Dealing with debt you can’t pay is stressful, but when that debt is owed to the IRS, the stress is compounded. Owing back taxes has all kinds of consequences for both your business and personal finances. Doing nothing isn’t likely to make the situation better, and it can make things much worse.
If you’re an entrepreneur who is behind on your taxes, here’s what you need to know.
What are Back Taxes?
Back taxes is a term that’s typically used to describe taxes that are owed from prior years to the Internal Revenue Service, or to your state or local taxing authority. Sometimes, though, the term back taxes is used to refer to tax returns that haven’t been filed.
Those two situations can be quite different. Interest and penalties may be applied in both situations, but if you simply haven’t filed returns at all it is possible that no additional taxes are owed. It’s even possible you are due a tax refund.
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What Happens If Your Business Owes Back Taxes?
Back taxes can create a number of headaches for you, both personally and as a small business.
You can’t file an accurate personal income tax return. Many business entities are what’s called “pass through entities” which means the information about business income and expenses flows to the owner’s tax return. Examples include sole proprietors, LLC members, S corp shareholders, and partnerships, for example. If your business doesn’t file the forms required to report income and expenses in a timely manner, you can’t file an accurate personal tax return.
Interest and penalties start accumulating. While you may be able to file an extension to get more time to file, that doesn’t give you more time to pay if you owe the IRS. Again, for many business owners, the business doesn’t directly pay taxes to the IRS. Instead, the tax obligation flows through to the individual’s income tax return. The IRS can assess penalties for late filing and interest for late payments.
You can delay or lose a refund. The IRS will hold refunds if its records show taxes are past due. And you have three years after the filing deadline to claim a refund.
Your Social Security benefits may be reduced. If you are self-employed and don’t file a federal income tax return, your self-employment income will not be reported to the Social Security Administration and you won’t receive credits towards Social Security retirement or disability benefits.
The IRS may file a tax lien. The IRS may file a Notice of Federal Tax Lien against your property for unpaid taxes. This lien may include business and/or personal property depending on your business entity and the types of taxes owed.
Hurt your business credit. While tax liens are no longer reported on consumer credit reports (personal credit) they can be reported on business credit reports and hurt your business credit.
Make it difficult to get small business loans. Many types of loans, including bank loans, SBA loans and other types of small business loans, require copies of tax returns and/or up to date financial statements when you apply.
And in more extreme cases, you can have your passport revoked or you could face jail time.
How To Find Out If Your Business Owes Back Taxes
If you gets a tax notice or other correspondence from the IRS stating that returns have not been filed or that taxes are owed by the business, it’s important to respond to those quickly.
If your business credit report lists a tax lien, that’s another sign that your business may owe back taxes. (It’s also possible it’s a mistake and your business has been mixed up with another one. That’s one reason it’s important to check and monitor your business credit.)
You can reach out to the IRS but even tax professionals who are used to dealing with the IRS are reporting long wait times on hold, and sometimes inaccurate information from less experienced IRS employees.
What To Do If Your Business Owes Back Taxes
If your business has not filed its business tax returns by the appropriate deadline, or if your business owes taxes, then it is in your interest to get caught up as soon as possible. Failing to do so can be expensive.
If you aren’t sure whether your business has filed required returns or paid all its required taxes, it’s smart to consult a tax professional such as a CPA or enrolled agent. Trying to navigate this on your own may be confusing, since you will have to determine which forms should have been filed (and weren’t) and what taxes should have been paid, including self-employment taxes, taxes that often flow through to your personal tax returns, and more.
You may have several options when you’re dealing with back taxes, either for your business or personal income taxes.
- Request an extension. This is a very temporary solution, and it doesn’t buy you extra time to pay your taxes without additional cost, but it is almost always better than not filing at all.
- Request a payment plan. Both individuals and businesses may request a payment plan from the IRS if they qualify. Payment plan options include a short-term payment plan (paying in 180 days or less) or a long-term payment plan (installment agreement, paying monthly).You can apply for a long-term payment plan online if you have filed all required returns and owe $25,000 or less in combined tax, penalties, and interest. (Sole proprietors and independent contractors should apply as individuals.)
