By Kitty J. Lin, Attorney at Law
If you own your own business, your worst nightmare is the situation when your business fails. To add further salt to the wound, not only did your business fail, but you realize you still owe the taxing authorities for sales taxes and payroll taxes, and you are still personally responsible for those, even if you are no longer in business. Filing for bankruptcy may help, depending on your situation. There are several categories of taxes, and they are treated differently in bankruptcy, depending on what category they are in.
Personal Income Tax
First, as previously discussed in our article about dischargeability of personal taxes, Can Taxes be Discharged When Filing Bankruptcy?, taxes that you personally owe are dischargeable if they are more than three years old, filed more than two years ago, assessed more than 240 days ago, not filed fraudulently, and the taxpayer is not guilty of willful tax evasion are dischargeable in a Chapter 7 or Chapter 13 bankruptcy. Taxes that do fall under this category (meaning the taxes are less than three years old, or filed less than two years ago, or assessed less than 240 days ago, was filed fraudulently, or the taxpayer was found to be guilty of willful tax evasion), are considered “priority taxes” which are not dischargeable in bankruptcy. Any debt that is considered non-dischargeable in bankruptcy means that you are still responsible for paying this debt whether you file for bankruptcy or not. If you have any non-dischargeable debt, see Non-Dischargeable Taxes: What Happens if I Cannot Afford to Pay My Tax Liability?
If you owe the state sales tax, whether or not they are dischargeable will depend on whether the sales taxes are considered an “excise tax” or “trust fund tax.” How the sales taxes are categorized depends on your state. Sales tax is considered a trust fund tax if the tax is assessed on the customer at the time of the sale and the responsibility to collect the tax is on the business owner. The business owner is supposed to collect the tax to turn over to the taxing authority. Trust fund taxes are not dischargeable in bankruptcy.
Sales tax that is the responsibility of the owner for the privilege of doing business in the state is considered an excise tax. California is an “excise tax” state, so that means that the business owners are responsible for the sales tax, not the customer. It may be a little confusing, since almost all the business owners pass on the sales tax to their customers, but the ultimate liability of the sales tax is still on the business owner. Excise taxes are dischargeable in bankruptcy, so that is good news for failed business owners in the state of California.
Payroll taxes are broken out into two parts: those taxes that are taken out of an employee’s paycheck, and those taxes that are paid by the employer. The taxes that are taken out of an employee’s paycheck (such as federal income tax, state income tax, social security, and medicare) are considered “trust fund taxes.” It is the business owner’s responsibility to turn over those funds taken out of the employee’s paycheck to their taxing authority. The funds taken out of the employee’s paychecks are “held in trust” by the business owner to be turned over to the taxing authority. If the business failed (or even if the business is still continuing), and the funds were used to pay off other debt or expenses other than to turn over to the taxing authority, the taxing authority will not be sympathetic. They only care that the business owner withheld these funds, but used it for other purposes than which it was held for. As with the sales taxes that are considered to be “trust fund taxes” payroll taxes withheld from an employee’s paycheck are considered non-dischargeable in bankruptcy.
The payroll taxes that are paid by the employer are “non-trust fund taxes.” These taxes are dischargeable in bankruptcy.
The dischargeability of taxes in bankruptcy is a complicated issue that should be discussed with an attorney prior to filing. If you need to consult with an experienced bankruptcy lawyer or bankruptcy attorney, please call us at 877-9NEW-LIFE (877-963-9543) for a free consultation today.