Closing a Business That Owes Taxes: 6 Ways the Tax Debt Outlives the Company

Tax debt is the one obligation a closing business cannot leave inside the company. Other creditors can be told, correctly, that the entity they lent to no longer has anything; the taxing authorities were never relying on the entity alone, and the statutes they work under say so in language that reaches officers, members, buyers and, in some cases, the owner's own bankruptcy.

You can close a business that owes taxes. What follows are the six routes by which the balance survives the closing, arranged roughly in the order owners discover them.

1. Withheld Payroll Tax Becomes a Personal Assessment

Section 6672 of the Internal Revenue Code makes a person required to collect and pay over tax, who willfully fails to do so, liable for a penalty equal to the tax not paid over. The IRS calls these amounts trust fund taxes "because you actually hold the employee's money in trust until you make a federal tax deposit." Willfulness, in the IRS's phrasing, requires no evil motive, only intentional disregard of the law or plain indifference to it. Paying the landlord instead of the deposit is the familiar version.

The statute builds in a warning. Section 6672(b) requires written notice that the person will be subject to the penalty, and that notice must precede the notice and demand by at least 60 days. The warning is not a defense. It is a clock, and the owner who receives it should already have a tax professional reading it.

Only the withheld portion counts. The employer's own matching share of payroll tax is not trust fund tax, and the penalty does not reach it.

2. Sales Tax Names Officers of a Dissolved Corporation

New York's sales tax statute anticipated the closing. Tax Law section 1131(1) defines persons required to collect the tax to include "any officer, director or employee of a corporation or of a dissolved corporation," employees and managers of LLCs under a duty to act for them, and "any member of a partnership or limited liability company." Section 1133(a) then makes every such person "personally liable for the tax imposed, collected or required to be collected."

The phrase dissolved corporation is the part worth rereading. The legislature considered the owner who files a certificate of dissolution and assumes the sales tax account went with it, and it wrote the definition to follow the officers out the door. Dissolution, far from ending the liability, is a status the statute expressly contemplates (whatever the owner's accountant may have said in a hurried conversation at year end about the corporation being "gone," and however reasonable that sounded at the time, the statute's authors had already considered the argument and written their answer into the definition). Liability still depends on the person's duty or conduct, and whether a passive LLC member stands where an officer stands is something counsel should check against the later provisions of the article.

Collected sales tax was the customers' money. New York treats it that way.

3. The State Declines to Accept the Dissolution

In New York, the Department of State "shall not file" a corporation's certificate of dissolution "unless the consent of the state department of taxation and finance to the dissolution is attached," under Business Corporation Law section 1004, and a corporation with New York City business activity and tax liability needs the city's consent as well. The consent follows a review for unfiled returns and unpaid tax. Delaware's section 277 is blunter: no corporation is dissolved until its franchise taxes are paid and its annual franchise tax reports, including a final one, are filed.

A company that owes state tax may therefore find that it cannot close at all, in the formal sense, until it pays. It can stop operating. It remains a corporation on the state's books, with the annual obligations that status carries.

4. A Buyer Inherits the Seller's Sales Tax

Closing often means selling what is left. Under New York Tax Law 1141(c), a purchaser of business assets in bulk from a sales tax vendor must notify the Tax Department at least ten days before taking possession or paying; the consideration becomes subject to a first priority lien for the seller's taxes, and a purchaser who skips the notice becomes personally liable for them, up to the greater of the purchase price or the fair market value of the assets. The seller, meanwhile, owes a final sales tax return within 20 days of ceasing business, under the Tax Department's bulletin.

So the tax debt reaches the sale price before the seller does.

5. A Payment Plan Opens the Question of Who Was Responsible

A closed business can still ask the IRS for an installment agreement. It calls the number on the notice or 800-829-4933, and a larger request may call for Form 433-B. But the Internal Revenue Manual directs that trust fund recovery penalties "must be considered and, if appropriate, assessed in connection with consideration of installment agreements for any out-of-business corporation or out-of-business LLC." Asking for a plan, in other words, invites the inquiry described in the first section.

An offer in compromise is narrower still. It requires filed returns and, for employers, current deposits; an open bankruptcy case makes the taxpayer ineligible; and an accepted offer carries continuing compliance obligations, generally for five years, with default able to restore the original liability. None of it is a discount on request.

The IRS will take a closed company's money on a schedule. It will also ask whose money the schedule should have been.

6. Bankruptcy Sorts Tax Debt Rather Than Erasing It

Whether you can file bankruptcy on sales tax or payroll tax depends first on who files. An LLC or corporation receives no Chapter 7 discharge at all, because section 727(a)(1) of the Code reserves it for individuals; the entity is liquidated and its tax claims are paid, if at all, in the statutory order. Taxes hold a priority there. Section 507(a)(8) gives eighth priority to listed governmental claims, including income taxes within defined look-back periods and "a tax required to be collected or withheld and for which the debtor is liable in whatever capacity."

For an individual, the same list becomes a list of survivors. Section 523(a)(1)(A) excepts from discharge taxes "of the kind and for the periods specified in section 507(a)(3) or 507(a)(8)," whether or not a claim was filed, and the Supreme Court held in United States v. Sotelo (1978), under the former Bankruptcy Act, that an officer's section 6672 liability, though labeled a penalty, was not dischargeable. A Chapter 13 discharge carves out the same trust fund category. Whether a particular state's sales tax sits in the withheld-or-collected clause or in another subparagraph is a question for bankruptcy counsel, and the answer changes what a plan must pay.

A corporate Chapter 11 discharge has its own exceptions, including taxes for which the corporation made a fraudulent return or willfully attempted to evade. The pattern is consistent across the Code. Tax debt is ranked, timed and in large part preserved.

What a Settlement Company Cannot Touch

Delancey Street negotiates merchant cash advances, loans and similar private business obligations and is not a law firm; it has no role in IRS or state tax matters and cannot negotiate a trust fund penalty. Its free, confidential review can help an owner see which balances are private and negotiable and which belong with a CPA, enrolled agent or tax attorney, and it works with independently licensed counsel where legal questions arise.

You sign the payroll checks for years and then learn, in a single letter, that you were also signing for the deposits.