Updated February 1, 2022

So far, the uncertainty created by what was a most unpleasant 2020 (putting it mildly) is creeping into 2021 as well. However, as we begin to emerge from the COVID-19 pandemic, we can be certain about at least two things: First, many businesses struggled last year and will emerge with federal tax liabilities and, second, there’s a solution.

There’s no shortage of misconceptions when it comes to the Internal Revenue Service (IRS). Many lenders upon learning of an issue with the IRS will (a) turn and run, (b) recommend Chapter 11 bankruptcy (a costly alternative, especially if the only issue is an IRS liability), or (c) attempt to pay off the IRS from the initial funding. While there’s absolutely a time and place for these strategies, most situations involving the IRS can be better resolved by simply negotiating a reasonable repayment arrangement. Information is the best defense against uncertainty. Armed with the knowledge of a few basic principles, lenders can provide better advice to their clients, which may be the difference between a business that survives (and ultimately thrives) and one that ceases to exist. As such, it is important to address some common misconceptions.

Tax resolutions: when is the amount owed too much?

Many lenders, consultants, and even business owners themselves put too much emphasis on the total amount owed to the IRS. They see a substantial federal tax liability and conclude there is no way the business can repay the debt and/or the IRS will not allow the business to continue operating. By focusing on the overall liability, it’s easy to make an erroneous assumption that the business is not viable.

Rather than fixate on the overall liability, a lender should instead determine whether the business is current with its filing and depositing requirements. The highest priority, by far, when negotiating a resolution with the IRS is to (a) ensure all returns are filed and (b) the business is making its current withholding (941) and unemployment (940) deposits in full and on time. A business that cannot ultimately make its federal tax deposits in full and on time is not viable. However, if the business is current and compliant, an installment agreement can allow the business to service its debt and operate into the future without interference from the IRS. A representative who understands how the IRS operates, as well as the lender’s concerns, can negotiate an agreement that covers all the unpaid liability regardless of the amount owed.

DOES THE IRS REQUIRE LARGE MONTHLY PAYMENTS?

Generally, a business owner (or local attorney or local accountant, none of whom deal with the IRS Collections Division on a regular basis) initially approaches the IRS with uncertainty. The first question posed to the revenue officer is typically: “What’s it going to take to make this go away?” At that point, the IRS can frame the issue and take advantage. Frequently, the revenue officer will respond by saying, “The IRS requires 20% down and the remainder paid within two years.” Unfortunately, the business owner likely will agree to those terms because of the perception or belief there is no alternative. That perception is incorrect.

The vast majority — approximately 95% — of all installment agreements with the IRS fail. Occasionally, they fail because the business simply was not viable. More often, IRS agreements fail because they were set up to fail in the first place. Businesses working with factors or asset-based lenders already have issues with cash flow, and many are just breaking even. Cash flow cannot support the combination of a substantial down payment with a large monthly payment. The business cannot pay its current bills, remain current with federal tax deposits, and make large payments to the IRS. The owner will be forced to choose between paying rent, vendors, current taxes, or the back taxes. Usually, the business accrues new liabilities, the agreement with the IRS terminates, and the business is in worse shape than before.

There is no basis for the idea that the IRS requires 20% down and the remainder paid within two years. In fact, it’s the exact opposite. The Internal Revenue Manual indicates, “Installment agreements must reflect taxpayers’ ability to pay on a monthly basis throughout the duration of agreements. If full payment cannot be achieved by the collection statute expiration date, and taxpayers have some ability to pay, the Service can enter into partial payment installment agreements.” The amount of the monthly installment payment should not be based on an arbitrary timeframe or the size of the liability. Instead, the monthly payment should reflect an amount the business can afford, which fits into cash flow and substantially decreases the likelihood that an agreement will terminate.

IF PAYMENTS ARE “AFFORDABLE,” WILL THE BUSINESS PAY THE IRS FOREVER?

The IRS’s ability to collect delinquent taxes is not infinite. Rather, it’s limited by a statute of limitations, which is generally 10 years. Once the statute of limitations expires, the IRS can no longer collect the debt. At that point, the taxpayer can stop making the monthly installment payment.

