Barbara’s Blog

From time to time, every business experiences a cash shortfall. Bills come in from vendors, employees have to be paid, an installment on your bank loan is due, and the landlord is knocking at the door.

What do you do?

Don’t use the money you’ve set aside for certain tax obligations because you can be held personally liable for 100% of this money.

Tax money that’s sacrosanct
Some of the money that a company collects is not to be touched. The company is merely a fiduciary holding the money in trust.

Examples of trust fund taxes:

• Withholding from employees’ paychecks for federal income taxes and FICA
• Withholding from employees’ paychecks for state income taxes and, where applicable, other state tax obligations (e.g., disability contributions)
• State sales taxes

Potential penalties
If you fail to pay over these trust fund taxes, you can face a 100% penalty for the unpaid taxes. The federal government has a Trust Fund Recovery Penalty. And many states, including California, have the same rule for state payroll taxes. The penalty applies if a “responsible person” (someone with decision-making power and check-writing authority) willfully fails to pay these taxes. Willfulness is inferred when a responsible person knows the taxes are unpaid but chooses to pay others instead.

Regardless of whether there are other owners besides you or that you set up your company as a corporation or limited liability company to achieve personal liability protection, the government can seek to recover all of the trust fund money from you. The government has three years to go after any responsible person and up to 10 years to collect the amount owed. The personal assets of the responsible person are fair game here. And the IRS can get your assets using a federal tax lien, levy, or seizure action.

Let’s take an example. Say you have an S corporation with three equal owners, all of whom have the authority to make day-to-day business decisions (including who to pay) and to write checks or make electronic bank transfers. Your business is in a cash crunch and with the limited funds you have, you choose to pay your vendors so you’ll continue to have inventory. You don’t pay the U.S. Treasury the amount owed for income tax withholding and the employees’ share of FICA. The IRS can choose to recoup all of the unpaid taxes from you alone. You and your co-owners are “jointly and severally liable” for these taxes. It means that the government usually pursues the person with the deepest pockets. If you pay, you can seek to recover a share from your co-owners, but that isn’t the government’s concern.

State sales taxes
Like wage withholding, merchants who collect sales taxes are merely holding the funds for their states. Say your state has an 8% sales tax rate and you sell a $10 item. You collect $10.80 from the customer; 80¢ belongs to the state. The failure to pay your sales tax collections can result in serious penalties. Ever notice a store on Main Street that’s been shut with a notice posted on the door saying “Closed due to failure to pay sales taxes”?

What to do?
If you find yourself in a cash crunch, recognize that the first parties to be paid are the federal and state government with respect to trust fund money. After that, it’s up to you to decide how to apportion the limited funds you have among your employees, vendors, and other creditors.

If you need additional cash, don’t be tempted to use trust fund money. Use any other resource you can to meet your obligations. Borrow from family and friends. Tap out your credits. Even take distributions from your retirement accounts (though this should definitely be a last resort).

Finally, let this difficult experience teach you a valuable lesson about cash flow management. Use software or online solutions to help. And work closely with your CPA or other financial advisor so you never again face a cash crunch.

Taxes may already be a fond memory for you if you’ve filed your 2011 tax returns, but unfortunately there’s no time to rest. The clock keeps ticking as tax obligations continue unabated for this year and beyond. According to a recent NFIB survey, tax uncertainty continues to plague small business.

Here are some of the survey’s findings:

• 20% of small business cited taxes as the single most important problem facing them today.
• 22% said it is the single most important external impediment to growth.
• Small businesses spend on average $74 per hour to comply with the federal tax code, which is the most expensive paperwork burden imposed on small businesses by the federal government.
• 88% of small business owners use paid preparers to complete their tax returns.

What does this uncertainty do to small business and the economy? The NFIB fact sheet says that it

“hinders long term planning and create[s] uncertainty which prevents small businesses from making investments.”

It drains small businesses of valuable resources that could otherwise be spent on hiring, research, and other activities that would benefit the nation.

What’s up for 2012?

If Congress fails to take action now, the more than four dozen tax breaks that expired at the end of 2011 will not apply for 2012. This means:

• Many small business owners will owe the alternative minimum tax (AMT), especially those living in high-income tax states; higher taxes on owners means less money for hiring, etc.
• Businesses won’t be able to claim the research credit or many employment-related tax credits; the incentives won’t be there to incentivize.

What’s up for 2013?

If Congress does not make changes for 2013, it will be “taxmaggedon.” What to expect in the absence of any Congressional action:

• The Bush-era tax cuts will expire. This pushes the top tax rate up to 39.6%, the capital gains rate to 20%, and many other unfavorable tax rules.
• The Medicare surtaxes on earned and unearned income (as created by the Patient Protection and Affordable Care Act of 2010) will take effect for the first time.

What to do!

Become political. Whether you fall on the left or the right, you must urge your representatives to act. Just like a parent’s torment when a child goes missing, the uncertainty (not knowing what the tax rules will be) is killing us.

As the tax filing deadline is nearing, it’s worthwhile to think about the vast amount of time it takes business owners to handle tax responsibilities. According to an April 12th hearing statement of Senator Max Baucus (D-Mont.) regarding tax administration practices from around the world, small business owners in the U.S. spend on average about 23 work days each year on their taxes. This means they effectively have to take three weeks off from work so they can meet their tax obligations.

In comparison, it only takes a business owner in Ireland 9.5 days a year and, in Canada, 15 days a year.

Overall, the U.S. ranks 62nd in ease of paying taxes for businesses; the UK ranks 16th, while Hong Kong ranks 3rd.

The tax burden is eroding productivity because it is taking up precious time that could be devoted to marketing and other activities to generate revenue. In effect, the government is shooting itself in the foot when it comes to generating revenue; if the compliance burdened were lessened on businesses, they could earn more revenue and pay more taxes.

Even the IRS in its instructions to Form 1040 and supplemental forms admits that it takes a “business filer” (someone filing Schedule C, C-EZ, E, F, or Form 2106 or 2016-EZ) on average 32 hours to keep records, do tax planning, complete the return, submit it, and do other tax-related chores. These business filers account for more than 30% of all individual filers.

The National Small Business Administration released a survey on April 11th, which found that 87% of owners needed to use outside accountants or other tax preparers for compliance. Again, this may save owners time, but it costs money that could be used by businesses for other purposes.

Bottom line: Taxes cost businesses a lot of time and money (no news to business owners). Very few business owners can afford the time off for a three-week vacation on a tropical isle, let alone three weeks to do taxes.