The IRS loves payroll taxes

guest commentary by David Potts

You own a business. Your sales and profitability are significantly lower than last year. Cash flow has turned negative and you don’t have enough money to pay all your vendors and creditors on time. The banks have tightened their lending standards and you can’t borrow more money. Your suppliers are threatening to change your terms from 30 days to C.O.D. You’re under extreme pressure. You’re faced with hard choices. Who do you not pay? Who is the least important creditor?

When faced with these hard choices some businesses will choose to not pay payroll taxes. When I say payroll taxes I am talking about the taxes withheld from your employee’s wages and the company’s matching portion of Social Security tax.

So you are sitting at your desk, stressed and embarrassed, deciding who won’t get paid. Your suppliers have faces. You know them by name and have played golf with them. Hmmm. If you wait to pay your payroll tax deposit you would be able to pay most of your bills that are due this week. You can catch-up paying your past due withholding tax next week. Besides, if you can’t catch up next week you have heard the IRS will let you pay in installments.

Before you make the choice to pay the IRS last consider this: Payroll taxes have a special place in the heart of the IRS.

The IRS believes that this money is your employee’s money, not yours. I know several previous business owners who are still making monthly payments to pay back payroll taxes years after they closed their business, some even having filed bankruptcy. All wish they had made a different choice and paid their payroll taxes first, not last.

When you skip paying a payroll tax deposit the IRS doesn’t come knocking at your door next week. Since sales are still slow and your cash flow still negative, it is easy for you to make the choice not to pay your payroll taxes again next week. You have to pay the utilities first because they will cut off the electricity if you fail to pay them. You have the confidence that sales will pick up soon. But what if they don’t?

I’ve seen businesses fail to pay their payroll taxes for more than a year before the IRS contacted them asking for payment. In an effort to keep their business’ doors open they paid the squeaky wheel first, not the IRS. They clung to hope that business would turnaround, but it didn’t. The result was the accumulated payroll taxes plus the associated interest and penalties quickly became an insurmountable debt; tens or even hundreds of thousands of dollars. And the IRS doesn’t come to console you; they come to collect from you.

Here’s the general order of events.

If you have failed to prepare and send in your payroll tax return, Form 941 Employer’s Quarterly Federal Tax Return, the IRS will send you a notice requesting you file the return.

After you send in your payroll tax return, they now know how much you owe in past due payroll taxes and send you a notice for the assessed amount, plus penalties and interest.

If you can’t pay what you owe, they finally send you a series of letters ending with a final letter sent by certified mail. These letters inform you that liens will be filed, bank accounts will be levied, and assets can be seized.

You finally contact the IRS to work out an installment agreement. Now you have to pay payroll taxes on this week’s payroll plus the amount agreed upon in the installment agreement.

Sometimes sales don’t improve enough and you are left with no other option but to close the doors. In hindsight, you should have closed the doors a year ago. You are a corporation so at least the majority of your creditors can’t collect from you personally. You might even file bankruptcy personally to prevent creditors from collecting on debts you personally guaranteed. It is all over. You even feel a sense of relief.

But wait. Your relief is short-lived. Remember I told you that payroll taxes have a special place in the IRS’ heart? The portion that you withheld from your employees wages are called trust fund taxes. The trust fund portion of the payroll tax doesn’t include the company’s matching portion for Social Security taxes, just the portion withheld from your company’s employees. Even if your business was incorporated, the IRS is going to attempt to collect the trust fund portion of the unpaid payroll taxes.

The Trust Fund Recovery penalty will be assessed against you personally if you are a responsible party, generally an officer or an owner. And they will continue to collect this debt until the statute of limitations expires — 10 years from the date of assessment. The IRS won’t leave you much money to live while collecting this debt.

You wouldn’t ever consider not paying your employees. If employees aren’t paid they generally won’t come to work. Consider payroll taxes as part of your employee’s wages. They are.

Current times are uncertain. Many businesses have seen drastic decreases in sales and have seen profitability evaporate. Depending upon which economist you listen, the economy could be lackluster until 2010. By then new taxes will likely be eroding your cash flow. If you have cut all the costs you possibly can and you still can’t pay all your bills on time, it may be a sign that you own a failing business.

Businesses fail, sometimes slowly. It just happens. It doesn’t mean you are evil or a bad person. It’s embarrassing and stressful. But take my advice. Pay your payroll taxes.  Let your other creditors help you decide when to close the doors. Their collection efforts aren’t as effective or long reaching as those of the IRS.

David Potts is a certified public accountant also accredited in business valuation. Owner of Potts & Company, Certified Public Accountants for more than 25 years, his practice focuses on small and medium size businesses and their owners in the areas of taxation, accounting and bookkeeping, business valuation and business advisory services. He is a Fort Smith native and a graduate of the University of Arkansas at Fayetteville. You can follow his blog at ThePottsReport.com.

Potts can be reached at [email protected]