There’s no need to panic when a liability with the IRS, even a large one, is uncovered. There is a solution. An installment agreement neutralizes the threat of the IRS liability, regardless of the amount. Fundamentally, the monthly payment should be based on a figure the business can afford. If a business can remain current and afford a “substantial” payment, then that business should expect to make a “substantial” payment. However, some businesses will only repay part of the liability over the statute of limitations, which is why these agreements are called “partial payment installment agreements.” Once the statute of limitations expires, the business will no longer make the monthly payment. Because the IRS allows some businesses to pay part of their liabilities over time, the most important consideration is not the overall liability but whether the business can comply with the terms of the agreement.

What is a tax lien and can lenders fund with one in place?

Lenders are understandably concerned about IRS liabilities. They want and need to protect their collateral from levy and conversion — two situations in which the IRS can take their money. The IRS plays by different rules and has what some refer to as a “super priority” based on the 45-day rule. Once a federal tax lien is filed, the IRS moves into first position on any revolving assets — inventory and receivables — upon the lender’s actual knowledge of the lien or 45 days from the date the lien is filed, whichever is earlier. The lender’s exposure is the total amount of the liability subject to the federal tax lien. The total liability is one of a few elements that determine a lender’s exposure to the IRS, but that exposure can be mitigated by an affordable installment agreement.

After determining the total liability, the lender should ask what happened to create the liability in the first place. If the problem has been addressed and fixed, the total amount owed is much less important. Rather, the lender’s attention should shift to whether the business has entered into a formal installment agreement with the IRS.

But, I can just request a subordination of federal tax lien, right?

The installment agreement is important on several levels. So long as the business can remain current and compliant and service its debt, regardless of the size of the liability, the business is viable (at least relative to the IRS). The IRS cannot levy bank accounts or receivables while the installment agreement is in effect and in good standing. More importantly, the installment agreement is a prerequisite/requirement for a subordination of federal tax lien, which puts the lender’s secured interest relative to the inventory and receivables back into first position ahead of the federal tax lien. So long as the business has an installment agreement in place with the IRS and the lender has secured a subordination of federal tax lien, the lender has nothing to fear from the IRS in terms of levy or priority.

SHOULD I JUST PAY THE IRS FROM MY INITIAL FUNDING?

Paying off the IRS liability from the initial funding is an understandable temptation. No one wants an IRS liability hanging over their head. Again, it all comes down to cash flow. If the business can make a large down payment and/or large monthly payments and cash flow is not adversely affected — i.e., the business can meet all its current obligations — then there’s no problem. However, if the business is already struggling to meet its current obligations, to the IRS or otherwise, removing a substantial sum of money from cash flow will only make the situation worse. Once a business gives the money to the IRS, it can’t ask for it back later when it’s struggling to pay bills. The business will exchange one IRS liability for another — the old periods may be paid, but the business will fall behind in the current and future quarters.

Falling behind with the IRS is also costly because of the assessed penalties — failure to file, failure to deposit, and failure to pay. These penalties are front-loaded. For example, the IRS assesses a failure to deposit penalty on each untimely deposit with a maximum of 10% for deposits made 15 days or more late. The IRS assesses an additional 5% on unpaid amounts 10 days after the initial notice requesting payment. If a business pays off old debt without also paying its current obligations, it’s actually getting further behind with the IRS. For every dollar paid toward old taxes (that should be used to get current and compliant), the business is accruing $1.15 on new liabilities. Lump sum payments to the IRS can be costlier in the long run and contribute to pyramiding, with a business accruing liabilities on top of liabilities. The better solution is to stop the bleeding, negotiate an installment agreement, and secure a subordination of federal tax lien.

The existence of a federal tax liability with the IRS, even a large one, does not mean a business isn’t viable. The lender doesn’t have to turn down the deal, recommend bankruptcy, or struggle to repay the entire liability from the initial funding. A representative who understands how the IRS operates, as well as the lender’s concerns, can negotiate an affordable installment agreement with the IRS, thereby removing the uncertainty from the situation. The business can continue to operate, the IRS can be paid in full (or a substantial portion can be paid over the statute of limitations), the business can avoid costlier alternatives, and the lender can fund a happy and healthy client. Uncertainty will be replaced by opportunity.

When federal tax issues arise, don’t wait for the IRS to file a tax lien or issue levies. Be proactive. Fill out the form below to speak with a specialist.