Ending a Business With Payroll Tax Debt: What To Know

If you’re thinking about closing a business, you might assume that your business’s tax liabilities go away when the business closes. In some cases, this isn’t true, especially when it comes to payroll tax debts. If you shut down your business with outstanding payroll tax debts, those debts could follow you after your business is closed because the IRS might deem you to be personally liable for them.

The goal of this article is to discuss when and how this might happen, and what you can do in case it does. Payroll tax problems can be particularly stressful and complicated, so it often helps to consult with a tax professional, such as one from 20/20 Tax Resolution. We offer free consultations, so feel free to contact us at your convenience.

Key Takeaways

Owners of sole props and pass-through entities are personally liable for payroll tax debts due to the business structure.
If a business and its owner are separate entities for tax purposes, then the business-related tax debts are only the responsibility of the business.
If there are unpaid trust fund taxes when a business closes, anyone responsible for those unpaid taxes may be subject to the Trust Fund Recovery Penalty (TFRP), a penalty that imposes personal liability.
Before imposing the TFRP, the IRS will conduct a Form 4180 interview to identify who is responsible for the unpaid trust taxes.
If the IRS requests a Form 4180 interview or a business has tax liabilities it can’t pay before closing down, it’s a good idea to first consult a tax pro with experience handling payroll tax issues.

An Overview of Payroll Taxes

One reason why payroll taxes are so confusing is that there are different terms that can be used to refer to them. These terms often overlap, but also have distinctions between them:

Payroll taxes: These are taxes that are used to pay for government social programs, such as Social Security and Medicare. Some payroll taxes are paid for by both employers and employees, while others are paid by just employers.
Employment taxes: This is an overarching term that usually refers to both payroll taxes and federal income taxes.
Trust fund taxes: These taxes an employer withholds from an employee’s paycheck primarily for payroll and income tax purposes. The reason these are called “trust fund” taxes is that they consist of the employee’s money that the employer holds “in trust” until the employer can remit them to the IRS or other appropriate government agency.

These aren’t absolute definitions, and the term “payroll tax” is sometimes used interchangeably with employment tax or trust fund tax. However, for purposes of this article, we’ll be using the above definitions because the distinction between these taxes can make a difference in terms of individual and business liability after a business closes.

Another important factor that can affect what happens to payroll taxes after a business closes is the type of form or structure the business has.

The Effect a Business’s Form Has on Tax Liability

There are many different ways to structure a business. For purposes of payroll tax liability, we’ll focus on whether there’s a legal distinction between the business itself and the business’s owner or if the business is a pass-through entity.

If a business is a sole proprietorship or a general partnership, then its owner(s) are directly responsible for its taxes and other liabilities. If the business and its owner(s) are separate entities for tax and/or liability purposes (such as a corporation), then the business-related tax debts are only the responsibility of the business. The IRS can go after business assets (using a lien or levy) to help collect the outstanding business tax debt. If the business has no assets available, the IRS can’t then go after the owners. Instead, the IRS will mark the business tax debts as not collectible.

One major exception to this personal liability protection for owners is if the unpaid business taxes that exist during closure include trust fund taxes. If that’s the case, then personal liability for the owners is possible.

Why Trust Fund Taxes Are Different

The IRS treats trust fund taxes differently because the IRS views unpaid trust fund taxes as a form of theft of employee money. When a business doesn’t pay its taxes to the IRS, the business is withholding its own money from the IRS. When a business doesn’t pay the trust fund taxes it collects, the business is withholding its employees’ money from the IRS.

This is why the IRS is less flexible when negotiating a settlement for unpaid trust fund taxes and why the Trust Fund Recovery Penalty exists.

The Trust Fund Recovery Penalty

The Trust Fund Recovery Penalty (TFRP) is a penalty the IRS imposes on individuals it views as responsible for failing to collect, account, and/or send trust fund taxes to the IRS. There are two notable features of this penalty.

First, it’s a significant penalty, equal to the unpaid trust fund tax balance. This amounts to the employee’s withheld portion of income and FICA (Social Security and Medicare contributions) taxes. Depending on how much your employees get paid, this could be thousands or tens of thousands of dollars per month. If your business has many employees, this can quickly add up to a significant sums of money.

Second, the TFRP imposes personal liability on those the IRS deems responsible for the trust fund tax collection failure. In other words, even if your business closes down while insolvent, the IRS can still go after the responsible individual(s)’ personal assets to recover the TFRP.

Who Does the IRS Consider a Responsible Person?

