How To Resolve Unpaid Sales Tax and Protect Your Personal Assets

Unlike income tax, the sales tax your company collects from customers never belongs to you. You only hold it in trust for the state. You act as trustee for the state. Spending that money, even to cover your ordinary operating expenses, is considered a serious breach.

This sort of breach can lead to devastating consequences for both you and your business, including:

• Personal liability
• A tax audit
• Liens
• Business closure (in extreme cases)

This guide will explain the steps you must take to resolve unpaid sales tax and protect your personal assets from the state.

If you’re a small business owner or own a larger corporation, partnership, or limited liability company (LLC), and you owe outstanding sales taxes, consider contacting a local tax attorney. Taking quick action can help avoid serious consequences.

Why Would Your Company Owe Back Sales Tax Debt?

Small businesses may fall behind on sales taxes for several reasons. A common reason this happens is operating on tight margins and using collected sales tax to pay operating expenses. Unpaid sales tax can also arise if a small business:

• Is unclear about its sales tax obligations or recent changes to its state’s sales tax laws
• Lacks a dedicated accounting staff, a tax professional, or sophisticated software

There are also instances in which a business intentionally underreports sales to reduce its tax liability. For underreporting income tax liability, you may need to call the IRS and request a payment plan.

Regardless of the reason, business owners should address any back taxes swiftly. This doesn’t mean paying the full amount due immediately, but it does require you to demonstrate your intent to settle your debts. If you fail to do this, not only will you have to pay tax penalties, but your tax problems may even lead to criminal charges.

Sales Tax Laws

Sales tax is a business tax that retailers add to the price of goods and services that customers pay when they buy. It’s usually expressed as a percentage of the purchase price.

There is no such thing as a federal sales tax, nor are there federal sales tax laws in the United States. As such, sales tax generally doesn’t involve the Internal Revenue Service (IRS), the federal agency primarily responsible for collecting income taxes. Instead, state and local laws primarily govern sales tax matters.

Each state has sales tax laws and regulations. They typically cover several topics, including:

• Taxable items and services
• Sales tax rates
• Entities required to collect sales tax
• Filing periods for sales tax returns
• Sales tax-exempt transactions
• Sales tax payment due dates
• Consequences for non-compliance
• Rules and deadlines for sales tax filing

Many state sales tax laws allow cities and counties to add their own local sales taxes to the state rate. This means your business’s sales tax responsibilities depend heavily on what you sell and where you sell it.

Business Sales Tax Obligations

When businesses collect sales tax, they’re acting as tax collectors on behalf of the government. Collecting sales tax is only one part of a business’s sales tax obligations.

In most locations, businesses need to report total sales, taxable sales, and the amount of tax collected. Businesses that charge sales tax must also remit tax payments to the appropriate tax authority. This is usually the state or local Department of Revenue. The total amount of sales tax the business is responsible for collecting from customers and remitting to the tax authorities is known as its sales tax liability.

Use Tax

Although distinct from sales tax, use tax is related to a business’s sales tax obligations. It refers to the tax on goods purchased without paying sales tax.

Stemming from online or out-of-state purchases, use tax applies to individuals and businesses. If a business buys something for its own use (not resale) and doesn’t pay sales tax, it may owe use tax. Many states combine sales and use tax reporting on a single tax form, even though businesses are considered taxpayers for use tax purposes.

Unpaid Sales Tax Consequences

Managing sales tax can be complex, especially if you sell in multiple states or online. There are serious consequences for a late filing or unpaid sales taxes. Even minor tax issues can result in fees and penalties. If you owe a significant amount in unpaid sales taxes, the consequences will be even greater.

Below, we’ll discuss some of the more common consequences of failing to pay sales tax as required by law.

Penalties and Interest

The tax authorities may charge penalties and interest on the tax due. Over time, this can increase your tax debt. The more you owe, the greater the fees, penalties, and interest. This can add up, especially if you owe several years of sales tax.

Tax Liens

The government may also place a tax lien on the business’s property, which may affect bank accounts and other assets. Liens can be particularly problematic for some small business owners because, under certain circumstances, the government may also be able to place a lien on the owner’s personal property.

