Owning a business comes with risks, but also certain protections. If your business incurs debt, such as business loans or business debt, it’s likely that you won’t be held personally responsible for it as long as you’re organized as a corporation, LLC, limited partnership, or another entity with limited liability rights. However, when it comes to tax debt, there are many situations where the IRS can choose to hold you and other responsible parties personally liable for business taxes and penalties, regardless of the structure of your business.
If your spouse’s business incurs tax debt, you may also face questions about liability, especially in community property states or if you are involved in the business. The IRS may seek to collect on your spouse’s business tax debts from shared assets, depending on your filing status and business involvement. The IRS may also pursue collection for a spouse’s tax debt, including both business and personal tax obligations. If the IRS seeks to collect on a spouse’s debts, shared assets may be at risk. Liability for a spouse’s tax may depend on the nature of the spouse’s tax obligations and the timing of the debt.
This is often the case with payroll taxes and associated penalties. The IRS has the authority to seize assets, including those jointly owned, if a spouse’s tax debt is unpaid. Learn more about when the IRS can hold business owners personally accountable for business taxes and what you can do to protect your personal assets. Or get help now by contacting Damien’s Law today.
Key Takeaways
- Certain types of business structures (for example, LLCs and corporations) protect owners from personal liability for business debts.
- Even if you are protected from personal liability, some types of tax debt may lead to personal liability.
- The IRS may assess a Trust Fund Recovery Penalty for unpaid payroll taxes.
- If you are hit with the Trust Fund Recovery Penalty, you are personally liable for the penalty—equal to 100% of the unpaid tax.
Introduction to Spousal Tax Liability
Spousal tax liability is an important concept for married couples to understand, especially when it comes to tax debt and tax liabilities. When you and your spouse file a joint tax return, you are both jointly and severally liable for any tax debt that arises from that return. This means the Internal Revenue Service (IRS) can pursue either spouse—or both—for the full amount of the tax debt, including any interest and penalties, regardless of who earned the income or caused the tax issue. This shared responsibility can lead to unexpected tax liabilities, putting your personal assets at risk if your spouse incurs tax debts. Being aware of how spousal tax liability works is essential for protecting your finances and avoiding surprises when it comes to paying taxes.
How Business Taxes Work and When They Put You at Personal Risk
Business owners can choose from a variety of structures when establishing their companies, and that choice plays a significant role in their liability for taxes and other debts.
Limited liability companies (LLCs) create a barrier between the owner of the business and the business itself, limiting the owner’s personal liability for business debts. Corporations also create a wall between owners and businesses, protecting owners from business debts.
In contrast, sole proprietorships and partnerships that are not organized as LLCs or corporations are liable for all of the business’s debts. These business structures do not come with any inherent liability protections.
It’s important to note, though, that liability protections are not absolute. When certain criteria are met, business owners, members, and even shareholders can be liable for certain tax debts. Additionally, joint liability can arise for spouses if both are involved in the business or if they file taxes jointly, potentially making both responsible for business tax debts. Filing joint tax returns (joint returns) can create shared tax debt, making both spouses responsible for the full amount, regardless of who earned the income or caused the tax issue. Couples can choose to file jointly or filed separately, and this decision affects each spouse’s tax liability and whether the tax debt is considered marital debt.
Which Taxes Put You At Risk of Personal Liability?
In general, business owners are safe from being personally liable for corporate income tax and state franchise or gross receipts taxes. If an individual is held personally liable for business taxes, those debts usually come from trust fund taxes, such as sales tax and payroll withholding taxes.
Trust fund taxes include situations where you collect the tax from another party, hold it “in trust”, and then send it to the government. For example, if you collect MS sales tax from a customer, you hold on to it until you remit it to the government. Similarly, when you withhold state or federal taxes from an employee’s paycheck, you send those taxes to the government.
In both cases, you do not pay the tax. Rather, the customer or the employee pays the tax – you just facilitate the process. The money never truly belongs to the business – it belongs to the state or federal government from the very beginning, so any business that actually uses that money is essentially using funds that aren’t theirs. That’s why the law allows the government to hold individuals personally liable for these taxes if they’re not paid. The tax bill resulting from trust fund taxes can lead to personal liability if the tax debt incurred is not paid.
