This article has been reviewed by tax expert Erica Gellerman, CPA.
According to the U.S. Internal Revenue Service (IRS), it’s estimated that more than 8 million Americans owe over $80 billion in back taxes. Most business owners do their best to pay their small business taxes in full by the due date. However, it’s possible you might miss the deadline because of too many things to do. Or, you might not be able to afford your full tax bill.
Failure to file and pay past due taxes can lead to a number of problems and penalties. Here’s what to do when your business owes back taxes, so you can get back on track with the IRS and the day-to-day responsibilities of running your company.
Consequences of Owing Business Back Taxes
Under the standard tax deadlines for businesses, most companies must file their tax return and pay their full tax liability by March 15 or April 15 of the year, depending on the type of business you have (taxes are due the following business day if the 15th falls on a weekend or on a holiday). If you don’t file and pay your taxes by the deadline, your business owes back taxes.
Here are just a few of the issues that can arise if your business owes back taxes:
- Interest and penalties accrue – As long as your taxes are overdue, interest and penalties can add up fast. For example, if you file your return more than 60 days after the due date, the IRS can assess a minimum penalty of $205 and a maximum penalty of 25% of the amount of taxes owed, plus interest. That’s just the penalty for late filing. The penalty for late payment can range from 0.5% to as much as 25% of your unpaid taxes per month.
- You might forfeit your tax refund – Many taxpayers are not overly concerned about filing their tax returns, because they are sure they have overpaid their taxes. However, the IRS won’t let you claim a refund indefinitely. Generally speaking, after three years, the IRS will consider your overpaid taxes a “contribution” to the United States Treasury and refuse to issue the refund.
- Your property could be foreclosed – As soon as your taxes become overdue, you will receive a notice from the IRS. If you don’t submit payment within 10 calendar days of receiving the notice, the IRS will file a business tax lien on your property. Ultimately, the IRS can enforce the lien and seize your business assets (personal assets too, if you’re an unincorporated business).
- Your passport could be revoked – If you have not filed your taxes for a number of years, or if you owe more than $53,000 in back taxes and are not paying off the amount due under an installment agreement or Offer in Compromise, the Secretary of State could revoke your passport.
- You could face jail time – This is obviously the most extreme situation, and it doesn’t happen as often as news programs and crime dramas lead us to believe. However, purposely ignoring notices from the IRS or evading your tax responsibilities could ultimately lead to your arrest.
Remember, if you have reasonable cause for filing and paying your taxes late, the IRS won’t charge you any penalties. For example, if a fire destroyed your financial records or you had a death in the immediate family, the IRS will accept this as reasonable cause. Other than legal issues, there can also be financial ramifications if you fail to file past due business taxes. Failure to file past due taxes could disqualify you from getting a personal or business loan.
What to Do If Your Business Owes Back Taxes
If your business is behind on taxes, here are the steps you should take to mitigate the damage:
- File for an extension – You can file for an extension to file your tax return, giving you and your tax preparer until the fall to file, rather than March or April. This won’t reduce the amount of taxes you owe or stop interest and penalties from accruing, but does give you more time to get your return together.
- Respond to all IRS notices – it’s important to respond as soon as possible to any IRS notices that you receive by email or regular mail. Even if you’re unable to afford your taxes, it’s important to keep a line of communication open with the IRS.
- Consider a payment plan – If you’re unable to afford your entire tax bill right away, you can set up a short-term or long-term payment plan with the IRS. Businesses that qualify can set up a payment plan online. Alternatively, you might be able to take advantage of an offer in compromise. This settles your tax bill for less than the amount owed if you demonstrate an inability to pay.
- Request currently not collectible status – If the IRS finds that you can’t cover reasonable living expenses and pay your taxes back, they might temporarily place your account in “currently not collectible” status. You will still owe the tax, and penalties and interest will continue to accumulate, but the IRS won’t engage in collection efforts against you during this time. The IRS will review your financial situation every year and expect you to pay when you’re able to.
- Contact a CPA or tax attorney – If you owe a large amount in back taxes, it’s wise to retain a CPA or tax attorney who is experienced in settling tax debt.
- Consider bankruptcy – Filing for business bankruptcy is never something you should take lightly, but it can be a last resort for business owners who owe a lot of back taxes.
If you filed your tax return on time and found that you made a mistake, you should file an amended tax return.
How to File and Pay Business Back Taxes
If you missed the tax deadline, you’re in luck: the IRS has made the process to file your back taxes easier. In years past, all past due tax returns had to be filed on paper forms. With the introduction of Modernized e-File, you can electronically file your 1040 returns for the past two tax years. If you’re going back further than two years, or if you need to file past due taxes not reported on Form 1040, you’ll need to file using paper forms. Corporations, partnerships, and multi-members LLCs usually use different forms for their small business tax returns.
