Bad Idea Jeans and the Internal Revenue Service

admin   March 12, 2010   Comments Off on Bad Idea Jeans and the Internal Revenue Service

In a “Saturday Night Live” skit involving an ad for Bad Idea Jeans, five or six thirtyish guys are chatting as they ready themselves for a pick-up basketball game. 

One of them mentions that he is gutting and rehabbing his apartment. 

“You’re renting, right?” another asks. 

“Yeah,” responds the first, “month to month,” following which a baritone voice intones “Baaad Idea Jeans” and the camera cuts to a Bad Idea Jeans label attached, Levis-style, to the back pocket of the renter’s pants. 

Another fellow then mentions that he plans to tell his wife about an adulterous relationship, even though the affair is over and he and his wife are getting along great. “It’s the right thing to do,” he lectures his pals, following which we again hear the Bad Idea Jeans voice-over and are directed to the Bad Idea Jeans logo on that dim soul’s rear pocket. 

After that, yet another of these obviously really smart guys chimes in with his plan to take in a homeless drug addict, and so forth and so on. 

You get the joke because neither you nor anyone you know is as stupid as the guys in the ad. On the other hand, people do act on some pretty bad ideas, not least in the world of business — and, in the world of business, not least when a business runs short of cash. One such candidate for a pair of Bad Idea Jeans whom tax and bankruptcy attorneys encounter frequently is the client who has not remitted payroll tax withholding to the IRS. 

In case you don’t have time to finish this column because you have to take an urgent call from an angry creditor, here’s the point: Failing to remit payroll taxes to the IRS is a baaad idea. Never, ever fail to remit payroll taxes. Not only does it almost never save the business, it is also an almost certain path to the hellish world of IRS collections. 

Bottomless hole 
When you rob the IRS Peter to pay private creditor Pauls, there is soon no possibility of getting out of the hole. Your cash flow stinks (we knew that) and you have no hope of increasing it because you have no working capital. You will never obtain bank or other normal commercial credit (for one thing, you can’t show that your payroll taxes are up to date), and when the IRS wakes up (It will. You’ve been filing the quarterly returns, just not paying, right?), it will relatively quickly seize company assets (bank accounts go first) and assert a claim for payment against all those in the organization bearing any possible responsibility for the failure to timely remit. 

The claim for payment against responsible parties is known as the “trust fund” penalty, or the Section 6672 penalty (sounds very Soviet, nyet?). It is generally not dischargeable in bankruptcy (that is, in the bankruptcy of the individual tagged with the liability). All those with any authority to direct or influence which bills of the company are paid and which are not can be assessed. The IRS has asserted the trust fund penalty against company officers, controlling shareholders, comptrollers, bookkeepers, outside accountants, board members, partners in a general partnership (irrespective of whether the partner had anything to do with the business), executors of wills (with respect to an operating business owned directly or indirectly by the estate), bank officers, consultants and management companies. 

The IRS doesn’t always prevail (many cases are resolved in favor of the taxpayer through an administrative appeals procedure), but even a successful challenge imposes an emotional and financial cost. Furthermore, if you really are the boss, you have no chance of dodging the liability. Failure to remit payroll taxes is also a crime (but is treated as a criminal matter only in the most egregious cases). 

Here’s what happens with a company with a $1 million or $2 million annual payroll: The trust fund penalty balloons into six figures by virtue of interest, penalties and the disturbing number of payroll periods that seem to fly by, and the company eventually either closes or files for bankruptcy. If it closes, all those tagged with the trust fund penalty are stuck with an obligation that they may never be able to pay off. 

Fixing the problem
If, rather than closing, the company files for bankruptcy, payroll tax problems present some barriers to successful reorganization. First, from day one of the bankruptcy and without any slippage whatsoever, the company must keep its payroll tax obligations current. Second, the IRS will expect to be paid in full with interest and penalties, albeit over as long as 60 months. 

Now, bankruptcy doesn’t sound as bad as closing the business and cutting off a source of repaying the IRS, but here’s why the guy who tries to use bankruptcy to solve a trust fund penalty problem has earned his Bad Idea Jeans: He should have filed bankruptcy before he started missing the payroll deposits. He spent weeks or months stiffing a creditor whose debt is non-dischargeable (corporately and personally) so he could pay creditors whose debts are dischargeable. Bad idea, huh? 

And to make it sweeter still, he has likely dragged innocent company officers and financial people into a fight over who should satisfy the trust fund penalty assessment. Furthermore, if the business is not really a viable candidate for bankruptcy reorganization, the owner will wear himself out keeping it afloat anyway, solely for the purpose of covering a trust fund liability that need never have accrued. 

If you are tempted to solve a cash flow problem by delaying deposit of your employees’ payroll taxes, you must do one of the following three things immediately: Cause the company to file for bankruptcy (need a lawyer), undertake a privately negotiated workout with all your creditors (need a lawyer), or close the business (maybe need a lawyer; depends on whether or not there are assets). If you can’t afford a lawyer, that means the income you are trying to protect is not worth the anguish, so close the business. 

If you’ve earned your Bad Idea Jeans, but the sky hasn’t fallen yet and your company has some cash that it wants to pay to the IRS, contact an attorney or accountant and attempt a “designated” payment. 

Finally, if you’re not the boss, but are involved in the management of a company that is not paying its payroll taxes and are concerned that the IRS may attempt to hold you responsible for the trust fund penalty, consult an attorney urgently. It is likely that you should immediately resign from the company. Really. Even if you can’t afford to quit. 

Forget the yutz who rehabbed the apartment he didn’t own. Think catastrophe. Think that, short of being accused of a crime, being stuck with the trust fund penalty is the worst thing that can happen in your business life. Because it is.

© Maryland Gazette. Reprinted with permission.