If you’ve decided to close your business, you may be unsure of what happens to your financial and tax obligations. Dissolving your business does not mean dissolving your tax obligations. State and federal tax debts persist, and in some cases, you may face personal liability for unpaid business taxes, particularly those that are considered trust fund taxes.
Learn more about what happens to your tax debt after your business closes and when your business’s tax debt may become your personal responsibility. Or contact us at W Tax Attorney today to set up an initial consultation and talk about your options.
Key Takeaways
- Closing your business does not absolve you of your business’s tax obligations.
- The treatment of business income tax debt depends on the business’s structure.
- Regardless of the business’s structure, owners or key employees may face personal liability for trust fund taxes, such as payroll and sales tax.
- If you do not make payment arrangements, tax agencies may come after you personally for those debts.
- A tax attorney can help you through the process of closing your business and minimizing tax burdens.
What Happens to Tax Debt After a Business Closes?
When you close your business, you have to close your business accounts with the IRS and all state agencies where you have an account. This means filing final tax returns and settling your tax bills. If you run a single-member LLC, sole proprietorship, or general partnership, you run a pass-through entity. This means that those tax debts pass to you automatically.
You still have to pay them even if the business is no longer operating. However, if you cannot pay the taxes you owe, you can request an offer in compromise or installment agreement, depending on your circumstances.
This isn’t the case with other business structures, where the tax debt typically remains the sole responsibility of the business itself. For example, if a corporation owes corporate income tax, the corporation is responsible for paying that tax, and if the corporation goes bankrupt, the IRS may not be able to collect those taxes.
You must also pay your employees all wages owed and make any remaining federal or state payroll tax deposits. This involves reporting employment taxes, including employee income tax, Social Security tax, and Medicare tax.
When Business Tax Debt Becomes Your Personal Problem
People often choose a specific business structure because of the protection it gives them from their business’s debts, so they’re often surprised to find out that there are cases in which their company’s tax debt can become their own personal debt.
The tax debts most likely to result in personal liability include payroll taxes, sales tax, and unfiled returns for which you were responsible. Payroll tax and sales tax are funds that are held in trust. The government—the IRS or the state in the case of payroll taxes and your state tax agency in the case of sales tax—trusts business owners to collect funds from their employees or customers and then hold onto them until their next payment date.
When a business fails to do so and uses the funds for other purposes, tax agencies consider this a grievous misuse of government funds, as the money never belonged to the business in the first place—the business was simply meant to pass the money through their account to the appropriate tax agency. By extension, the Internal Revenue Code and most state tax codes allow the revenue agency to hold individuals personally liable for these taxes, regardless of the business’s structure.
The Trust Fund Recovery Penalty and What It Means for You
The IRS will attempt to collect past-due payroll tax from the business in any way possible. This means sending a series of notices, possibly imposing a lien on business assets, and even seizing business assets to cover the amount due.
But what happens when a business has no assets to levy or—as we’re discussing in this article—the business closes? The IRS doesn’t give up on the money it’s owed. Instead, it moves on to assessing the Trust Fund Recovery Penalty. The TFRP holds certain responsible parties personally liable for unpaid payroll taxes.
The focus isn’t on the business’s current status or who has the “right title” to be held personally responsible. The IRS focuses on who has decision-making power over how money is spent and when taxes are paid. Potential liable parties include:
- Officers and employees of a business
- Corporate directors and shareholders
- Board of Trustees members
- Anyone with control and authority over funds and their disbursement
- Third-party payers
- Payroll Service Providers
- Professional Employer Organizations
If the IRS thinks you’re liable, they’ll send Letter 1153, and you must respond quickly if you want to protect yourself. The party deemed to be a liable party must be both responsible for collecting or paying withheld taxes and willful in their failure to collect or pay them. This doesn’t mean that they must have intentionally decided not to pay them; willfulness exists if an individual should have been aware of the past-due taxes and was indifferent to their obligation to pay.
The Trust Fund Recovery Penalty is a massive financial burden to individuals. It’s equal to 100% of the past-due taxes, and the IRS can use any collection methods it would use for any other type of debt. Once the IRS has deemed you to be a responsible party, they can place a lien on your personal assets, garnish your wages, freeze your bank accounts, and seize your assets.
Unpaid Sales Tax or State Withholding
If you’re responsible for state sales tax and/or state withholding, you may also face personal liability for these taxes. But the exact process varies from state to state. It also varies from how the IRS uses the Trust Fund Recovery Penalty.
The IRS doesn’t assess payroll taxes against individuals. Instead, it assesses a TFRP equal to the amount of unpaid withholding tax against individuals. State revenue agencies, in contrast, typically just assess the tax itself against a responsible person.
Most states allow the tax agency to decide upon a responsible person for sales and withholding tax. They can then hold that person accountable for the past-due tax. For example, in New York, a responsible party is one who is actively involved in operating the business, decides which financial obligations are paid, is involved in personnel activity, and has authority over business decisions. Many states have identical or similar requirements.
