When Can the IRS Come After a Business Personally?
Tax season can be an impersonal, bureaucratic nightmare for many business owners. But there’s a personal side to taxes, too. That’s because when you’re a business owner, there can be a high level of personal risk involved.
Your time, energy, and money all go towards keeping your business afloat, and your personal assets can be vulnerable if something goes wrong — like accumulating back taxes. In 2011, businesses owed over $100 billion in tax debt.
Taxes are a necessary evil, and understanding how they work is too. Depending on the nature of your business, you could be held personally responsible for sale and use taxes, withholding employee income taxes, or corporate income taxes.
Fortunately, there are ways to protect yourself and your assets. Whether the IRS can come after a business personally is determined by how the business is structured and the nature of the offense.
In a sole proprietorship, the individual and the business are the same in the eyes of the IRS. The business is not taxed; the business owner’s income is taxed. There are benefits to a sole proprietorship: they get off the ground quickly, there are fewer legal hoops to jump through and less government control, and you are in charge of all of the operations. However, you are also solely liable for any debts incurred by the business, and the IRS can come after you and your assets personally if the business hits tough times and back taxes are owed.
Partnerships involve two or more people entering into a business agreement together. They are similar to a sole proprietorship in terms of taxation, with each individual partner taxed on his or her income derived from the business.
There are two types of partnerships, and the potential individual liability varies a great deal between them. In a general partnership, there is an equal, personal responsibility for the business — including any debt it incurs — so you should be cautious when entering into such a partnership, because there are limited personal protections.
A limited partnership, meanwhile, involves less risk for the limited partner while the general partner takes on the risk. If you’re a limited partner, the IRS cannot come after you personally, so this acts as one way to protect your personal assets. However, limited partners have limited control over the business. If you take on a more active role in the company over time, even if you’re a limited partner on paper, you may be considered a general partner by the IRS if tax issues arise.
The most popular alternative to a sole proprietorship or partnership is a corporation. When you incorporate your business, it puts a few degrees of separation between you as an individual and your business. The corporation becomes responsible for unpaid taxes and other debt, and creditors can only pursue corporate assets.
Different types of corporations are treated differently, though.
C corporations are the most popular type of corporation. With a C corporation, company debt and legal obligations cannot become the personal responsibility of any individual associated with the business. This means personal assets are protected.
However, C corporations are subject to what’s called double taxation. The company’s income is taxed after deducting expenses and salaries, and what remains is distributed to shareholders and then taxed as personal income.
S corporations are much like C corporations, but they avoid double taxation. Profits are only subject to taxation at the shareholder level. However, S corporations have to meet more qualifications and follow more rigid rules in terms of shareholders, profits and losses, and the type of stock.
Limited Liability Companies (LLCs)
LLCs are a unique type of corporation, and an increasingly popular alternative to standard business corporations and C corporations. They are taxed like a sole proprietorship or partnership as the owner’s income, while offering a degree of protection to the owner’s personal assets. Basically, the owner is protected against any wrongdoing by employees or other owners, and the creditor can only go after the LLC’s assets.
However, the protections of a limited liability company are just that: limited. If you personally commit any wrongdoing through the LLC, such as failing to deposit taxes from an employee’s wage, you can be held personally responsible. So while an LLC protects your personal assets against employees, partners, or co-owners, it doesn’t protect you against yourself.
While corporations typically protect the individuals involved and their personal assets, due to the billions of dollars in back business taxes owed to the IRS, corporations don’t necessarily offer the protection they used to. Taxing bodies are more often relying on a “responsible person” in a company to take responsibility for owed taxes.
The responsible person can be determined by simply their title. The president, vice president, or treasurer could be held personally liable. In other cases, the responsible person may be whoever was “under a duty” at the company to take care of tax obligations. An inquiry would be required to determine who this person is and what degree of knowledge he or she had in terms of their tax obligations. If you have a title or role that makes you responsible for the company’s tax duties, you could be personally liable for back taxes, and your personal assets may become fair game.
Regardless of how you choose to structure your business, one of the best ways to avoid personal risk is to familiarize yourself with and follow IRS rules, and keep detailed tax records. While it’s not always possible, paying your taxes correctly and on time is the easiest way to keep the IRS off your company’s back.