Here’s what a small business may face if issued with tax liens by the IRS.
In this article:
- What Are Tax Liens?
- How Are Tax Liens Carried Out?
- How Are Tax Liens Avoided?
- Which Types of Property Are Susceptible to Business Tax Liens?
- How Do Tax Liens Affect Small Businesses?
- Could Tax Liens Be Removed?
Effects of Tax Liens on Small Businesses
What Are Tax Liens?
Before we discuss how tax liens affect small businesses, let’s get to know this subject matter closely. Tax liens are issued as a kind of collateral for unpaid tax debt.
Whenever you owe money to a lender, personal assets are usually pledged, such as home equity (among others). The same concept guides the core idea behind tax liens.
Imposing a tax lien allows the government to safeguard its collection process from taxpayers that have chronically neglected to pay their IRS debt in full. Tax liens give tax debt priority over other types of debt, including credit card debt and financial loans.
This means the government has first dibs on a taxpayer’s assets, before any other lenders or creditors, should the situation escalate to the seizure of property.
Small businesses with unpaid and overdue tax debt can receive a lien notice from the IRS. Properties that may be covered by tax liens will depend on the structure of a given business.
With business partnerships and sole proprietorships, tax liens extend to personal properties. Meanwhile, for incorporated businesses or limited liability companies (LLC), tax liens may only be attached to business assets.
A million tax liens are served by the IRS annually.
Limited Liability Company (LLC) Definition: a U.S. business structure wherein the owners are not personally or legally responsible for liabilities and debts incurred by the company
How Are Tax Liens Carried Out?
Tax liens as means of IRS collection have three stages. They are as follows:
- Notice and Demand for Payment. This is where a taxpayer is informed of overdue tax debt. This letter will consist of the amount you owe, as well as its corresponding interests and penalties. After receiving this letter, a taxpayer is given 10 days to pay in full or reach a payment agreement with the IRS.
- Notice of Tax Lien. This letter is sent once the 10-day period following receipt of Notice and Demand for Payment has expired.
- Notice of Levy. If the Notice of Tax Lien has also been ignored, the IRS will proceed with sending a Notice of Levy to a delinquent taxpayer. This prompts a 30-day period in which a taxpayer can still make payment arrangements with the IRS. If none are made, the IRS can enact lawful property seizure.
How Are Tax Liens Avoided?
The best way to avoid a tax lien is by paying your business tax in full and on time. However, if that is financially improbable, there are still other options which you may consider.
Here are possible ways to circumvent a tax lien:
- Provide the IRS with Proof of Financial Status. This will not erase your tax debt. What it will give you is extended time to pay off what you owe the IRS. The upside is your properties won’t be subjected to a tax lien. The downside is the accrual of penalty and interest attached to your outstanding tax debt, which will continuously add up until the debt is fully paid.
- Installment Agreement. This is a convenient way to take care of tax debt. It can be arranged via phone or online. Here you are agreeing on a fixed monthly payment plan with the IRS to satisfy the full amount of tax debt.
- Offer in Compromise. If paying your tax debt in full will put you in a dire financial situation, the IRS might accept an offer in compromise. This means you get to pay a smaller percentage of what you actually owe. To qualify for this tax relief option, you have to prove your indigent status with the IRS. The agency also looks into tax return history and current monthly income to ascertain which offers in compromise to accept.
Which Types of Property Are Susceptible to Business Tax Liens?
As discussed above, the types of property that may be attached to a tax lien depends on a business’ structure. The rule of thumb is simple: personal assets of sole proprietors and business partners are not exempt, while those of LLCs and incorporators are.
Here are examples of assets that are susceptible to IRS tax liens:
- Current Assets (Cash, receivables, money orders, deposit accounts, etc.)
- Fixed Assets (Land, building, machinery, furniture, tools, equipment, etc.)
- Home equity
- Investment portfolio
- Bank deposits
How Do Tax Liens Affect Small Businesses?
Tax liens affect businesses in a variety of ways. Here are three examples:
- Loan Eligibility. Tax liens appear on business credit reports. This automatically compromises a business entity’s credit score, which then results in fewer lenders willing to approve loans. Should you need additional funding to expand, or just to keep your business finances afloat, borrowing money may prove challenging.
- Managerial Control. Having your properties attached to tax liens severely restricts managerial control over your business. For one thing, it is doubly difficult to liquidate your property. Even plans for expansion can be held back by the fact that the IRS has legal claims over your business assets.
- Social Standing. A business entity’s social standing is crucial to its success. A compromised reputation has a direct effect on customer response. Given how tax liens remain in a business’s credit report for years, this IRS penalty proves rather detrimental.
- Financial Loss. This is perhaps the most obviously unpleasant consequence of tax liens. If not dealt with appropriately, it can lead to tax levies, which can quickly escalate to property seizure. Such means a substantial financial loss to small businesses.
Could Tax Liens Be Removed?
Yes, they can. In fact, the IRS can remove tax liens if any of these are proven:
- IRS procedures were not followed in carrying out the tax lien.
- Lien withdrawal will allow a taxpayer to pay their tax debt faster.
- The National Taxpayer Advocate determines that withdrawal is in the best interest of both the government and the taxpayer.
Aside from the aforementioned cases, other options exist to temper the effects of tax liens. These include:
- Subordination. This is where the IRS agrees to let other creditors get priority over collateral assets if it means the taxpayer can improve their financial situation and thus pay their tax debt faster.
- Property Discharge. This is where the IRS lifts a tax lien attached to a certain property if it means that the taxpayer has access to a financial safety net that improves their capacity to pay their tax debt.
Tax liens are not a death sentence to small businesses. There are ways to solve this tax concern and avoid its repercussions, as discussed above.
Do you have any experiences about tax liens affecting your small business? Feel free to share your experience with us in the comments section below.
If you owe back taxes, visit taxreliefcenter.org for more information on tax relief options.