When a business fails and closes it often has unpaid federal and Washington State taxes. Usually there isn’t much in the way of federal income taxes (Washington State has no income tax) but even if there are unpaid income taxes those will not normally be a serious issue if the business has operated as an entity such as an LLC or a corporation. The business will pay off creditors to the extent of its assets but the owners will usually be protected against personal liability for income taxes owed by the entity. The limited liability will also protect the owner from personal liability for Washington State B & O taxes. But if the business had employees and withheld taxes from them, or if the business collected Washington State retail sales tax a problem for the owner may arise because of “trust fund” liability. Washington’s Department of Labor and Industries has also become active in seeking payment of unpaid workman’s compensation premiums from owners of a defunct business under a law L & I has only recently begun to enforce. Our office is currently engaged in litigation with the State on this issue. We hope to discuss the L & I issue in a follow-up article. In this article we will discuss only settlement options for trust fund obligations owed to IRS or Washington’s Department of Revenue. Our Washington state tax lawyers are experienced with these matters.
Trust fund obligations arise under federal and Washington law where one or more persons who are responsible for overseeing the business finances participate in withholding taxes from employee compensation or collecting state sales tax, if the funds are not remitted to the government. The collected funds are called “trust fund” taxes and the responsible person may be held personally liable if she is adjudicated to have acted “willfully” in not remitting the funds.
Following is a brief discussion of some of the big differences in settlement options for federal and Washington State trust fund liabilities.
Settling Federal Payroll Trust Fund Liabilities.
Taxpayers may submit an Offer in Compromise to settle payroll trust fund liabilities while the business is still operating, but IRS will not process an offer for payroll tax liability (which would include the non trust fund portion) unless both the business financial statement and the personal financial statement of all persons who may be liable for trust fund assessments are taken into account. For this reason, settling an in business payroll obligation is a difficult and uncommon route. After the business closes, and once a Trust Fund Recovery Penalty (TFRP) has been assessed, the individually assessed person may proceed with an Offer in Compromise for the TFRP assessment and may also include any other outstanding personal tax obligations. The offer is likely to be made on the basis that the IRS will be unable to collect the full amount of the taxes owed ( a “doubt as to collectability” offer), and therefore the success or failure of the offer will turn on the facts and circumstances of the the taxpayer’s financial situation. In other words, the offer will be processed the same way in which IRS processes all offers.
Differences between Federal and Washington Revenue Trust Fund Liabilities.
Even though the Washington State sales tax trust fund liability is based on the federal trust fund law, there are big differences between the two. In fact, about all that the two assessments have in common is that each allows the government to assess certain defined individuals for what is a tax obligation of the entity, and neither the IRS nor Washington State tax trust fund assessments is dischargeable in a personal bankruptcy. Apart from this the two laws could not be more different:
1. A Federal trust fund assessment may be made either while the business is still operating (within the limits I discussed above), or after it closes, but the Washington trust fund assessment may be made only after the business ceases to operate (the definition is a actually little more complicated).
2. A federal trust fund assessment will be in the amount of the withheld income tax and FICA/medicare premiums, but will not include the penalties and interest assessed against the entity for failure to deposit, late payment, etc. These can be substantial amounts because the entity may have been behind for many months, or longer. Penalties against the individual assessed with the trust fund liability are assessed later, in connection with failure to pay the trust fund assessment, along with interest. However, a Washington State trust fund assessment will include not only the full sales tax determined to have been collected, but will also include the penalty and interest which were added into the assessment against the entity. Because a sales tax audit of the entity often includes a 50% evasion penalty, in addition to other penalties and interest, the sales tax trust fund assessment may greatly exceed the actual sales tax which was collected. Why the State legislature departed so greatly from the federal law of trust fund recovery is a good question, but the law was enacted in 1987 and has been repeatedly applied by Revenue and remains to be challenged in court.
3. IRS will have 10 years from date of assessment of the trust fund to collect it, although there are circumstances which toll (suspend) the statute of limitations for collection, the most common of which is an individual bankruptcy. The state collection period runs 10 years from date of filing of the state tax warrant, but it may be renewed for an additional 10 years under the Washington State judgment renewal statute.
4. Most astonishingly and, in this writer’s opinion completely at odds with the philosophy of an offer based on ability to pay, is the fact that the Department of Revenue’s stated position is that it will not accept an offer for less than the trust fund tax balance itself. What this means is that if the sales tax collected and not remitted was, say, $80,000, while the penalties and interest were another $60,000, the minimum Revenue would accept to settle would be $80,000 regardless of the dire straits of the former business owner and his or her family.
Those of you familiar with the plot of “Les Miserables,” will recognize the similarity between that plot and the Department of Revenue’s policy towards persons who are already living in the aftermath of a failed business. Moreover, the Department’s settlement policy is not required by statute; it is a policy adopted by Revenue under its own authority. Given the absence of a Legislative mandate for the Department’s position, we would not hesitate in an appropriate case to submit and argue an offer for less than the full amount of trust fund taxes still owed.
In the period before a business closes it may be possible to make some payments designated for application to trust fund portions only. But, while the IRS honors voluntary payments designated for trust fund only, Washington does not. Therefore, if a business with employees also collects sales tax, and if it is possible to make at least some payment towards mounting tax debt, serious consideration should be given to paying sales tax before payroll tax. It is our experience that dealing with IRS may be, at least for now, much less difficult than dealing with Washington State.
Call us for a consultation with experienced tax lawyer Martin Silver at (206) 224-3461.