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Defending the Small Business - Part 15 - State & Local Taxes 11/22/2008 3:50:12 PM
Small business owners often overlook state and local taxes to their great peril... State and Local Taxes
Whereas state and local taxes aren’t likely to put a small business under, they can cause the SBO a lot of grief if they are overlooked or ignored. Fortunately, in Texas there is no state income tax. For SBOs in other states, reporting and paying state income taxes can be nearly as burdensome as federal payroll taxes. The key, again, is to accept the fact that these taxes have to be paid, and withhold and make deposits each pay period so there is little opportunity to inadvertently spend that money.
In Texas and many other states, the state imposes a franchise tax. This is a very annoying tax that SBOs often ignore. The problem with ignoring this tax for a corporation or limited liability company is the fact that your corporate charter will eventually be revoked. This can be devastating if a SBO gets in trouble and needs to rely on the liability protection that a corporation or limited liability company will provide. Suddenly an SBO may find himself personally liable for all the company debts simply because he didn’t file this return and pay the tax.
Another problem is that the company will not be allowed to prosecute or defend itself in court if these taxes are not paid and the charter is allowed to be forfeited. This can be remedied simply by filing the return and paying the tax, but many SBOs don’t know this and let creditors take default judgments against them at will. Fortunately, the Texas legislature recently enacted a $150,000 income exclusion for small businesses that will eliminate the franchise tax problem for smaller SBOs. But for those outside Texas or with revenues over $150,000 the franchise may still be a problem.
Personal and real property taxes are almost always a line item in the bankruptcies I file. Since few taxing authorities vigorously prosecute those who don’t pay them, they tend to be a low priority. Over time they can become quite large and difficult to pay. The best way to handle them is to establish an escrow fund. This can be done with the mortgage company or by creation of an escrow fund at a bank or savings and loan. Then each month you deposit one twelfth of the amount you will need for the year. This can also be done with insurance so that when the time comes to make the payment the money is in hand. Don’t think you can pull these large payments from current cash flow. It just won’t happen and you will just end up paying late fees and penalties.
I have had one unlucky SBO in Chapter 13 for ten years simply because she didn’t have the discipline to pay her property taxes. She was a self employed cleaning woman and barely made enough to survive. She owned her house outright so the taxes were not escrowed each month. When she was unable to pay the taxes for three years, the City of Dallas turned her over to an attorney and a suit was filed. She didn’t hire an attorney to contest the suit, so before long the property was put up for sale at a tax auction. Without enough money to pay rent, if she had lost her house she may have ended up on the street. That’s when she sought our help.
We put her in Chapter 13 and were able to stop the sale of her home. The problem was that she now had to make monthly payments to the bankruptcy trustee. This didn’t leave enough money left over for her to escrow taxes for the following year, so she was always getting behind on her payments. When she got too far behind, she’d get dismissed and we’d have to start over again. Unfortunately, repetitive bankruptcy filing is considered an abuse of the bankruptcy system, so two or three bankruptcy filings is the most anyone can hope to file. If our client lets this bankruptcy get dismissed, she will may end up homeless.
Sales and use taxes aren’t as much of a problem for the SBO because a sales tax permit and a bond are usually required before a business can open. To get the permit, SBOs are given instructions as to what is expected of them. The SBO must remit the taxes periodically and, if they don’t the taxing authorities come down on them quickly and effectively.
There are a myriad of other taxes and assessments state and local governments assess against the SBO’s property. Assessments for street improvements is one that can be quite devastating to SBO. When you buy real property, be sure and find out if the state, county, or city plans to widen the road in front of your property. These assessments can be very large and jeopardize the unsuspecting SBO’s ownership of the property should he be unable to pay it.
Finally, I have had many SBOs devastated when they purchase or lease property and find out that, in order to get an occupancy permit they must make thousands of dollars of repairs. I know of several instances in which businesses that were planning to make a quick move to improve business or get a better lease rate, ended up out of business for several months while required repairs or upgrades were completed. Compliance with the American Disabilities Act, environmental laws and local codes and ordinances are usually the sources of these types of costly delays and business interruptions. If you have a realtor he or she should check out all of this for you. If you don’t use a realtor, you will have to do it yourself or hire an attorney to do it for you. But, whatever you do, don’t ignore these most serious problems.
