The IRS really hates businesses that fail to pay their payroll taxes for good reason. The government ends up paying for these failures twice. First, they never get the money. Second, they end up having to credit the employees with the withholding and potentially pay refunds on the money they never received. The resulting IRS policy is to put you out of business as soon as possible to avoid the run-up of these tax debts.
What should you do if your cash flow just can’t hack it?
Step 1 is to stop digging the hole. Immediately, start paying your payroll taxes for each payroll at the same time you pay the employees. If your cash situation is so bad that paying your payroll taxes and employees is not feasible, start laying them off until you get it down to what you can pay. In my experience, the idea that your business is going to magically improve next week never happens.
Step 2, you need a new business plan yesterday. The planning process needs to consider all the standard cash flow options such as collecting on receivables, stringing out suppliers, and improving inventory turns. Cash flow is one thing, but profitability is the only thing that works in the long term. Unless you can find a clear path to profitability, the company is not going to survive. Recognize it. Close it. Go on to something new.
Step 3 is to minimize the impact on you the business owner. The IRS will eventually show up and assess a penalty on you personally for the monies withheld from the employees’ paychecks. You can minimize this impact by paying those trust funds personally and designating that payment to be applied to the “trust funds only”. This will reduce the unpaid trust funds portion that the IRS could eventually assess upon you. This only works if you make the payment voluntarily. The company cannot do this.
Unpaid payroll taxes are the worst tax debt you can have. The IRS will eventually shut you down, but they usually don’t show up until the debt is large. You then file for bankruptcy, but the IRS will assess the Trust Funds Penalty on you personally. Now you’re out of business and an employee again. But you owe $100k or more with the IRS threatening levies against your wages for the next 10 years. The time for action is now.
You owe the IRS a lot of money. What can you do to get your life back on track? Basically, it comes down one of three options:
- Convince the IRS that you are not in a position to pay
- Make a deal to make monthly payments over a period of time
- Make an Offer-in-Compromise in that the IRS will take some smaller amount and write off the debt balance.
Figuring out which of these three doors is the best option for you depends on your situation as defined by an IRS formula called the Reasonable Collection Potential or RCP. The RCP takes your monthly income and offsets that with “allowable” expenses to determine your disposable income (i.e., what you could pay the IRS monthly). This is the base line amount for negotiations with the IRS.
If your RCP is zero, then the IRS will check a box on your file as “Uncollectable” and go away for 18 to 24 months. They will revisit the case every couple of years until the Statute of Limitations expires at which time, they will write-off the balance.
If your RCP is a positive number, all is not lost. You can to some extent arrange your financial affairs so as to minimize the RCP calculation. Making these payments regularly usually means that the IRS will leave you alone until the Statute of Limitations date gets close. If a final check of your records does not show anything stupid like the purchase of Leer Jet, then they will likely write-off the balance.
Finally, there is the Offer-in-Compromise that is so famously shown on TV as “I only paid pennies on the dollar”. Frankly, that is hooey. Why would the organization with the most collection powers in the world just let someone go? The answer is that they don’t. Fully 80% of Offers are rejected by the IRS. The 20% that are accepted only happen because the taxpayer was able to demonstrate that this was the best deal that the IRS could expect to make.
There is a fourth option that makes sense in some cases – filing bankruptcy. The rules are a little complicated and you need to consider this with an experienced attorney who specializes in bankruptcy.
There are ways to navigate out of this mess. It takes a considerable amount of work to evaluate which is the best route to take.
Bankruptcy allows a debtor to get a fresh start by ‘discharging’ some of their debts including those owed to the IRS. But there are lots of exceptions. Here are some of the general rules for you to discuss with your attorney if this is a path you are considering:
- 100% penalties (trust funds) assessed on a responsible party for failure to pay the payroll taxes of a business are not dischargeable.
- Tax debts due to income tax returns are dischargeable provided that the due date of the return was at least 3 years before the bankruptcy filing date and the return was actually filed at least 2 years ago. Tax fraud negates this rule as does a conviction for tax evasion.
- Tax liens filed against property that were filed prior to the bankruptcy petition date remain in place and are enforceable.
- The Statute of Limitations is automatically tolled (put on hold) for the period of the bankruptcy estate plus 6 months.
- The IRS is not allowed to continue collection processes while the bankruptcy estate is in existence.
There was recent good news for people in the 11th Circuit of the Court of Appeals which includes Florida. The court held that income tax returns that were filed late are still eligible for discharge provided they were filed at least 2 years ago. The 1st Circuit in Massachusetts holds a contrary position that any late filed returns are never dischargeable. Too bad for the people in the Northeast.
If you or someone you know has received a Notice of Intent to Levy or some other federal or state tax issue, please feel free to contact me at either (352) 317-5692 or email firstname.lastname@example.org.
During bankruptcies, an automatic stay prohibits creditors from taking collection actions while proceedings are ongoing. But a Wisconsin couple recently found that the stay was not an absolute thing. Enter the IRS.
In Pansier v. U.S., 2019 PTC 494 (E.D. Wis. 2019) a district court affirmed a bankruptcy court’s decision to lift the automatic stay. This lift let the IRS levy the debtor’s pension even though the bankruptcy case was still in motion. The reasoning from the bankruptcy court: The pension was exempt from regular creditors and was therefore still available to the IRS outside of the bankruptcy.
Take-away: The IRS has far more collection power than most creditors!
If you or someone you know has received a Notice of Intent to Levy or has some other federal or Florida state tax problem, please feel free to contact me at either (352) 317-5692 or email email@example.com.