Small business owners have options when they can't afford to pay taxes
by Joyce M. Rosenberg
Associated Press

It’s a chilling moment that many small business owners go through at this time of the year, when they realize they don’t have enough money to pay their income taxes. They need to start working immediately on two solutions–first, how to pay their tax now, and second, how to avoid the problem in the future.

Many owners in this situation understandably feel some panic when the realization sinks in that the IRS will be expecting money that they don’t have. Some might be tempted not to file their returns–but that’s not an option that anyone should consider. Not filing a return on time subjects a taxpayer to steep late‑filing penalties in addition to late payment penalties and interest.

They might also be thinking of filing for an extension of the filing deadline. That’s not likely to help owners with a funds shortfall as even when they do get an extension, they still have to estimate their tax liability and report that amount to the government.

Accountants say small business owners do have options, but they should all be considered carefully, since all carry financial consequences. For example, the one that might seem the easiest, dipping into credit cards, can also be the most expensive, considering that the interest rate on cash advances often run 20 percent or more.

Another one to avoid is to divert payroll tax money to pay income taxes. Barbara Weltman, a tax attorney in Millwood, N.Y., and author of “J.K. Lasser’s Small Business Taxes,” noted that business owners can be personally liable for payroll taxes that aren’t paid.

Many owners decide the solution is to raid their retirement accounts, or to tap a home equity line of credit. These are viable options, but owners need to consider the penalties that can be incurred by withdrawing money from a 401(k) or otherretirement account, and the loss of investment income they’ll suffer. And diminishing the equity in their homes will add another monthly payment and can also limit their financial options for the future.

Jeffrey Berdahl, a certified public accountant with Berdahl & Co. in Center Valley, Pa., suggests owners consider an installment payment agreement with the IRS.

“The IRS is user‑friendly to work out some kind of installment plan,” he said.

Generally, the IRS says you cannot be turned down for an installment agreement as long as you don’t owe more than $10,000 and you’ve timely filed your returns and paid any tax due during the previous five years. You also cannot have entered into a previous installment agreement during that time. And you must pay the amount you owe within three years.

If you owe more than $10,000, you can still request an installment agreement, but Berdahl said you might need approval from an IRS district office, and chances are you’ll need to furnish the government with more financial information.

To apply for an installment agreement, you need to file Form 9465, Installment Agreement Request; if you’re filing the form with your return, it must be attached to the front. You can download the form from the IRS Web site, www.irs.gov; it includes instructions and an explanation of how the installment agreement works.

You will need to pay late payment penalties and interest, and generally there is an administrative fee of up to $105. Before you sign any papers, you should do some number crunching–and maybe even get some advice from a tax adviser–to be sure that this indeed the best and most financially sensible way for you to deal with the problem.

There’s a larger problem that an owner in this situation needs to deal with: how to avoid being in the same predicament in the future. The first thing an owner needs to do is figure out what went wrong, and this might best be accomplished with some professional help.

Often, the problem is that an owner doesn’t have a good handle on the company’s cash flow. In that case, he or she needs to set up a better accounting system, or get someone to help them keep track of their finances.

Equally common is an owner just doesn’t set aside money for taxes. Weltman suggested owners set up a tax account, which is an interest‑bearing account separate from business or personal accounts, and deposit money there so it’ll be available at tax time.

While a tax account can help any business, Weltman noted that people whose business is freelancing can be especially vulnerable to tax money shortfalls if they don’t set aside some of their earnings for taxes.

“They take money in, collect a fee like $1,000 and look at it like it’s money to spend,” she said. “Put 25 percent of it away automatically so the money will be there.”