In that case, you must use the original forms for the tax years for which you are filing. In other words, that means you can’t use this year’s tax preparation software package or this year’s tax return to try to file last year’s taxes. Doing that might cause problems with the current year’s return, and it will almost certainly lead to you having to submit the past due tax return again.
You can find any previous year tax forms you need—as well as the instructions and tax tables for each year—on the IRS’s website. Simply search for the appropriate tax form number or form title.
Get the Right Documents to File Your Back Taxes
If you’re more than a year or two past due on your tax filings, you might have a hard time locating your tax documents. If your business is your sole source of income, you’ll have to catch up on your bookkeeping in order to be able to accurately complete your previous year’s filings.
This means you’ll need to recreate your books using your bank accounts and credit card statements. Banks and credit card companies are getting better about allowing access to historical statements online, but if you use a smaller bank (local banks especially, which don’t always have robust online banking services), you might have to request statements from them.
If you also have income from a W-2 job, or if your spouse was employed, you will need the W-2s for each tax year. You could either ask your employer—or your spouse’s employer—for a copy of the W-2s from previous years. Employers should keep these records for at least four years, and many employers retain payroll tax records much longer. Asking your employer for a copy of your W-2s should be your first course of action. This also holds true if you were a 1099 payee. Ask the business that paid you for a copy of your 1099. They should have a copy as long as they paid you $600 or more for the year.
If you can’t get a copy of your W-2 or 1099 from the payer, either because the payer is unreachable or because you have back taxes that fall outside the record-keeping requirements, you can complete Form 4506-T to request a transcript from the IRS. There’s an online alternative to request a transcript. Just keep in mind that IRS transcripts only include federal tax information. If you live in a state where you must file a state or local tax return, you’ll have to contact those tax authorities and ask if transcripts are available.
Pay Your Business Back Taxes Before Applying for a Business Loan
It’s especially important to pay your back taxes before applying for a business loan. Most lenders require at least your most recent tax return in order to process a business loan application. Some require several years’ worth of tax returns. There are several reasons for this:
- Verification of income. Some business owners might be tempted to inflate their income numbers in order to qualify for a loan. However, the opposite is true when they are filing their tax returns. Potential lenders will use your business’ tax returns to verify the income you are reporting on your loan application.
- Profitability trends. Especially if you are applying for a long-term loan, lenders want to see a history of profitability. This is why many lenders will ask for three years’ worth of tax returns. Having a history of profitability increases your chances of getting the loan you need at a good rate.
- Responsibility and trustworthiness. While filing your tax returns and paying by the tax deadline has no direct bearing on your credit score, failing to file past due taxes can indicate a lack of responsibility and trustworthiness. These two things could negatively impact a lender’s decision regarding your loan.
Your lender will probably also ask to review your company’s financial statements, but this does not preclude your requirement to provide tax returns with your loan application. Your tax return does not take the place of a carefully kept set of books, but it is usually the “final word” on the assets and liabilities in a company. Not all business owners work with a bookkeeper who enters the tax preparer’s adjustments into the bookkeeping software. Your lender will be aware of this, and they will want to examine your tax return so that they can get a complete picture of your business’ assets and liabilities.
If you have an existing tax lien against your business or if you are currently on an IRS payment plan, your eligibility for a business loan will depend on the specific requirements of the lender. Some lenders don’t mind if a tax lien falls under a certain amount of money, but others require you to fully resolve a tax lien before applying.
Can Owing Back Taxes on Your Personal Return Be Harmful?
Some business owners are impeccable with their business finances, but their personal finances are much less organized. Depending on the type of loan desired, as well as the entity structure of the business applying for the loan, many lenders will want to take a closer look at the personal finances of anyone who owns 20% or more of a business.
The lender might even require a personal guarantee of the loan, meaning if the business defaults, the owners or shareholders could be on the hook for repaying the loan. That’s why owing back taxes personally can be harmful if your business is in need of funding.
Just as your lender will likely request your business tax returns so they can make a decision about the business’ ability to repay the loan, they’ll also likely want to see your personal tax returns to determine if you will be a viable guarantor of the loan. For this reason, you should file your personal past due tax returns before applying for a business loan. If you are in business with a partner, encourage your partner to file their tax returns prior to applying for a loan, too.
The Bottom Line
Typically, a business owner does not file their tax returns for one of two reasons. Either they are overwhelmed by the amount of work required to file the returns, or they are unable to pay the amount of taxes they owe.
Using good business accounting software or hiring a bookkeeper throughout the year can help you with both issues. A good accountant or bookkeeper will make sure your records are in order so tax time is a breeze. At the same time, they will help guide you regarding the amount of your income you should reserve in a savings account to cover any taxes you will owe at the end of the year.
When your business owes back taxes, it can derail your plans for your business if not addressed. If you haven’t filed your tax return, make it a priority to file as soon as possible. Making sure you file and pay back taxes as soon as possible will put you in the clear with the IRS and let you focus on the fun of running your company.