Behaviors That Increase Your Risk of Personal Liability
There are a few clear warning signs that indicate you may need to reevaluate your business’s finances or how you manage your tax obligations. If a spouse incurred tax debts through risky behaviors, both spouses may be at risk depending on their involvement.
Filing late or erratically: If you are required to file tax returns and make deposits for payroll taxes or sales tax but fail to do so on a regular basis, that could cause you serious issues in the future. Not only will you be on the hook for interest and penalties, but once the IRS or state tax agency determines that your behavior is willful or negligent, they may hold you personally liable for what is owed.
Using trust fund taxes for general business expenses: Another risky behavior is using any withheld funds, such as sales tax or payroll tax, to cover business expenses. This indicates a serious cash flow issue, and borrowing money from the government without their consent never ends well. Additionally, the government will realize that they’re not being paid. At that point, you’ll have to pay what you owe, all accrued interest, and any penalties that have been tacked onto your bill. At that point, not only will you have the tax debt to worry about, but the cash flow problem that started it all. If a spouse understated income or tax liability, it could increase the risk of both spouses being held liable.
Filing Status and Tax Liability
Your tax filing status as a married couple plays a major role in determining your tax liability and how much you may owe. When you choose to file your tax returns as married filing jointly, you often benefit from lower tax rates and increased eligibility for valuable tax credits and deductions. However, this also means you are both fully responsible for any tax debt or tax obligations that result from the joint return. If one spouse underreports income or claims improper deductions, both spouses can be held accountable for the entire tax liability.
Alternatively, married couples can choose the married filing separately status. Filing separately limits each spouse’s liability to their own tax obligations, which can help protect you from being responsible for a spouse’s tax debt. However, this filing status may reduce your eligibility for certain tax benefits and tax credits, and often results in higher overall tax rates. It’s important to weigh the pros and cons of each filing status and consider your unique financial situation before deciding how to file your tax returns.
What is the Trust Fund Recovery Penalty?
The Trust Fund Recovery Penalty may be imposed when a business fails to pay withheld income and employment taxes. The IRS considers these taxes to be held in trust until they are deposited. Until they can be deposited, they are not supposed to be used in any way. Because of this, a company that fails to make timely payroll tax deposits can incur significant penalties.
Before assessing the Trust Fund Recovery Penalty, the IRS makes several attempts to collect past-due payroll taxes and get a business back on track. The IRS may also intercept your tax refund to cover unpaid business tax debts. Businesses can use In-Business Trust Fund Express Installment Agreements to get caught up on this type of tax debt – that allows you to pay up to $25,000 in payroll taxes over up to 24 monthly installments.
The IRS generally only turns to a Trust Fund Recovery Penalty as a last resort. If they do not think the business has any intention of paying back what they owe, then they must hold responsible parties accountable for that debt.
The Trust Fund Recovery Penalty is equal to 100% of the unpaid withheld taxes. This is an important distinction. The responsible person is liable for the penalty, but the business remains liable for the tax debt. The IRS has the authority to seize assets, including bank accounts and property, to satisfy tax debts. The IRS may also file tax liens or pursue collection actions for a spouse’s unpaid taxes or a spouse’s tax bill. If you are facing IRS enforcement actions, including tax liens or issues related to a spouse’s tax bill, consulting experienced tax attorneys can help you understand your options and protect your rights.
Potential Liable Parties
The IRS may hold a wide range of individuals accountable for unpaid trust fund taxes, including:
- Officers and employees of corporations
- Members and employees of partnerships
- Corporate directors or shareholders
- Board of trustees members
- Anyone with control over funds to direct where they go
- Third party payers
- Payroll Service Providers
- Professional Employer Organizations
It’s important to distinguish between who has control over funds versus who makes payments. For example, if the business owner tells the staff member not to make the deposit or to use the funds elsewhere, the staff member is not the responsible party—the owner is. However, that can vary in situations where the person accepting the “order” is a licensed tax pro who should have known the implications of that decision.
The Trust Fund Recovery Penalty requires willful failure to pay. The responsible party must have either been aware of the past-due taxes or must have been in a position where they should have known about the past-due taxes. They must also have chosen to disregard the law or have shown indifference to the law’s requirements.