Is Bankruptcy a Solution?
The business may be able to discharge certain tax debts in bankruptcy. Individuals may also be able to discharge income taxes related to their business if they are at least three years old. Beyond that, it may be impossible to discharge most business taxes in bankruptcy.
Unfortunately, bankruptcy is unlikely to provide any relief from the Trust Fund Recovery Penalty. Per the IRS, the Trust Fund Recovery Penalty is usually excepted from an individual’s discharge. This debt has priority status.
Bankruptcy may provide temporary relief in the form of an automatic stay, as creditors cannot attempt to collect from you while your bankruptcy case is going through the court system. However, once your bankruptcy has gone through and the TFRP remains intact, the IRS can resume collection efforts.
Other types of tax debts may survive the bankruptcy process. Tax debts typically left out of an individual’s discharge include sales tax debts and debts resulting from returns that are three or fewer years old.
Addressing Tax Obligations While Closing Your Business
How you close your business matters. Simply closing up shop and ignoring all communications addressed to your business will likely lead to heavy penalties, more aggressive collection efforts, and significant stress for you. Plan on filing the appropriate forms reporting your last year of business income, as well as any other required forms, including state tax returns and federal payroll returns.
On a state level, you’ll likely need to report the closure of your business to all states in which you are registered. For example, if you’re an online company, you may have sales tax accounts in multiple states. The specific filing requirements you have depend on your business structure, whether or not you liquidated assets if you profited or lost money on the sale of assets, and other specific circumstances, which is why it’s important to work with a tax professional as you wind down business operations.
It’s entirely possible that some tax debt will remain after you’ve filed all of your final returns, gotten rid of your leftover inventory, and otherwise wrapped up business obligations. Figuring out how you’ll resolve these outstanding debts is part of closing down your business, and it’s important to be proactive.
Depending on the situation, you may qualify for an installment agreement or offer in compromise. In many cases, as long as you are making reasonable progress toward paying off your tax debts, the IRS will consider holding off on more aggressive collection actions. This is why acting early is much better than waiting until the IRS is on the cusp of seizing your assets.
How a Tax Professional Can Help
If you’ve held off on hiring a tax professional or reaching out to a tax relief firm in the past, but you’re now facing a potential (or already assessed) Trust Fund Recovery Penalty, this is the time to hire a tax attorney. The Trust Fund Recovery Penalty can cause financial devastation for individuals, especially since it is not dischargeable in bankruptcy and may result in the loss of your assets. When you bring in a qualified tax professional early, they can go over your IRS transcript for a better understanding of your tax history, dispute inaccurate TFRP assessments, and help you explore different payment options.
The end of a business doesn’t have to mean personal financial ruin. The earlier you take action regarding your business tax debt, the more options you have at your disposal so you can move forward and enjoy a fresh start.
Your business has closed. It’s time to turn the page and see what comes next, so don’t let unresolved tax issues hold you back and limit your personal options. Wherever you are in this process—sorting through a pile of IRS letters, a TFRP bill, or complete confusion about the state of your business taxes—the team at W Tax Group can help you move forward. Call us at 877-500-4930 or reach out online to set up an initial consultation.
Frequently Asked Questions
My business is closed—why am I still getting IRS letters?
If you did not file the appropriate forms to alert the IRS to your business’s closure, they may assume your business is still active, resulting in additional communications to your business. Additionally, if you have unpaid payroll taxes, you have been personally assessed the Trust Fund Recovery Penalty.
I declared bankruptcy; why is the IRS still contacting me?
Many tax debts are not dischargeable in bankruptcy, including debts that are less than three years old and the Trust Fund Recovery Penalty. While the IRS cannot take collection actions against you, they may still contact you.
I didn’t handle taxes or have any payment authority in my old business. Why am I being assessed?
The IRS may have information indicating that you had financial responsibility in your role, had decision-making authority, or otherwise were in a position of financial authority. They may have conducted interviews to determine who to hold responsible for unpaid payroll taxes.
Can I settle this debt even though the business is closed?
Yes. There are many payment options available to those with outstanding personal tax debt, including an offer in compromise, an installment agreement, or currently not collectible status.
Can I handle this issue without help?
Business taxes are complicated, and the Trust Fund Recovery Penalty is one of the most serious tax consequences an individual may face after their business falls behind on tax debt. While you aren’t legally required to seek legal assistance, it is highly recommended.
Sources:
https://www.irs.gov/pub/irs-pdf/f940.pdf
https://www.irs.gov/pub/irs-pdf/f941.pdf
https://www.irs.gov/businesses/small-businesses-self-employed/employment-taxes-and-the-trust-fund-recovery-penalty-tfrp
https://tax.illinois.gov/individuals/collection.html
https://texas.public.law/statutes/tex._tax_code_section_111.016
https://www.tax.ny.gov/pdf/publications/general/pub131.pdf
https://www.irs.gov/irm/part8/irm_08-025-001#idm139672494641824
https://www.irs.gov/businesses/small-businesses-self-employed/closing-a-business
