Where did your tax debt come from?

When I look back on how I ended up nearly 100 pounds overweight a few years ago, I really can’t identify how it happened. I definitely remember hitting 180 lbs and thinking, “Hmmm, I’ve gained a little since I left the Navy.” But when did that become 260 pounds? I honestly don’t remember.

Tax debt can be very similar, especially payroll tax liabilities for small business owners. For individuals, it’s a bit more shocking, since tax time is generally only once per year, rather than four (or even more). The reality, however, is that your tax liabilities didn’t just suddenly appear out of nowhere, just like all my extra weight didn’t suddenly appear while I slept one night.

For the vast majority of taxpayers, both individuals and businesses alike, their very first tax bill stems from a series of events.

For individuals, it can be that you simply don’t pay attention to your tax situation throughout the year (hint: you should!). You think of your taxes as a once a year affair, rather than taking a proactive approach to regular tax planning. Perhaps you got a bonus, a raise, or a gambling win at some point in the year that boosted your overall income for the year into a higher tax bracket, and didn’t adjust your withholding at that time to compensate. Or perhaps you had a large debt forgiven or took money out of an IRA early, and didn’t plan for the tax consequences. Failing to take into consideration a significant life change, such as no longer being a homeowner or losing an exemption and tax credits because of a child growing too old to claim, can also have a major impact on your tax situation.

For businesses, it can start with a rough month, and simply not having the cash laying around on the 15th to make the payroll tax deposit for last month’s payroll. Essentially, it becomes a matter of convenience to skip that Federal Tax Deposit one time. Well, in my experience, that one time becomes an expedience for the entire quarter, then two quarters, with no warning or anything from the IRS. Then, suddenly 8 straight quarters have gone by and you get a tax lien notice and a call from IRS Collections, not to mention you are suddenly informed of the massive penalties, which can double the size of your initial tax debt.

Whenever you have a “life event”, be sure to take into consideration the potential tax consequences. What is a life event? Anything to do with large asset acquisition or disposal (such as a home), anything to do with children, marriage, divorce, bankruptcy, foreclosure, job change, moving, or anything that drastically changes your bank account balance. If you are self-employed, there are even more definitions for a “life event”.

For business owners, don’t fall into the “it’s easier not to pay this month” trap, especially with payroll taxes. The long term consequences simply aren’t worth it. In fact, it’s cheaper to raid your personal retirement plan and pay the 10% early withdrawal penalty than it is to pay the penalties that add up for not paying payroll tax deposits. If you have a short-term cash crunch, it’s also better to put off paying OTHER bills, rather than the IRS. It’s simply cheaper to catch up on rent, utilities, vendors, and other business bills, rather than paying the IRS’ extortion-level penalties.

If your business is experiencing a longer term cash crunch than just one month, than you need to take a serious examination of your business. Cut costs wherever you can. If you have insufficient revenue coming in to cover the complete costs of maintaining an employee (their salary, benefits, worker’s comp, payroll taxes, etc.), then you need to start cutting hours, considering temporary layoffs, and letting some employees go entirely. Yes, it sucks to cut somebody’s hours or lay them off, but you’re running a business, so run it like one.

You should also look at ways to increase revenue. I do not discuss business growth and marketing on this particular blog, as it is not the place for it, but I do substantial marketing consulting and coaching for a number of businesses in various industries, and the most fundamental thing I tell each and every business I work with is this: As a business owner, you are first and foremost a marketing and sales professional, and a contractor, trucker, baker, childcare provider, or chef second. If you don’t embrace this concept, your business won’t survive, pure and simple, so invest the time and money into better marketing your products and services, and you will make more money.

If you take a proactive approach to tax planning, you will never have an unexpected tax liability. Discuss with your professional tax advisor any potential consequences of a life event. Business owners, keep your books up to date and be sure to review your financial statements every month. The vast majority of businesses that I have helped resolve tax problems for over the past four years kept their business records in a drawer, if at all, and failed to properly maintain accounting records (which is required by law, just for the record).

If you need assistance getting your books in order, setting up QuickBooks, selecting a payroll service, or need advice about the tax consequences of a personal life event, please contact me.