Sales taxes, payroll taxes, quarterly estimated tax payments: There are so many different types of taxes that it's no wonder many small-business owners run into tax trouble. But with states strapped for cash, this may be the ideal time for tax-plagued entrepreneurs to face up, 'fess up, and pay up, says Jonathan Medows, a Manhattan-based CPA. Medows spoke recently with Smart Answers columnist Karen E. Klein. Edited excerpts of their conversation follow.
Q: How do small-business owners get into trouble with taxes?
A: Sometimes they try to prepare their own tax returns, but business returns are very nuanced. People who aren't comfortable with tax law may not be able to adequately reduce their tax liability, and they just can't pay what they owe. Other companies have cash-flow problems, so when they get money in, they pay other bills first and put their taxes on the bottom of the list. Or they expand too quickly and have cash-flow problems, and then when they withhold taxes from their employees' payroll, they use it to fund operations instead of remitting it to the proper government agencies.
Q: That sounds like a practice that could get out of control quickly.
A: Yes, but that's human nature. I built this [accounting] practice while going through rabbinical school, and I always say I got my pastoral training on my clients.
Q: Are there people who simply procrastinate or don't understand more complicated tax requirements, such as paying sales tax in multiple states or making estimated quarterly payments?
A: Sure. I had one self-employed client who came in with 12 years of outstanding tax returns. The sad part is that she was owed refunds for some of those years, but refunds expire after three years. There was a significant amount of money due her that she could not claim.
Q: What should entrepreneurs with tax problems do?
A: They should realize that avoidance doesn't help anything. In fact, now's a very good time to get your act together and take care of the problem.
Q: Why is that?
A: Most people wait until their income goes up or their business picks up to deal with their back taxes or their failure to file. That's actually the worst time to do it. You should be dealing with this stuff when you're broke. If you're underemployed or your income is low, the tax authorities are more likely to issue forgiveness or take a much-reduced amount on what you owe. They are showing a bit more flexibility because of the economic times.
Q: How do the states and the IRS typically pursue back taxes?
A: They send letters notifying you that you owe money or they may put levies or liens on you or your business. Many states are in dire financial straits right now, and they're getting more aggressive about pursuing this.
That's another reason this is a good time to straighten out your tax problems. Many states, including New York, now have something called "voluntary disclosure programs."
Q: How do those programs work?
A: The voluntary disclosure program encourages taxpayers who haven't paid their taxes to come forward and pay what they owe, offering significant incentives to people who commit to paying. In New York the program was instituted in September 2008 and it's unknown how long it will be in place. That's why I advise my clients to beat the tax department to the punch and go to them before they come after you.
Q: What incentives do they offer people who come forward?
A: They will agree not to pursue criminal charges against you, and many of the states will also waive penalties that normally would be levied on back taxes. If you're having a difficult time financially, they will often negotiate with you so you can pay a reduced amount or get on a payment plan that lets you pay the full amount over a number of months.
Q: I've seen advertisements for firms that offer to handle these kinds of tax negotiations on behalf of companies or individuals. Do you need to hire a special attorney or former IRS agent?
A: It may pay to get someone to help you, particularly if you're not good at negotiating on your own behalf. But those charlatans on TV can't do more than your own accountant, or you yourself for that matter. They take their fees up front—and they're not cheap. They also will not prepare your taxes if you're a non-filer. They'll tell you to hire your own accountant to do that.
Q: How do you know what agency to approach if you're an entrepreneur who owes back taxes or hasn't filed a return?
A: Check with your state's tax agency to see if they have a voluntary disclosure program and follow the instructions they give you. Have a professional work with you if you're not comfortable doing it yourself. More often than not, the authorities are willing to negotiate with you, especially when the economy goes bad.
At the federal level there is not currently a voluntary forgiveness program, but you might get a payment plan or some reduction in what you owe, depending on your financial situation.