A “responsible person” is anyone who has the authority and power to collect or pay trust fund taxes and willfully fails to comply with this duty. This means not just an owner can be considered responsible, but also a:

Third-party payer
Payroll service provider or administrator
Bookkeeper
Shareholder
Accountant
Corporate officer or director
Member of a partnership
Any person with control over the business’s funds and the authority to direct how they’re spent.

The IRS can hold multiple people responsible for the TFRP, and this liability is joint and several. This means that if two people are both equally liable for the TFRP, it’s still possible for the IRS to collect 100% of the TFRP from just one responsible person.

If the IRS holds you responsible and you don’t pay this penalty, it could lead to liens on your personal property or the IRS levying your personal assets, including the use of wage garnishment.

Finding the Responsible Person

The IRS will sometimes need to do a bit of investigating to figure out exactly who the responsible person is. This usually means assigning a Revenue Officer to your case and conducting one or more Form 4180 Interviews.

These interviews can occur in person or over the phone and consist of the IRS asking questions to decide whether the person being interviewed had sufficient involvement with the business’s finances to be responsible for the unpaid trust fund tax payments. Some of these questions could relate to the person’s:

Check-writing authority.
Involvement with preparing and/or signing payroll tax returns.
Knowledge that the trust fund taxes weren’t being paid to the IRS.
Ability to decide which bills get paid and when.
Physical access to the business’s bank accounts, such as login information or PINs.

How to Properly Close a Business

If you want to close your business in a manner that limits the chances of personal liability for unpaid payroll taxes, follow these steps.

Step 1: Close Your Tax Accounts

You’ll need to let the IRS and relevant state taxing entities know about your business closing down, and you can do this by closing down your IRS business account and cancelling your EIN (employer identification number). There may also be state tax accounts you need to close.

Step 2: Pay Your Employees Their Final Wages

Your employees are entitled to their final wages and compensation, but when doing this, you’ll need to collect, withhold, and pay the required employment taxes.

Step 3: File Your Final Tax Returns

You must file the final tax return for the year you close your business. There may be multiple final returns to file for both state and federal taxes, including payroll tax returns, such as IRS Form 941, Employer’s Quarterly Federal Tax Return, and IRS Form 940, Employer’s Annual Federal Unemployment (FUTA) Tax Return.

Step 4: Keep Records Documenting Who’s Responsible for Trust Fund Taxes

If you suspect you might have trust fund tax problems when closing your business, make sure to take note of who might qualify as a responsible person for TFRP purposes. Identify and store relevant documentation, if applicable.

Step 5: Pay Any Outstanding Business Taxes

Whether they’re sales taxes, business income taxes, trust fund taxes, or payroll taxes, make sure these get paid. If you or your business can’t immediately pay these in full, make other arrangements to settle them.

Resolving Payroll Tax Debt After Closing a Business

If you can’t afford to pay all of your business’s taxes, consult with a tax professional to discuss what exactly needs to be paid, when it needs to be paid, and how it can be paid. Whether the business owes the tax or one or more individuals have been hit with a penalty, you can plan your tax strategy accordingly, including consideration of the following tax settlement options:

In a typical unpaid tax case, you might be able to request these yourself. If you’re looking at a potential TFRP or unpaid trust fund tax situation, it’s highly advisable to first talk to a tax resolution professional before agreeing to anything with the IRS.

20/20 Tax Resolution Is Ready To Help With Any Payroll Tax Problem

Whether you’re closing your business, wishing to continue business operations, or you’ve just received IRS Letter 1153, payroll tax problems can’t be ignored. 20/20 Tax Resolution can help limit your exposure to TFRP personal liability, as well as negotiate with the IRS on your business’s behalf when trying to deal with payroll tax debt. Contact us to schedule a free consultation before the IRS takes its next step in its payroll tax collection efforts against your business.

Get a free consultation

We Are Committed To Finding SolutionsLearn More

Payroll Tax Debt and Business Closure FAQs

Can the IRS come after me personally for payroll taxes if the business is closed?

Potentially. If your business’s tax debts were transferred to you after you closed your business (which could happen if your business was set up as a pass-through entity) or if a portion of the payroll tax debt included trust fund taxes, then the IRS can most likely hold you or someone else from your business personally liable for the unpaid payroll taxes.

Does bankruptcy help with payroll tax debt?

In most cases, payroll tax debts aren’t dischargeable in a bankruptcy proceeding. This is true whether it’s you or your business filing for bankruptcy.

Can I handle the Form 4180 interview myself?

You could, but you shouldn’t. It’s not recommended because you might accidentally incriminate yourself or waive one or more of your rights. If hiring a tax pro to represent you during the interview isn’t possible, you should at least have a tax pro help prepare you for the interview.