Payroll Taxes – A Personal Liability Trap

Recently, I was speaking with a very successful small business owner who almost stepped into a payroll tax trap. The business owner wanted to give a bonus to a key employee. The business owner, who uses a payroll processing company, thought that it would be okay to write the bonus check out of the business checking account. However, the business owner, who did not consult the payroll processing company was not planning to deduct payroll taxes from the bonus check. The business owner was about to step into a trap.

Bonuses like salary are compensation and are subject to payroll taxes. Failure to deduct payroll taxes will subject a business owner to personal liability. The fact that the business is a corporation or LLC will not shield the owner from personal liability.

Further, the personal liability for unpaid payroll taxes is not dischargeable in bankruptcy. I was also recently speaking with another small business owner who is in financial trouble. The business owner made the decision to use the business’ scarce cash to pay vendors instead of paying payroll and sales taxes. The business owner planned to get caught up on the past due taxes, hoping, like many struggling businesses, that sales would improve in the future.

When sales did not improve, the business owner considered closing the business and filing for personal bankruptcy. Doing so would protect the business owner from other business liabilities that the owner personally guaranteed like bank loans. This business owner was surprised to learn that they could not discharge the unpaid business payroll and sales taxes in a personal bankruptcy.

So if the business owner files a personal bankruptcy, the owner would exit the personal bankruptcy still being liable for all the payroll and sales tax. Then the business owner would have lost everything–house, cars, business and the job working for the business with the liability for the unpaid payroll and sales tax still haunting them.

In these tough economic times payroll taxes and sales taxes are bills a business should not defer in the hope that times will improve.

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