Last week, my firm received mail from Internal Revenue Service (IRS) advising that their records showed that no payroll tax returns had been filed on behalf of a certain corporate client which I recognized as now defunct. The company never had employees and now, clearly, it never will.
The next day, I received a similar letter from the IRS for another client. Same story.
A couple of days later, I received notices from our state’s revenue department asking for returns for out-of-existence companies.
And then I realized: taxing authorities are looking for money. And they’re looking for money from the dead.
You see, before the economy tanked, entrepreneurship was riding a high – especially in the tech sector. Almost anyone thought they could be the next Facebook, Yahoo, or (giggle) MySpace. All they needed – or so they thought – was a server, some time on their hands and a clever domain name – preferably one with “my” or “ster” in the title. It was quick and easy to form a company and, at the time, banks were practically giving away money for start-ups and the like. Plans were big. Google big. And with a “we don’t need no stinkin’ business plan” mentality, some companies started up, snatching up office space and anticipating hiring 10-20 employees right away. In theory, it sounded good. But as my friend Don is fond of saying, “We don’t live in theory.”
When the tech sector started to crash, it crashed hard. Suddenly, many of those start-ups that seemed like a good idea were struggling to pay bills. They weren’t hiring after all. And all that was left were big, empty spaces in renovated warehouses – or in some cases, their mom’s basement. With no money and no prospects, many of those entrepreneurs simply packed up, put on a suit, and went back to work in corporate America. It was as if the whole thing had never happened.
That, however, left behind a lingering problem: corporations have perpetual existence. In most jurisdictions, corporations live on forever unless and until they are dissolved by shareholder action, operation of law, or court order. Most of the time, that involves filing some minor paperwork. But the thing about these start-ups is that the paperwork bit often got ignored: folks just walked away.
From a tax and legal perspective, without that paperwork, the company lives on. If the company ceases to exist, there has to be some kind of wrap-up. How else is the IRS (or your state or municipality) to know, for example, that the company no longer exists if you never filed a final tax return or otherwise gave notice? Filing those last bits of paper with taxing and state authorities (since corporations are formed under state law) provide that oh-so-important notice.
If you don’t file – and simply walk away – you’re not off the hook in most cases. Tax returns have a statute of limitations meaning that there is a limit to the amount of time over which the accuracy of those returns can be challenged. If you don’t file a return, you never set the clock running; there is no statute of limitations. In simple terms, that means you’re never actually in the clear.
Playing catch-up years after the fact can be time-consuming and in some cases, expensive, which is especially annoying when you’re trying to move on from a company that you abandoned because it wasn’t making money in the first place. So what are the best ways to avoid that hassle?
- First, plan ahead. I know that you have big dreams. We all do. But be realistic and focus. Don’t tell the IRS, the Department of State, or any other tax entity that you’re planning on hiring 50 employees this year when that’s really on your long-term wish list. Don’t offer up that you’re planning on selling cigarettes, games of chance, or booze unless that’s really in the cards. Don’t suggest that you’re going to be taking in hundreds of thousands of dollars in revenue or sales per quarter when that’s what you aspire to do but on paper, it’s highly unlikely. You see, all of those indicators that your state or federal taxing authorities ask you about aren’t meant to be about what you hope happens – that paperwork helps IRS and your state and local taxing authorities figure out what tax forms you will be responsible for filing and on what basis (annual, quarterly, monthly, etc.). The bigger you make your operation sound, the more tax forms you’ll be responsible for completing. And while you can’t get away from all of the paperwork if you’re actually hiring lots of employees and making lots of sales, there’s no reason to stack up filing responsibilities if it’s just you on your sofa.
- Second, get competent advisors. I know that paying for professional advice is often at the bottom of the priority list when dollars are tight but we often find that it’s the case that “you can pay us now or you can pay us more later.” It’s easier and cheaper to prevent a mistake than to fix one.
- Next, do your research. I get that research is the boring part. It’s much more fun to get a great idea and run with it. But do take a few minutes to slow down and figure out a plan. There are some wonderful – and free – resources available to you online, including a slew of good stuff from the Small Business Administration: on their site, you can get assistance writing a business plan, locate an SBA office near you and find a mentor. Take the time to check it out.
But if things don’t work out with your business – and that happens more often than you think with the National Federation of Independent Business’ Education Foundation estimating that nearly 2/3 of small businesses will fail in a 10-year period – what happens then? Do you just walk away? I say no. There is value in taking the time to wind down properly.
From a legal standpoint, keeping a company open forever can expose you to liability and nobody wants that – you want to sleep at night, right?. Depending on the state where you incorporated (or organized, depending on the type of company), the steps to unwind can be as simple as filing an affidavit or as complex as filing a series of forms. Check your state’s laws (or check with your tax pro) to be sure.
On the tax side, same thing. When you’re ready to walk away, make sure that you’ve wrapped up the loose ends. That includes filing final returns and getting tax clearances, if appropriate. But do take care of it sooner rather than later. In some states – and on the federal level – there are penalties associated with not filing certain kinds of returns. Penalties and fines can range from charges per year to, in many cases, charges per return – even when no tax is due. Those penalties and fines, together with interest, can really add up and in some cases, can move to collections and court, resulting in even bigger costs. Ignoring collections efforts can saddle you with levies and liens.
Don’t be fooled into thinking that if there’s no ongoing business, there are no worries. Taxing authorities are feeling incredible pressure to collect revenues. And they’re willing to turn over a few stones – waking the dead – and send out collections notices. I’ve noticed a considerable uptick in the number of civil suits and violations filed against businesses for failure to file returns (again, even when no tax is due). Remember that since you have a legal obligation to file, it’s your burden – not theirs – to prove that there is no tax due.
Is it the best use of taxpayer resources for authorities to chase dead corporations? Of course not. But filing a lawsuit against businesses is fairly simple for many tax authorities – especially when penalties for failing to file are statutory. In addition, many taxing authorities are pushing collections efforts off on private agencies – debt collectors – who get paid to pursue what they perceive as “deadbeats” and “scofflaws.” Since many of those agencies are paid on a percentage basis depending on collections, many taxing authorities figure they have nothing to lose by handing over a list of potential sources of revenue. The result may be more phone calls, more bills, more nasty letters, and more agita for taxpayers.
I know it’s tempting to let the mail pile up and pretend that the problem – the dead company – doesn’t exist. But ignoring it won’t make it go away and it can make the problem worse.
The bottom line is that if you make the decision to start a business, treat it like a real business from start to finish. That includes not only making the right choices in the beginning but making the right choices at the end – even when it’s not fun anymore. Because you know what’s less fun? Fighting about your defunct business after the fact.