppose that Bill works for a large company. He will receive from the company a W-2, which is a document that says how much income he received from that company in the past year.

Bill, however, earns income from other sources. In addition to his regular job, he sells his photos and teaches English to foreign kids. From both activities, Bill earns additional income. He does not receive a W-2 form where the additional incomes are declared.

At this point, it is up to Bill to include the extra income in his final tax return. If he decides not to report the extra income, it may or may not be caught by the IRS. Trusting that Bill will file a complete tax return is what we call voluntary compliance.

 

Voluntary Compliance for Large Corporations

Voluntary compliance can take on a slightly different meaning in the context of corporations. It can be a way to practice corporate social responsibility.

As individual taxpayers, companies must declare their income, too. They must follow the regulations and obey the laws, and, as for individuals, it is very hard and time-consuming for the government to check all of them.

An alternative is to let all tax filings be based on voluntary compliance. It is in the interest of the company itself to provide an honest tax return. It will help build a good reputation for the business and will increase its credibility.

 

Related Readings

CFI offers the Certified Banking & Credit Analyst (CBCA)™ certification program for those looking to take their careers to the next level. To keep learning and developing your knowledge base, please explore the additional relevant resources below:

  • Corporate vs Personal Income Tax
  • Form 1040-EZ
  • Progressive Tax
  • How to Use the IRS.gov Website

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