Can sales tax or employee withholding tax be included in bankruptcy?
The short answer is no:
- Sales tax and employee withholding taxes are nondischargeable in Chapter 7 bankruptcy and Chapter 13 bankruptcy
Nondischargeable means that they won’t go away if you file bankruptcy on them.
These two types of taxes are different from income taxes, which can be dischargeable in bankruptcy in the right circumstances.
Generally, only businesses and their owners will owe sales tax and withholding or trust fund taxes.
WHAT ARE SALES TAXES?
Minnesota taxes certain sales at 6.875% or more, depending on where you are doing business.
This includes most retail sales and some services.
In general, businesses are required to keep a percentage of any sale and pay it to the state every month or quarter, depending on the sales volume of the business.
If you do not pay the sales taxes promptly, there are penalties and interest that the state will assess against you.
What if the business is losing money?
When a business begins to lose money it is tempting to think about using money that should be set aside for sales taxes to pay current expenses.
This is because:
- Sales taxes are due less often
- The state is not ‘paying attention’
- The state is less aggressive in collecting the taxes
However, it is unwise to let the sales tax payments slip because sales taxes are never dischargeable in bankruptcy.
Whilst debts to
- Suppliers
- Lenders
- Employees
Can generally be forgiven or discharged through a bankruptcy, sales taxes aren’t.
WHAT ARE WITHHOLDING TAXES?
The federal government requires employers to withhold a portion of their employees’ wages to pay Social Security and Medicare taxes.
This withholding is in addition to the half of those taxes that employers must pay.
These taxes are also called 941 taxes, or trust fund taxes.
Like sales taxes, these taxes are due quarterly.
Should you pay creditors instead of taxes?
However, the IRS will not be as active as banks, suppliers, or employees in demanding that the struggling business owner pay up.
This means that it can be tempting to ignore them and pay the more pressing creditors first.
For the same reason as sales taxes, this is a bad idea.
Withholding taxes are never discharged in bankruptcy, and the dollar amount of the debt can get quite high once you factor in all of the penalties and interest.
WHAT SHOULD THE STRUGGLING BUSINESS OWNER DO?
Entrepreneurs are forever optimistic that they will turn the corner and start making money.
To the entrepreneur, it often seems like a good idea to delay paying these types of taxes, and to pay current expenses like bank loans, suppliers, or employee salaries instead.
The first thing to do if you don’t have enough cash flow and operating capital to cover your expenses is to talk to a lawyer about the best way to go forward.
You are at a point where one decision could make the difference between:
- Walking away from your business and start again
And
- Paying thousands of dollars of taxes, penalties, and interests on these two types of taxes
If all is lost and you already owe sales taxes and withholding taxes, and you do not have the money to pay the taxes off, then you have two options left.
1. Wait until the statute of limitations ends which can take 10 to 15 years or even longer
2. Pursue an offer in compromise with the IRS which will only work on the withholding taxes, not any state sales taxes
Conclusion
If your business is struggling, you’re thinking about withholding sales tax or employee tax, why not consider filing for Chapter 7 Bankruptcy or Chapter 13 Bankruptcy instead?
Call us at 612.824.4357 now, and tell us how we can help you?
