In the United States, we have what’s called a system of voluntary compliance. Taxpayers tell the government what their income is and what expenses they have, and they figure their tax accordingly. It’s the honor system, but with a catch: Other parties also tell the government about your income and certain expenses. This is called information reporting, and it’s the way government checks up on taxpayers. It’s not a covert operation; you get copies of everything reported to the government. Who reports to the government on your child’s income and on payments he may have made? Here are some examples:
Employers report on wages and other benefits your child earned on Form W-2. This form also shows federal, state, and local income taxes that he paid on his wages and benefits through withholding. Banks report on interest your child earned on Form 1099-INT. Corporations report on dividends they paid to your child on Form 1099-DIV. Brokerage firms and mutual funds report on proceeds from the sale of securities on Form 1099-B. Lenders report cancellation of debt of $600 or more, such as forgiveness of certain student loans (whether or not you child is required to report this cancellation of debt as income). Schools report student interest that your child or you have paid (if it’s $600 or more) on Form 1098-E.
The government’s computer uses this information to cross-check that what’s been reported on the return is correct. If a different amount is reported, the taxpayer will get a notice from the government adjusting the tax bill. There’s another catch to this so-called honor system of taxes: It’s called withholding. Most taxes in this country are paid through withholding, primarily on wages. The government knows that withholding has been made on your behalf because it’s done under a worker’s Social Security number. Because tax has been withheld, the purpose of filing a return is to figure the exact amount of tax that should be paid, compare it with what was already paid, and settle up with the government (either pay extra or get a refund of an overpayment that has been made).
