When a cash-strapped business faces tough times, often the first creditor to go unpaid is the taxman. What's worse is that a business that doesn't pay its tax bill is also unlikely to file its return.
These decisions are some of the worst a struggling business can make.
Failing to pay - and worse, failing to file - result in the accrual of expensive penalties. These include the failure-to-file, failure-to-pay and failure-to-deposit penalties. These penalties are cumulative and can substantially affect a business' bottom line.
Moreover, the IRS has "super creditor" status, meaning it can file liens and levy property without prior court authorization.
When a business fails to timely file a required return, it is generally subjected to a failure-to-file penalty equal to 5 percent of the total tax due for each month the return is filed late, to a maximum of 25 percent. Thus, a business owing $10,000 in taxes that files a return only five months late will have $2,500 added to the tax bill.
And the penalties don't stop there.
When a cash-poor business fails to file, almost invariably it fails to pay taxes. The failure-to-pay penalty, like the failure-to-file penalty, maxes out at 25 percent of the total tax.
However, this penalty accrues at a much slower rate - from 0.5 percent to 1 percent of the total tax due per month. In our example above, the business would face a $500 failure-to-pay penalty.
The failure-to-deposit penalty is imposed when a business fails to remit employment taxes. Although a taxpayer generally files and pays employment taxes quarterly and at year-end, a business may be required to remit these taxes monthly. The failure-to-deposit penalty ranges from 2 percent to 15 percent of the deposit amount and accrues very quickly. For example, deposits made more than 15 days late are subject to a 10 percent penalty.
A failure to deposit can also result in an even more serious penalty: the trust-fund recovery penalty. This penalty arises when a business fails to pay over an employee's withheld taxes - funds belonging to the employee but held in trust for the government. The penalty applies to any "responsible person," which includes most people with any control over the business, including simply check-signing authority. This penalty creates a personal liability and is not dischargeable in bankruptcy.
So what's the best advice for a struggling business? If at all possible, pay your tax liability on time before you pay other creditors. If you can't pay, by all means file on time. No matter what, do not use funds withheld from employees' pay as a business loan. That is a no-win situation.
In the event your business is facing tax penalties, there is hope. Many penalties will be abated if the business had reasonable cause not to perform the required action. If the business has been otherwise tax-compliant, it may be eligible for the first-time abatement of the failure to file, pay and deposit penalties. This little-known remedy applies to only the first tax period for which the business is noncompliant.
For more information about these and other tax remedies, contact the University of Idaho Tax Clinic, 322 E. Front St., Boise.