Just about every struggling business has tax problems. When expenses are very tight, it is very tempting for a small business with a few employees to withhold payroll taxes but then not pay them over to the IRS. Sole proprietors barely scraping by can’t scrape up the money to make their personal estimated income tax payments each quarter. Then these tax debts grow out of control quickly. Because of the extraordinary collection powers of the IRS, tax debts are often the most immediate and frightening challenge for a business owner trying to figure out what to do.
In this blog I address how tax debts can be resolved in a way to enable a business to reorganize and continue to operate. Next week’s blog will look at how to deal with taxes owed by a business which is going out of business, leaving some tax debts still owed by the business’ owners.
If your business owes a lot of back taxes, a Chapter 11 or 13 bankruptcy could help the business survive by significantly reducing its monthly debt payments, enabling it to better meet its operating expenses. These two kinds of bankruptcies would improve the business’ cash flow in three basic ways:
- some of the taxes or penalties may be written off (“discharged”) altogether;
- payments for rest of the business’ other tax debts are generally stretched out over a much longer period than the taxing authorities would otherwise allow, greatly reducing the amount needed to be paid each month; and
- ongoing interest and penalties would stop accruing, allowing your business to pay off the tax debt much more quickly.
Most important, these benefits would happen while you and your business was protected from the often-aggressive collection efforts of the taxing authorities. (The rest of this blog focuses on Chapter 13, since Chapter 11 is much more complicated and beyond the scope of this blog. If your business is in the form orr a corporation, which is not able to file Chapter 13, please call me right away to talk about you situation.)
An Example
How this works is best illustrated with an example. Imagine that the sole proprietor of a small pet store in a neighborhood strip mall had suffered a huge dip in business when a large PetSmart store opened less than a mile away, at the same time when the bad economy was already hurting her business. She did everything possible to win back customers and cut expenses. She reduced the hours of her two employees and worked many more hours herself, realigned her inventory towards products with higher profit margins, and used cheaper but more effective marketing. Her profits started to edge back up after a very tough two years. But in the meantime she had not paid four quarters of payroll taxes on behalf of her employees (although withholding taxes from their paychecks). And she had not paid her own estimated personal income taxes for two full years. When she pulled together the money to pay her accountant to prepare the appropriate tax returns, she found out that she owed $5,000 in employee payroll taxes to the IRS. In addition, she owed another $4,000 to the IRS for the last two years of personal income taxes for not making the quarterly estimated tax payments. These personal income tax obligations included $1,000 in penalties owed to the IRS for her failure to file the appropriate tax returns and to pay the taxes. She was also reminded of another $3,000 she owed to the IRS for income taxes that the IRS has stopped chasing her from 5 years ago.
With all her efforts, this business owner is now generating enough business income to start paying her ongoing taxes as they come due. But she is very afraid that she could not do this if the IRS would demand payment quickly for her thousands of dollars in back taxes. And if the IRS would start imposing tax liens and taking other aggressive action, it would sink her business for sure.
The pet store owner had also run up about $25,000 on her credit cards 3-4 years ago when she first started the business, and still owed about the same because of the high interest, late fees, and other charges. She had thought about filing bankruptcy to deal with this debt, but had heard that she could lose her business and that it would not help her with her taxes anyway.
A Solution
If the pet store owner came to my office I would tell her:
1) If she filed a Chapter 13 case, she would likely be able to KEEP her business. Unlike Chapter 7 (the more common “liquidation” form of bankruptcy), Chapter 13 is designed to enable you to continue generating income (and paying your creditors) through your business.
2) In a Chapter 13 case she would likely be able to avoid paying some or all of the $1,000 in personal income tax penalties. That could potentially reduce the $5,000 she owes for the last two years of income taxes to $4,000.
3) Also, in a Chapter 13 she would likely avoid paying some or all of the $3,000 income tax debt from 5 years ago. Older income taxes generally must only be paid if she can afford doing so.
4) Plus she would very likely only need to pay back part of what she owes to many of her other creditors, such as the credit cards. She might even not have to pay anything to these other creditors because Chapter 13 requires certain kinds of debts, such as recent income taxes and all payroll withholding taxes, to be paid in full before these other obligations receive anything. Reducing her overall debt this way would make it more likely that she and her business would have the money to pay those mandatory tax debts.
5) In most situations, with a Chapter 13 she would not have to pay ongoing interest and penalties on the taxes, avoiding hundreds if not thousands of dollars in her case. By being able to focus on the prior tax obligations and not be required to divert precious funds to new interest and penalties, these taxes would be paid that much more quickly.
6) From the minute she files a Chapter 13 case, the IRS and any other applicable local tax authorities must stop virtually all of their collection activities. That includes garnishments of bank accounts and accounts receivable (customers who owe her money), as well as tax liens, “till taps,” and even payments on voluntary payment plans.
So this business owner would be able to run her business and be protected from the taxing authorities, and would be given up to 5 years to pay the remaining $4,000 in income taxes and $5,000 in withholding taxes, without any additional interest and penalties. She would generally not have to pay the $1,000 in income tax penalties, the older $3,000 income tax, or the $25,000 in credit card debt except to whatever extent she was able to afford to do so. At the end of her Chapter 13 case, she would owe no taxes or any other debt.
So Chapter 13 can be a tremendously helpful tool for a business owner to successfully address her or her tax debts. However, the intersection of tax, bankruptcy and business law is very complex. You need an attorney deeply experienced in these areas. Some bankruptcy attorneys shy away from business bankruptcies, but The Law Office of Andres Montejo has a great deal of experience with them. You can call me personally to talk about your business and its tax debts at 305-817-3677. I look forward to helping you and your business.