- Settle your IRS debt. An offer in compromise (OIC) can allow taxpayers to settle tax debt for less than the full amount. If you are an employer you must have made tax deposits for the current and past 2 quarters before you apply for an OIC. The IRS offers a free OIC prequalifier tool.
- Delay collection. You may apply to have the IRS place you in “currently not collectible” status. Taxes and penalties will continue to accrue. You may need to complete a Collection Information Statement providing the IRS with information about your finances. It may also file a Notice of Federal Tax Lien, which in the case of a business tax lien, can appear on your business credit reports.
- File for bankruptcy. You may be able to use a personal bankruptcy or business bankruptcy to reduce, restructure, or eliminate some or all of your debts. There are several types of bankruptcy available to individuals or businesses that may be used to either shut down your business or to regroup so you can continue.
How and When to Pay Taxes
Small business owners need to make sure they understand what taxes they need to pay, and when to file. It can be more complicated than the once-a-year federal (and state) tax return you may have been used to filing as an employee. You may have to pay:
- Income taxes (state taxes, federal income taxes and/or local taxes)
- Self-employment taxes (Medicare and FICA)
- Estimated taxes
- Employment taxes (aka payroll taxes)
- Excise taxes
- Sales and use tax (at the state or local level)
- Property taxes
For many business owners, income taxes flow through to their personal returns. For example:
Sole proprietorships: If you are self-employed (including as an independent contractor or freelancer), you are required to file an income tax return if your net earnings from self-employment were $400 or more. You are generally also required to pay self-employment taxes and quarterly estimated taxes. You’ll report business income and expenses on Schedule C, which you file with your personal income tax return.
S Corporations: Shareholders of S corporations report the flow-through of income and losses on their personal tax returns and are assessed tax at their individual income tax rates. However, S corporations are responsible for tax on certain built-in gains and passive income at the entity level.
S Corporation with employees (including an owner-employee) will also be responsible for payroll taxes (employment taxes) for employees.
Limited Liability Company (LLC) members: How you’ll file taxes depends on how many members your LLC has and the elections it makes. The IRS classifies a domestic LLC with two or more members as a partnership for federal income tax purposes, unless the files IRS Form 8832 and elects to be treated as a corporation. For income tax purposes, a single-member LLC is treated as a disregarded entity, unless it files Form 8832 and elects to be treated as a corporation for tax purposes. For employment tax and certain excise taxes, a single-member LLC is still considered a separate entity.
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Steps To Avoid Back Taxes
There are three big steps you can take to avoid back taxes:
- Stay up to date with your bookkeeping. Either learn how to use accounting software or hire someone to do it for you. Keeping your bookkeeping up to date will help you understand the health of your business and allows you to understand the implications for your taxes. If you pay payroll, consider using a payroll service to ensure these critical taxes get paid correctly and on time.
- Budget for business taxes. Just because you are bringing in more money than your business is spending, that doesn’t mean you’re free to spend all of it. You need to also budget for taxes so you don’t end up owing more than you can pay. You may even consider opening a business bank account that offers sub-accounts so you can set aside funds for tax bills.
- Know your tax filing requirements. Many business owners choose to work with tax professionals to for help with business taxes to make sure they don’t miss important due dates or fail to pay taxes that are due. If your situation is simple (a sole proprietorship with no employees, for example) you may be able to do it yourself using tax preparation software, but remember you may still have to pay quarterly estimated taxes, self-employment taxes and/or sales tax. Take the time to understand your tax obligations.
Paying Your Business Back Taxes Before Applying For A Business Loan
If you are going to apply for a small business loan, especially with lenders like banks that will require copies of past tax returns and/or financial statements, you need to catch up on your taxes first. This can be a Catch-22 of course: you need a loan to move your business forward but you can’t get a loan until you pay the IRS what you owe.
If your personal credit scores are strong, you may be able to use a credit card to make tax payments when you’re short on cash. It’s not ideal as you may need to pay a fee plus interest, and credit card interest rates can be on the high side. (You may be able to get get a 0% APR credit card and pay it off before that intro rate expires to save money.) If you need a little extra time to pay your tax debt, a credit card can come in handy.
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