When Business Taxes Become Personal – How to Protect Yourself From Personal Liability

A lot of entrepreneurs set up their businesses with specific structures designed to limit their liability for business debts and lawsuits. However, there's always a risk that you may face personal liability for business taxes or other debts, regardless of the structure of your business. This post outlines when you may face personal liability for business taxes and how to minimize the risk. 

Already facing threats from the IRS? Worried about your tax debt spinning out of control? Need help understanding the options and protecting your assets? Then, use TaxCure to find a licensed tax pro who has experience with business tax problems today. 

Key takeaways

• Your business structure plays a significant role in your personal liability for business debts.
• However, the IRS can assess personal liability for business taxes regardless of business structure in some cases.
• You may become personally liable for business taxes if the agency determines that you and the business are the same entity (aka alter ego).
• The IRS can also assess Trust Fund Recovery Penalties against individuals for unpaid trust fund taxes.
• Most states can also assess personal liability for unpaid sales tax.
• The IRS can also go after business assets for personal tax debt in some situations. 

How Business Structure Affects Liability 

First, let's look at how your business structure affects your liability. Here's a breakdown of the main considerations. Note that there are differences in general liability and liability for taxes.

 

Those are the general rules. However, the following sections will look at situations where you may become personally liable for corporate tax debts as well.

Are you personally liable for S-corp debts?

An S-corporation is a tax election. It is not a legal business entity. However, every S-corporation is either an LLC or a C-corporation. Both of those structures protect you from personal responsibility for business debts, and typically, the corporate structure protects you from tax debts. 

However, when you file an S-corp return, the corporation's profits flow to your personal tax return, creating instant personal liability. Payroll and excise taxes are owed by the S-corporation, but the IRS may be able to hold you personally liable by piercing the corporate veil or assessing a Trust Fund Recovery Penalty (TFRP) against you. 

Why are LLC owners personally liable for business taxes?

An LLC is a business structure created under state law – it shields the owners from liability for most business debts, with the exception of debts that they personally guarantee. However, LLCs may file taxes in a few different ways, which can affect their owners' liability for business tax debts. 

Single-member LLCs report their profits on their owner's personal tax returns, and they personally incur the tax. Multi-member LLCs report their profits on a partnership tax return. Then, the profits flow to their personal tax returns, and they have personal liability. In both cases, the LLC files payroll tax returns under its own tax ID number, and only the LLC is responsible for the payroll tax debt. 

However, LLCs may opt to be taxed as S-corps. In that case, as noted above, the LLC's owners are automatically responsible for taxes on business profits but not for payroll taxes. 

When LLCs and Corporations Don't Shield You From Personal Liability

The protections offered by LLCs and corporations are not absolute. Both the IRS and private creditors can "pierce the corporate veil" and hold you personally liable for business debts or taxes. Typically, this happens if there's no distinction between you and the corporation. For example:

• You comingle funds – you use personal accounts for business expenses and business accounts for personal expenses. You regularly transfer money between these accounts in cases where it's not an owner draw or contribution.
• You use business assets for personal use – this has a similar effect to co-mingling funds. 
• You don't meet the LLC or corporate requirements – for example, you fail to keep your LLC or corporation active with your Secretary of State. 
• The IRS determines that the business is your alter ego – this can happen due to any of the elements above, but it generally only applies to single-member LLCs or corporations. It means that the IRS has decided that you and the business are the same entity. 

If this happens, the IRS can hold you personally responsible for any taxes that are owed by the business, whether the business is still operating or getting ready to shut down. 

For example, say that a corporation owes $100,000 in corporate income tax. The IRS determines, based on the above factors, that the shareholders are personally liable for the corporation's tax debts. Then, the IRS can file tax liens against the shareholders and move forward with seizing their personal assets.

However, this isn't the only way that the IRS or the states can hold an owner personally liable for business debts. In some cases, the agency doesn't have to pierce the corporate veil.

The Trust Fund Recovery Penalty: The #1 Way the IRS Makes It Personal

If a business has unpaid payroll taxes, the IRS can assess a Trust Fund Recovery Penalty (TFRP) against individuals who were responsible for the unpaid taxes. The penalty is worth 100% of the trust fund portion of the tax debt. 

Here's a step-by-step example of how this may play out with a corporation. 

1. A corporation owes $100,000 in payroll tax debt. $65,000 is trust fund taxes withheld from employee paychecks, while $35,000 is employer matching payments.
2. The corporation doesn't pay the taxes, so the IRS files a tax lien against the corporation for $100,000.
3. The IRS decides to pursue the TFRP. The TFRP will be $65,000, which is the trust fund portion of the unpaid taxes.
4. To determine who may be individually liable, the IRS interviews people related to the business to learn more about how it handles payroll and general finances. 
5. The IRS identifies responsible parties, which may include owners, shareholders, or even employees.
6. The IRS proposes to assess the TFRP against one or more individuals, 
7. Each individual gets an opportunity to dispute the tax liability or agree with the assessment.
8. Once the TFRP is assessed, the IRS can go after the individual's assets. 
9. Note that if the TFRP is assessed against multiple people, the IRS can go after any of them for the full penalty – but the agency can only collect the penalty once. 

