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Filing for Bankruptcy?

You've still got to contend with the IRS.
February 23, 2001
URL: http://www.entrepreneur.com/article/38042

Q: What happens when a corporation becomes insolvent and files for bankruptcy? Does the IRS usually pursue the corporation for unpaid federal taxes? Can the IRS break through the corporate firewall and pursue the owner's personal assets for the payment of federal taxes?

A: The short answer to your questions is yes. The IRS has broad powers to collect back taxes and can grab company cars, bank accounts or any other valuable assets. Although you may be tempted to take up permanent residence in Iceland, keep in touch with the IRS even if your company is behind on paying its taxes.

Individual liability depends on the kind of taxes you owe. In general, a corporate officer or director won't be held personally liable for income taxes. But if employment taxes are due, the IRS can come after personal assets. And declaring bankruptcy won't do you any good-these taxes don't get discharged (wiped out) in a bankruptcy proceeding.

What are these "payroll taxes" that make the IRS charge like a bull in the ring? There are three types: federal income tax withholding (due for all employees); Social Security and Medicare taxes (fund payouts under the Federal Insurance Contributions Act, or FICA); and federal unemployment tax (which benefits workers who lose their jobs).

Instead of scaring you further, I'll lay out some solutions. Say you have $20,000 of past-due taxes and $50 in your checking account. Here are your options:

Let's say the situation is bleaker, and your company is behind $90,000 in payroll and income taxes. Your only assets left are IKEA couches and "Dotcom," the company's golden retriever. In this case, ask the IRS to consider an "offer in compromise," which is basically an offer to settle the debt permanently by paying only a portion of it. Offers in compromise are used for larger amounts, when there's little chance you'll ever pay off the whole amount through corporate assets or personal earnings. File IRS form 656 (request form) together with Form 433 (financial disclosure form).

Then there's what some consider the ultimate solution: bankruptcy, which comes in several flavors. There's Chapter 7, or "straight liquidation bankruptcy," which can wipe out unsecured debts; Chapter 13, which is tailored for the self-employed or those on salary; and Chapter 11, the classic "reorganization," which requires partial repayment of debts.

Businesses incorporate in part to avoid personal liability, but all bets are off when taxes remain unpaid. A crucial question: Did shareholders incorporate to foil the IRS? If there's an ulterior motive, the IRS can pierce the corporate shield and go after shareholders' assets.

The bottom line: Have a system in place for paying all your business taxes regularly, and get in touch with the IRS if fiscal woes find you short. Your business's future depends on it.

Joan E. Lisante is an attorney and freelance writer who lives in the Washington, DC, area. She writes consumer-related legal features for The Washington Post, the Plain Dealer, the Spokane Spokesman-Review and the Toledo Blade (Ohio). She is also a contributing editor to LawStreet.com and ConsumerAffairs.com.

In her practice, Lisante is counsel to ConsumerAffairs.com and was counsel for Zapnews, a fax-based customized news service for radio stations. Previously, she served as Assistant District Attorney in Queens County, New York, and Deputy District Attorney in Nassau County, New York.


The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.