This doesn’t seem like a tough question to most folks. You’ll pay the creditors to keep your doors open and delay paying the ones who may let you slide past due.
Well, an important analysis will likely lead to other priorities. Consider first to whom you may be personally liable if the doors close… Taxing authorities and holders of guaranties must be at the top of the list. Then consider whether you, as the business owner, have it in you to guide the company through the dark times.
Even if you are set up as a corporation or limited liability company to own your business and protect your assets from company debts, some claims for unpaid taxes create personal liability for those associated with the business. If you are focusing on who to pay to keep the doors open, you will likely not consider the IRS and the Department of Revenue (in most states), who will often be one of the last creditors to show up when you don’t pay on time. But sometimes, liability can pass on to the owners, officers or even an employee entrusted with making decisions on who to pay (yes, even the bookkeeper can be personally liable).
Personal liability for unpaid business taxes generally arises from the failure to pay sales or use taxes and federal payroll taxes. In the case of sales/use taxes, that money never belonged to your business. The business collected it for the state and even though it was mixed with other business funds, there is no way to trace it (similar to a trust). The state may use words like “conversion” and even “theft” when they finally come knocking to collect.
Federal payroll taxes consist of two components: 1) The amount withheld from the employee wages and 2) the matching amount of the employer’s contribution. In the eyes of the IRS, the amount withheld from the wages of the employee is the employee’s money, even though the employee never actually received it. Just as in the case of sales taxes, the employer collected that money from the employee for the government. It never belonged to the employer. Worst still – in both cases – there are penalties and interest accruing on the unpaid funds and interest accruing on the unpaid penalties. It isn’t long before the interest, the penalties and interest on the penalties, total up to more than the original amount of unpaid taxes.
Also, even if the state or IRS don’t show up for a year or more, the interest and penalties have been running the entire time and the government’s delay in trying collect doesn’t change that. Even if you can’t pay all of the payroll taxes, there is a means to designate what you can pay to be applied to the employee withholding portion of the total liability. Ordinarily, you can’t be held personally liable for not paying the employer’s share of the payroll tax. That’s just another business debt.
So, regardless of the likelihood of your business surviving, you need to prioritize the payment of sales/use and payroll taxes to avoid personal liability for yourself and possibly other employees.
YOUR OWN SURVIVAL
With your own survival in mind, you need to consider what business debts you have agreed to be liable for. Often vendors asked to extend credit to a new business require the owner to guaranty the business debt. If you have a business loan from a bank, you almost certainly have guaranteed it – perhaps putting up your home or other assets as additional collateral. If you’ve been in business for a while, you may not remember signing to guaranty those credit agreements years ago, but the creditors are like elephants: they don’t forget.
So, search your memory. Better yet, review your loan documents. If there is a 50/50 chance or worse that your business won’t survive, you need to get those creditors paid down as much as possible. If you’re sure the business won’t make it, go to the creditor and tell them you are ceasing business, but you may be able to pay down their debt ahead of others. You may be able to reach some compromise to get a release of personal liability.
CAN YOUR BUSINESS SURVIVE?
Before deciding which creditors should be paid to keep the business open, do an honest self-assessment. What are the realistic prospects for your business to survive? Is your wellbeing and health such that you can live with the stress of turning things around?
Now is the time when you’re thinking may not be very clear – and it needs to be. Experienced financial and legal counsel can help you come to an objective decision. They can identify the facts supporting your conclusion that you’ve got a chance of survival and feel good about moving forward. If they tell you the facts don’t support continued operation, then you won’t waste time thinking you should have hung in there.
Perhaps a bankruptcy may forestall a shutdown. If the business has suffered some unforeseen, uninsured, isolated incident and is otherwise profitable, then a Chapter 11 Bankruptcy may be an option to provide an opportunity to get the business back on its feet. Chapter 11 prevents creditors from filing collection suits and may even stop guaranty collection against you in some cases. Again, you need sound legal advice to consider this option as it’s a complex one and not inexpensive. Read KGR’s other blog on Chapter 11 here: Small Business Reorganization Act (SBRA) of 2019 updates to Chapter 11.
On the other hand, businesses shut down every day without filing bankruptcy. The assets get liquidated. Lienholders get paid first and other creditors get what’s leftover. If your business is hemorrhaging red ink, keeping it open so you can continue to draw a paycheck for a few more weeks or months is almost always a mistake. There will always be debts like the ones discussed earlier that will survive to make your afterlife difficult. So many times I’ve heard clients tell me they waited too long to pull the plug – often after liquidating their retirement (creating new tax liabilities), mortgaging their home and running up personal credit card debt. Don’t let this happen to you. Take stock of your situation, seek outside professional advice early and make good decisions while you have choices.
The Business Planning Group of KGR is here to answer your questions. Please contact James A. Knauer for more information.