The IRS uses a variety of techniques to determine who may be considered a responsible party before assessing the Trust Fund Recovery Penalty. They often conduct interviews with staff members and others in positions of authority to determine the scope of their duties and whether or not they had independent control over the business’s finances. This process is similar to the one used by state tax authorities that conduct responsible person assessments to determine who is liable for unpaid sales tax.
How the IRS Can Collect
Once the IRS has assessed the TFRP, they can use any collection method that they would use for any other type of tax. For example, they may place a lien on the individual’s assets, garnish their wages, freeze their bank account (including levying joint bank accounts if you share them with a spouse or business partner), intercept their tax refunds, or seize their property and sell it. The IRS can also seize assets or refunds due to a spouse’s debts; however, relief options such as injured spouse allocation or claiming injured spouse status may help protect your share of a joint refund from an IRS seize related to your spouse’s unpaid obligations.
Community Property States and Tax Debt
Community property states have unique laws that can significantly affect your tax debt and overall tax liability as a married couple. In these states, any income or assets acquired during the marriage are generally considered community property, meaning both spouses have equal ownership—regardless of who earned the income or whose name is on the account. This shared ownership extends to tax debts and tax liabilities as well. In addition, state tax debts and spouse’s taxes may be treated as shared obligations in these states, making both spouses potentially liable for amounts owed.
If you live in a community property state—Arizona, California, Idaho, Louisiana, Nevada, New Mexico, Texas, Washington, or Wisconsin—community property laws may make you personally liable for your spouse’s tax debts, even if you file separately. This means that if your spouse owes back taxes or incurs a tax debt during your marriage, the IRS can pursue you for payment, even if you had no direct involvement in the business or the tax owed. You may also be responsible for your spouse’s tax obligations and spouse’s tax debts, even if you did not directly incur them.
Filing separately in a community property state does not always protect you from being held responsible for your spouse’s tax liability. The IRS may still consider both spouses equally responsible for any tax debts incurred during the marriage, leading to unexpected tax liabilities. This can be especially concerning if your spouse owes back taxes or if you are unaware of their unpaid taxes.
Understanding how community property laws impact your tax obligations is essential for protecting your personal finances. If you are concerned about being personally liable for your spouse’s tax debts or want to avoid surprises at tax time, consult a tax professional familiar with community property states. Depending on state law, you may be responsible for your spouse’s tax debts or responsible for your spouse’s obligations. They can help you navigate your options and minimize your risk of being held responsible for a spouse’s debt.
Divorce and Tax Liability
Divorce can complicate tax liability, especially if there are outstanding tax debts from previous years. Even if your divorce decree assigns responsibility for a tax debt to one spouse, the IRS is not bound by that agreement if you filed jointly. Both spouses remain liable for the entire tax debt, regardless of what the divorce decree states. This means the IRS can pursue either spouse for payment, even after the marriage has ended.
Fortunately, there are options for relief. If you believe you should not be held responsible for your ex-spouse’s tax debts, you may qualify for innocent spouse relief or injured spouse relief. These programs can help protect you from being forced to pay tax debts that resulted from your spouse’s actions. It’s crucial to understand your tax obligations after divorce and to seek professional guidance to ensure you are not unfairly burdened by a former spouse’s tax liability.
Common Mistakes That Open the Door to Personal Liability
| Business Mistake | Why It Creates Risk |
|---|---|
| Using payroll tax money to pay expenses | Misuse of funds belonging to the IRS |
| Not filing 941s or state tax returns | Considered willful neglect and often leads to an IRS investigation. Failing to file can increase the total taxes owed, potentially impacting both spouses. |
| Ignoring IRS notices | Leaves the IRS in a position where they must resort to more aggressive collection efforts to collect what they are owed. If your spouse owes money, ignoring IRS notices can put both spouses at risk for collection actions. |
| Paying owners before paying taxes | Indication of poor financial management and misuse of funds |
| Commingling business and personal funds | Weakens barriers that protect you from liability for your business’s debts |
Protecting Assets from Seizure
If your spouse owes back taxes, the IRS has the authority to seize personal assets—including bank accounts, investments, and even your home—to satisfy the tax debt. To reduce the risk of asset seizure, it’s wise to keep your finances separate, avoid commingling funds, and maintain clear records of individual ownership. Consulting a tax attorney or financial advisor can help you develop strategies to protect your personal assets and navigate complex tax situations.