In sole proprietorships and some partnerships, there’s no legal separation between the business and the owner’s personal liability, making personal assets vulnerable. Corporations and limited liability companies (LLCs) usually enjoy more protection from personal liability, but it’s not absolute.

Tax Levies

In extreme cases, the government can seize business assets to satisfy the tax debt. This is called a tax levy. Whether the state places a levy on business or personal accounts depends on several factors, such as the amount owed and the reason for the delinquency.

As a general matter, more property is exempt from a levy than from a lien. That doesn’t mean your personal bank accounts will be exempt from a levy. If the government can pierce the corporate veil, there are few limits to what it can do to collect the tax debt.

Personal Liability: How State Tax Pierces the Corporate Veil

Usually, business owners don’t have to worry about business debts affecting their personal income and assets. This is especially true for corporations and limited liability companies (LLC). In general, these entities are protected from business creditors under the doctrine of the “corporate veil.”

A corporate veil means that the company shields business owners from certain collection activities. For example, if you own a retail store and fail to pay one of your suppliers, they can pursue the company for the money owed, but not your personal holdings.

This isn’t the case with state sales taxes. If your company fails to pay state sales taxes, the government can often pursue the business owner for the unpaid sales taxes.

Sales Tax and Trust Funds

We’ve established that the money you collect in sales tax does not belong to you. You collect this money on behalf of the state. The business acts as a trust, and the money it collects in sales tax operates as a trust fund.

When it comes to unpaid sales tax, sole proprietors and partners are automatically liable for the debt. While corporate owners and LLC owners are not automatically responsible, that doesn’t mean the state cannot come after them for the tax liability.

Your First Move: Voluntary Disclosure Agreements

Most companies have no problem turning over any state taxes they collect to the state treasurer. Unfortunately, things happen, and some business owners, for whatever reason, are not able to keep up with these deposits.

Some companies either intentionally or inadvertently use collected sales taxes to tide the business over until its cash flow problems resolve. Other times, making late payments on sales taxes is due to nothing more than poor management and a lack of reliable accounting software.

Regardless of the reason, it’s in your best interest as a business owner to do whatever you can to avoid the state’s aggressive collection activity. One useful tool is something called a “Voluntary Disclosure Agreement.”

Voluntary disclosure agreements (VDA) are the most critical and actionable solutions for companies owing sales tax. A VDA is a proactive tool through which a business owner voluntarily admits it owes state sales taxes before the government audits them.

One of the key benefits of a VDA is that it often allows the business owner to avoid severe penalties. In exchange for the business owner being forthright about owing back taxes, the government agrees to waive any penalties. In many cases, the government also agrees to limit the “look-back period.”

Executing a VDA is a delicate legal process. If you’re considering using one, having an experienced tax attorney handle it for you is a smart move.

Responding to a State Sales Tax Audit

If the government decides to audit your company for potential unpaid sales taxes, one of your first moves should be to contact a tax lawyer. These audits can be difficult and, depending on the results, devastating for your business.

You have no option but to comply with the state’s audit of your company’s financial records. Unless your company owes a significant amount in unpaid taxes, you shouldn’t have to worry about an audit. The same is true for companies that only owe a few months’ worth of sales tax.

Your attorney can serve as a go-between, controlling the flow of information from your company to the state auditors. They will also dispute any incorrect findings and explain any strange tax issues.

Disclaimer: State and federal tax laws change frequently due to new legislation, higher court rulings, and other means. While FindLaw strives to provide the most current information, it’s best to consult with a local tax attorney to discuss your case.

Getting Legal Help

While owing back taxes is far from ideal, it doesn’t have to ruin your business. You’ll have several options for resolving the unpaid sales tax. An attorney who has experience in dealing with your state’s tax authority can help you determine your best course of action.

The last thing you want to do is ignore the problem. By denying that you owe the unpaid sales tax, you are only inviting an audit. You may also open yourself up to personal liability, which is the last thing you need or want.

With so much at stake, time is of the essence. Contact a local tax attorney to help ensure your small business’s sales tax compliance.