Section Review

When the Financially Distressed Business Can't Pay the Taxman

Morris RobinsonMorris N. Robinson is managing shareholder of Robinson, Karp, Davis & Rosenblum, Wellesley. He is a business and tax attorney and serves on the Massachusetts Bar Association Tax Council. He is experienced in business workouts, including workouts with financial institutions and taxing authorities.

Financially distressed businesses often face huge unpaid payroll and sales tax liabilities. Unpaid withholding taxes can equal roughly 30 percent or more of total payroll. Unpaid sales taxes can equal 5 percent of gross receipts. These so-called trustee taxes are the personal responsibility of the business' managers; and usually cannot be discharged in bankruptcy proceedings.

Counsel is typically brought in at the eleventh hour when the taxman has aggressively levied against the business' bank accounts; and has threatened to seize its equipment and shut down the business. Experienced tax workout attorneys have two overall objectives: (1) to preserve the distressed business as a going concern while avoiding a Chapter 11 filing; and (2) to minimize the personal liability of the business managers. The following steps often help achieve these goals.

The workout attorney immediately contacts the tax officials and tries to establish a professional relationship based on trust. This is difficult since the tax officials have lost patience, the case is in collection, the taxes are owed and the distressed business has few procedural rights short of bankruptcy. The tax officials will immediately insist that the business remain current on all ongoing tax filings and related tax payments so that the unreported and unpaid tax liability does not continue to grow. These are non-negotiable demands that should be honored.

The tax officials will also immediately insist that all back tax returns be prepared and filed. They are particularly interested in payroll and sales tax returns, since these returns often report substantial tax liabilities. They are less interested in corporate and partnership income and excise tax returns since these returns normally report losses.

Tax officials will consider Installment Payment Agreements that stretch out the time period for paying unpaid tax liabilities and penalties and interest thereon. They will also consider Offers in Compromise that compromise these liabilities. Proposing appropriate terms is part of the art of tax workout representation. Normally, the tax officials do not approve Installment Payment Agreements that extend tax payments beyond 30 months. When considering an Offer in Compromise from the business, the tax officials consider how much they can realize from the forced sale of both the business assets and the personal assets of the responsible parties.

Collection action normally stops until the tax officials decide whether to approve or reject the Installment Payment Application. The business may appeal a rejection to the respective appeals offices of the IRS and the Massachusetts Department of Revenue. Normally, collection will not take place during the appeals process.

When delinquent federal tax payments are made, the attorney will attempt to apply them against the underlying tax and not against the penalties and interest. This limits the federal tax liability of responsible parties, since the federal liability of responsible parties is limited to the underlying tax and not to the related penalties and interest thereon. Federal tax officials may attempt to resist this application in the strongest terms. Application is not as important where Massachusetts taxes are involved since responsible parties are liable under Massachusetts law for the business' penalties and interest as well as its taxes regardless of how payments are designated.

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