Alleviating the Burden of Business Tax Debts through Bankruptcy—Part 2
February 8, 2010 by Oliveros & O'Brien, P.C.
When a business goes out of business, its owners can be left owing many of the tax debts of that business. Have you recently shut down a business and are concerned about whether you are personally liable on any of the taxes of the business? Or have you been closely involved in the finances of a business in which you were NOT an owner, and that business was shut down and still owes taxes? Finally, are you considering shutting down your business but need to know how to deal with its remaining tax debts?
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In last week’s blog we addressed how a small business can continue to operate while resolving its major tax debts. If the business is not a corporation but rather a sole proprietorship, Chapter 13 protects the owner and the business from the taxing authorities while the debts are reduced and the remaining portions are paid. At the end of the Chapter 13 case, the owner and the business are debt-free. This week’s blog looks instead at the taxes owed by a small business which is going or has gone out of business. It addresses businesses which are set up either as corporations or sole proprietorships. If you have a limited liability company (LLC), or partnership, or some other form of business, please contact us about your situation.
Personal Liability for the Taxes of Your Business
If your dead or dying business owes a lot of back taxes, the first step is determining whether or not you would be held personally liable for them. This depends on the type of tax owed:
1) Employee withholding taxes: If the business withheld income, Social Security, Medicare, or most other withholding taxes from employees’ paychecks, but then did not pay the IRS or Oregon those withheld taxes, then the owners of the business are generally held personally liable for those withheld taxes. EVEN people who are NOT OWNERS but have financial decision-making role in the business can be personally liable for such so-called “trust fund” taxes.
2) Corporate income taxes: The shareholders and officers of the corporation are usually not held liable for this type of taxes, as long as the formalities of the corporation were maintained. That particularly means that the corporation’s finances were kept strictly distinct from that of the shareholder-owners—that there was no commingling of corporate and personal assets. This type of tax is generally not much of a problem because corporations which are in deep financial trouble usually don’t have any taxable net income and therefore no corporate income tax.
3) Real property taxes: If your business corporation owns real estate, and is behind on the county real property taxes on that real estate, generally this tax will follow the real estate. That means that if the real estate gets foreclosed by or surrendered to the mortgage lender, the tax will generally be paid eventually by whoever ends up owning the property. The shareholders and officers of the corporation will not be held liable for the property tax (assuming they have no individual interest in the real estate). This is generally also true if your business is a sole proprietorship and the business owns real estate—you will not be held personally liable for real property taxes on any foreclosed or surrendered real estate.
4) Personal income taxes arising from business income: if you own a business which is a sole proprietorship (or an LLC or partnership), all business income gets reported on your personal income tax returns. You are of course personally liable for such income taxes. Indeed such taxes may well be more than otherwise because of “self-employment taxes,” which make up for what an employer would be contributing beyond the withheld amounts for Social Security. Income taxes are a common problem for struggling business owners because they often simply don’t have the money to pay estimated quarterly income taxes, and so they fall quickly behind.
Dealing With the Surviving Business Taxes
So, after the closing of a business of the four above kinds of business taxes the ones which tend to cause the most problems for the individual owners or other related parties are 1) employee withholding taxes and 2) personal income taxes from business income. The best way to deal with these taxes depends on a multitude of factors. Tax law is notoriously complex, as is bankruptcy law—especially as it relates to taxes and business. This is an area where you definitely need a highly experienced attorney. You need one who understands the complicated laws, can wisely balance the many considerations, and recommend the best option for you.
1) Employee withholding taxes: These cannot be discharged (legally written off) through a Chapter 7 or 13, no matter how old they are. If the amount you owe is relatively small and your other circumstances make filing a Chapter 7 sensible, then do so and make payment arrangements directly with the taxing authorities immediately after your Chapter 7 is completed. If your Chapter 7 trustee collects any assets from you during the case, the withholding taxes may be paid in part or even in full out of those assets, because this kind of debt is a “priority” one paid before most of your other creditors receive anything.
If, however, the amount of withholding taxes you owe is so large that you need more time to pay them than the taxing authorities would allow, and you need protection from them in the meantime, consider filing a Chapter 13 case instead. This would allow you up to 5 years to pay these taxes, usually without additional interest and penalties after the filing of the case. You would be permitted (and indeed required) to pay them as a “priority” debt before most other creditors would receive anything.
2) Personal income taxes: Unlike withholding taxes, personal income taxes (derived from business income or other sources) can be discharged in either a Chapter 7 or 13 if they meet a series of conditions. The rules are complicated but a starting point is that an income tax debt may be discharged if it is for a tax year whose tax return was due more than three years before your bankruptcy case is filed. Whether to file a Chapter 7 or a 13 is a multifaceted decision, but generally turns on how much income tax debt would remain if a Chapter 7 were filed. If most of the taxes were old enough (and met the rest of the conditions) to be discharged in a Chapter 7, that could well be the better option.
But just as with withholding taxes, if there would be a substantial amount of income taxes not discharged in a Chapter 7, Chapter 13 would give you up to 5 years to pay them. Again, no interest or penalties would continue to accrue after the filing of the Chapter 13 case. Also, these “priority” debts would be paid before most of the rest of your creditors would receive anything.
Conclusion
Michael O’Brien is an attorney greatly experienced in these areas. Call Mike personally to talk about your tax debts at 503-786-3800. Or click on the “Contact Us” tab above to set up a personal meeting with him or another attorney in his office. We want to help you get a fresh start.