The IRS can also assess a TFRP for unpaid excise taxes. In this case, the IRS is not holding you personally liable for business taxes. Rather, they are relying on other parts of the tax code to assess a penalty against you personally.

Personal Liability for Sales Tax

Most states have laws that allow them to hold responsible people in a business personally liable for business taxes. This is not the same as the TFRP assessment – in that situation, the IRS is assessing a penalty against an individual. In this situation, the state is transferring liability for the sales tax to an individual. 

Owners are the most likely to be held liable for unpaid sales taxes, but the state revenue agency may also look at managers, accountants, bookkeepers, or anyone who made the decision not to pay the sales tax and to use the money for other purposes. 

Are you personally liable for state withholding tax?

Most states also have laws that allow them to hold individuals responsible for taxes that were withheld from an employee's paycheck. 

Signs You're Facing Personal Risk for Business Taxes

If any of the following happen, personal liability for business taxes or TFRP may be imminent:

• Your corporation has unpaid taxes, and you know that you comingle funds or assets.
• A revenue officer has contacted you about an FTD alert – this is often the beginning of the TFRP assessment process.
• A revenue officer has asked you to schedule a Form 4180 interview – this is getting deeper into the TFRP investigation.
• You've received Form 2751, and the IRS has proposed a TFRP against you. 
• You have unpaid sales tax, and your state revenue agency has filed a tax lien against the business. 

As soon as you suspect that you may be facing personal liability, contact a tax pro. This is not an easy issue to deal with, and if you want to protect your assets, you need expert assistance. 

When the IRS Can’t Go After You Personally

If the following apply, the IRS generally cannot go after you personally, and if they are threatening to take your personal assets or file a lien against you personally, you have a strong case against them:

• Formal separation exists between you and the business. 
• The business has a clean compliance history.
• There is no fraud or willful intent to not pay the taxes.

Remember, the IRS makes mistakes. Even if they're saying that you're personally liable, you may be able to escape liability by appealing and working with the right tax pro. 

How to Minimize the Risk of Personal Liability

The best way to protect yourself is to be proactive. Keep these tips in mind:

• Set up a business structure that minimizes your risk of personal liability.
• Keep your business active – meet all state requirements for entity renewal and organization.
• Maintain separate accounts for personal and business use.
• Avoid excessive, unnecessary transfers between business and personal accounts. 
• Clearly document personal vs. business use of assets that are used for both personal and business purposes – for example, mileage and expense logs for vehicles that you use for personal and business purposes. 
• File and pay taxes on time.
• Prioritize trust fund taxes – that refers to taxes collected from other people and paid by you, such as sales tax, excise taxes, or payroll taxes withheld from employee paychecks. These taxes carry a greater risk of personal liability.
• Respond promptly to letters from the IRS or the state – otherwise, you may miss chances to appeal or present your side of the story.

Also, consult with a tax pro at the first sign of a problem. They can advise you and help you minimize your risk. 

Resolution Options if You're Personally on the Hook

Sometimes, you can't escape personal liability. If you're on the hook for a tax debt, here are the main options if you can't afford to pay in full. 

• Installment Agreements – make monthly payments.
• Offers in Compromise – apply to settle for less than owed, based on your income or assets.
• Currently Not Collectible – get the IRS to stop collection actions by proving that you can't afford to pay.
• Appeals – appeal when the IRS contacts you about tax or penalty assessments or any collection actions (liens, levies, etc). There are a few different ways to appeal depending on the situation. 

How a Tax Pro Can Help You

A tax pro can help you at every stage of this process – but it's critical that you find a pro with the right experience. Not all pros focus on resolution. However, TaxCure makes it easy to narrow in on the right choices – you can search for help based on the tax agency you're dealing with, the type of taxes, and other factors. Then, review the options to find the best fit. 

Tax pros can help you deal with the IRS or your state agency. They can argue that you're not personally liable. They can mount defenses based on extensive knowledge of alter ego doctrines, state law, and the Internal Revenue Code. 

If you are liable, they can help you set up payments, get back into compliance, and minimize your risks moving forward. A tax pro is your personal advocate. In contrast, anyone you talk to at the IRS is a government employee. You need someone who works for you, not the IRS. 

Don’t Wait for the IRS to Make It Personal – Get Help Now

If you're facing a risk of personal liability, don't wait. Reach out for help as soon as possible. Use TaxCure to find a professional to help you today. 

FAQs:

Can the IRS take my house for business payroll tax debt?

Potentially yes. If the IRS assesses the tax against you personally or assesses a TFRP against you, they can go after any of your assets. That includes your home, even though that's a very rare risk. 

Can I reverse an IRS decision to hold me personally liable?

It depends on the circumstances. There are ways to appeal IRS tax assessments both before and after they are final. However, the options vary drastically based on the timing and the specifics, and for best results, you should work with an experienced tax pro.

What's an alter ego liability?

That's when the IRS decides that you and a business are one in the same, and then, the agency goes after you for business taxes or goes after the business for your personal taxes. 

What is nominee liability?

This happens if you transfer assets to another party and the IRS decides that the transfer was made to avoid paying taxes. The IRS can then seize the value of the transferred asset from its new owner (the nominee).

Am I personally liable if I buy a business with tax debts?

It depends. The business structure, the specifics of the sale, and other factors determine your risk of personal liability when you buy a business with tax debts.