The Pitfalls of Using the IRS as a Lender

 I still owe my readers links to several high quality and FREE cash flow forecasts models. As I mentioned in my last post, my intentions are to build a quality cash flow forecast model myself that you can use. Unfortunately, I have not had the quiet time this week to do it, so I beg your forgiveness and urge you to check back Monday for the post on cash flow forecasting models.

Today I am motivated to discuss one of the absolute worst ways to improve cash flow. I am of course talking about not paying your business’ Federal payroll tax withholding (941 tax). By doing so, you can improve cash flow, but the cost is high and the practice is not worth it.

Often, when a business has cash flow problems, the owner has to make decisions about which of his venders are going to get paid first. Too often, owners find it easy to not remit their federal payroll trust taxes (often referred to as 941 taxes) to the U S Treasury on a regular basis as a way to have cash to keep their business going. Well-meaning owners plan on getting caught up when cash flow gets better. In effect, they are using the IRS as an “unwilling” lender. This practice is very easy because the IRS doesn’t usually make a collection call for months. Once the IRS flags the business taxpayer as delinquent, problems begin.

The concept of “Trust Taxes.” Employers are required to withhold taxes from their employee’s wages for Social Security, Medicare and employee income tax. Social Security and Medicare withheld totals 15.3% of applicable wages. Combined with the average taxpayer’s W-4 withholdings, the total of all of these amounts is approximately 25-28% of total payroll of an average business. The business owner is “entrusted” to protect these funds for the benefit of its employees, hence the term, “trust taxes.”

Penalties for failing to remit trust taxes and failing to file 941 reports in a timely manner are very high and can as much as 5% per month of the amount due up to 25%. This makes the unauthorized “loan” by the business owner the most expensive loan possible.

Officers, directors, and shareholders are all personally responsible for all trust taxes. In some cases, the IRS has been known to seek repayment of taxes, penalties and interest from anyone who has check writing authority in a business even if they aren’t officers, directors, or shareholders. Trust taxes survive both business and personal bankruptcy and continue to accrue penalties until paid. The normal practice of the IRS is to file a lien against all shareholders holding each of them jointly and severally liable for the taxes due.

The best way to avoid using the IRS as a last resort lender is to understand how serious the consequences are for doing so. Using a third party payroll service or professional employment organization (PEO) to handle payroll, payroll taxes and other employee benefits helps reduce employer risk because reputable companies who perform these services keep up to date on important state and federal laws and will often defend a business in tax court if a mistake is made.

If you do have past due trust taxes make sure you continue to file your 941 reports as required by law. The penalties for not filing reports are as high as not paying the taxes, so by filing the reports, the total penalties will be reduced. Contact the IRS immediately to keep a lien from being filed. Once a lien has been filed, no lender can loan you money until the IRS obligation is paid off or unless the IRS has agreed. The IRS will usually allow a payout arrangement of past due taxes as long as the current taxes are being paid. This arrangement will often be verbal. Having an IRS payment plan will not necessarily stop the penalties for failing to pay the taxes on time, so if you can borrow the money from another source, it will nearly always be less expensive than paying the IRS penalties. If you don’t feel you can deal with the IRS directly, contact a reputable CPA who specializes in IRS workouts, but avoid firms that claim they can make the IRS obligation go away for pennies on the dollar. When it sounds too good to be true, it usually is.