Additionally, you may be able to limit your liability for your spouse’s tax debts by applying for innocent spouse relief or injured spouse relief. These tax relief options can shield you from the negative consequences of a spouse’s unpaid taxes, especially if you had no knowledge of or involvement in the tax issue. Taking proactive steps and seeking professional help can make a significant difference in safeguarding your financial future.
Spouse’s Tax Liability and Credit Scores
A spouse’s tax liability can have a direct impact on your credit score, particularly if the IRS files a tax lien or levies your joint bank account due to unpaid tax debts. Unresolved tax debt can lead to financial hardship, damage your credit, and even result in bankruptcy if left unaddressed. To protect your credit score, consider filing separately, keeping your finances distinct, and addressing tax debts promptly.
Open communication about tax obligations and financial responsibilities is key for married couples. If you find yourself facing tax debt or are concerned about the impact of your spouse’s tax liabilities, don’t hesitate to seek help from a tax professional. Taking action early can help you avoid the long-term consequences of unpaid tax debts and maintain your financial health.
How a Tax Professional Can Help You
When your business is facing serious tax issues and you’re at risk of being held personally liable, you should immediately call a tax professional for more personalized guidance. While knowing your rights and obligations is helpful, a tax professional can take steps to stop escalation and protect your rights.
They may be able to prove that you should not be considered a “responsible party” in terms of the TFRP and therefore should not have that penalty assessed. If you are trying to get caught up on your past-due business taxes, your tax attorney can also help you be proactive and set up an installment agreement or an offer in compromise. A tax professional can also help you explore tax relief options, such as liability relief, and guide you through the process to request relief from the IRS. If you believe your spouse paid or should have paid the tax, a tax professional can assist with requesting innocent spouse relief, separation of liability relief, or equitable relief, depending on your situation.
It is crucial to take action as soon as you know you’re having tax issues. The longer you wait to come to an agreement with the IRS and address your tax concerns, the more you risk personal liability. Find out how the tax professionals at Damiens Law can help you navigate your business tax needs—call us at 601-202-4745 or send us a message online to schedule a discovery call.
Frequently Asked Questions
What is the difference between payroll taxes and income taxes for businesses?
A business’s income tax is not considered a trust fund tax. While the IRS will obviously still take steps to collect past-due income tax, they cannot hold individuals legally liable for corporate income taxes. In contrast, payroll taxes are trust fund taxes, and the IRS takes it seriously when those taxes are not passed directly along to them on your next scheduled deposit date. They are more likely to hold a responsible party personally liable for those taxes.
Can I be liable even if I’m not the business owner?
Yes. If the IRS determines that you are a responsible person in terms of TFRP liability, they can hold you liable for unpaid payroll taxes. The TFRP penalty is equal to 100% of the unpaid tax amount, so it can cause massive financial issues for individuals.
How do I know if I’m under investigation for the Trust Fund Recovery Penalty?
You may not know that you’re under investigation. But if the IRS conducts interviews to determine who the responsible party may be, you should assume that you are being considered as a potential liable party.
What happens if I ignore IRS letters about business taxes?
The IRS will become more aggressive in their efforts to collect past-due taxes. This may mean placing a lien on business assets or seizing assets to cover the tax debt. They may also assess the Trust Fund Recovery Penalty to recover unpaid payroll taxes.
Can I stop the IRS from taking personal assets if I act early?
The earlier you take action when facing tax issues, the better—and that’s especially true in this situation. The TFRP is often only assessed when other efforts to collect payroll taxes have failed, and if you show a willingness to work with the IRS, you may be able to avoid personal liability.
Can the state hold me personally liable for business taxes?
The laws vary from state to state, but in many cases, the state can hold individuals personally liable if a business doesn’t pay sales tax or state withholding (that’s income tax withheld from employees’ paychecks). If that happens, the state may file a state tax lien for business tax debts against you personally.
Sources:
https://www.irs.gov/businesses/small-businesses-self-employed/employment-taxes-and-the-trust-fund-recovery-penalty-tfrp
https://www.irs.gov/pub/irs-pdf/n784.pdf
https://www.irs.gov/businesses/small-businesses-self-employed/in-business-trust-fund-express-installment-agreement
