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This is Part 1 of a two-part post on the interlocking topics of tax compliance and commercial lenders.

CEOs have to keep their eye on at least two races, the first being their strategy to compete, and the second being to do so while in full legal compliance.

Full legal compliance means both tax compliance, as well as hewing within all other applicable laws.

This week we dive into tax compliance, and next week, how businesses that are in full compliance with all regulations present a far easier entity to partner with, from a lender’s perspective.

With regard to tax compliance, small businesses act out of various “motivations,” if you would call it that, not unlike the motivations of people in general. The mix of motivations may include:

• a sense of morality
• a belief in the legitimacy of government and trust in the system codified by government
• a desire to be part of the “tax paying public”
• risk aversion.

Keeping in the good graces of the Federal, state and local government regs by paying taxes on time, segregating and tracking employee withholdings, submitting annual W2 forms and the like are not just a strategy to avoid “getting caught” and commensurate penalties. Firms voluntarily comply with the tax laws because it is the just and right thing to do.

However, it is also true that the penalties of not complying can be stiff and can snowball to hamper one’s business.

Grapple with your business challenges, not tax compliance

As Paul Herman, CEO of a full service Westchester CPA firm, explained, “You should be in good graces with Uncle Sam because you want to be in conformity with the law. If you don’t file things such as the quarterly payroll taxes, withholding, annual W2 forms and 1099 forms on time, you will subject your company to penalties that over time could become significant. Businesses that “borrow” from the federal or state government bring onto themselves cash flow problems. They can find themselves behind the eight ball once they get into that habit. They will be charged interest and penalties, which can pile up rapidly.”

Here is one example of a faux pas that small businesses should avoid: treating an employee as a independent contractor.

The law clearly delineates between what constitutes an employee, and what constitutes an independent contractor. An employee should be subject to withholding and other payroll taxes, including both employer and employee-paid contributions to social security. In addition, depending upon the array of benefits that a firm offers, health insurance or pension plan deductions may apply.

If a company treats an employee like an independent contractor and thereby skirts the guidelines, that business will be in for a bumpy ride. The government can come in and do an employment audit and determine that someone who was treated as a contractor should properly be classified as an employee. That may entail being covered by the firm’s pension plan and other benefits extended to workers. Following this “hypothetical” example from step to step may ultimately mean the government disallows deductions to the pension plan, which in turn means that your business has underpaid its taxes.

Surely, the reader can see the direction this is going. One “oversight” can lead to serious penalties. So in all cases, utilizing solid accounting principles and complying with all legal and tax regs is paramount for your business.