Businesses Are Facing Financial Headwinds—A Practical Guide

*** The original article was featured on Bloomberg Tax, April 28, 2025 —

As a tax attorney who spends much of my time helping people and companies who have large, unresolved issues with the IRS or one or more state tax departments, it often occurs to me that the best service that I can provide to a client is to help the client sleep better at night. When speaking to accountants, I will sometimes get asked the question, how do we know when it is time to refer a client to a tax attorney. There are several answers to that question, but first and foremost, send them to an attorney when their tax issues keep them up at night.

While there are often things that an attorney can bring to the table to help the client (and get them sleeping better at night), there are many times when I wish that I had had the opportunity to speak to a client well before they were in the situation that led them to me. Maybe when they were starting to make the decisions that put them in an unfortunate situation.

My colleagues and I are quite aware that to the extent that tariffs are fully implemented, this will cause some of our clients to face very difficult decisions in the coming months. If part or all of your business relies on imports that will skyrocket in price, whether you buy parts and make products or buy products and resell them, we understand that stiff headwinds and hard decisions may be coming. Exporters may find themselves in a similar situation if reciprocal tariffs price them out of the markets into which they sell.

Many of my clients make decisions when faced with tough times that haunt them for years to come. What follows are some thoughts from experience in the trenches. One caveat – neither Scarinci Hollenbeck, LLC nor I condone the nonpayment of taxes, or unfiled returns. But we do understand the realities that businesses might face in the difficult times ahead and would like to help you make the best decisions possible.

Trust Fund Taxes—Always Pay These!

There is a reason why this comes first, ahead of the topics that follow. The moment that you collect sales tax, you are personally responsible to turn that sales tax over to the state. See, for example, NJ Rev Stat §54:32B-14 (2024). Similarly, you are personally responsible for all employment taxes that were withheld from your employees’ paychecks, both to the IRS and the state(s). IRC §6672 and, for example, NJ Rev Stat §54:8A-104(b) (2024).

These taxes are called trust fund taxes because you are said to hold these taxes in trust for the state or the IRS. The very moment it was collected or withheld, it was their money, and they expect you to pay it over to them. If you do not pay it over and are found to be a “responsible person” relative to these taxes, it is now your personal tax liability.

The IRS has 10 years to collect tax from the date that it was assessed. IRC §6502(a). The state of New Jersey, as an example, will send your liability to judgment if unpaid. The judgment lasts for 20 years and is renewable. See, for example, NJ Rev Stat §2A:14-5 (2024). Close the business? Still your liability. Move far away? Still your liability.

Some clients will neglect to turn over these payments to the IRS or the state and will tell me that they needed to keep the lights on or pay the rent or pay one more month’s salaries. Not paying trust fund taxes, however, should be the decision of last resort, with full knowledge of the financial risk that you are creating for yourself personally. If you are unable to pay this liability personally, it will hang over your head for years to come. Pay this first – it is the hardest liability to overcome, and the IRS and the states have no empathy for those who do not pay these specific taxes.

Do you think you might get out from under this liability by declaring bankruptcy? The only taxes that can be discharged in bankruptcy are income taxes and only if several conditions are met. Employment taxes? Sales taxes? Not ever dischargeable.

One last point about trust fund taxes. Criminal tax law is filled with cases about business owners who, rather than paying over employment taxes that were withheld from employee’s paychecks or sales tax collected from purchasers, used those funds to support their lifestyle. The IRS and the states like to make examples of people who do such things. As such, there are often oversized financial penalties and prison time. The IRS has a 90% conviction rate for the cases that they adjudicate, and depending on the specific tax crime, sentences can range from 1 to 5 years. More in some unusual situations.

Filing Tax Returns Late or Not Filing Them at All—Federal

Your business is struggling, maybe you have fallen behind a bit and you are very distracted with the minute-to-minute issues that you are faced with. Would not it be simple to just not file your tax returns right now, especially if paying the tax might be impossible at the moment or might force some hard decisions that you would prefer to put off? When a client comes to me with the question of whether or not to file, here is what I tell them. The penalties for failure to file a tax return on time are far greater than the penalties for failure to pay on time. Let us look at the penalties.

Individuals and Most Business Tax Returns

The penalty for filing late is 5% per month, up to 25% of the outstanding tax liability. IRC §6651(a)(1). If the return is more than 60 days late, there is a minimum penalty for late filing. In 2025, the minimum penalty is the lesser of the amount of the outstanding tax or $510.

There is an additional failure to pay penalty of 0.5% per month, up to 25% of the outstanding tax liability. IRC §6651(a)(2). If both the failure to file penalty and the failure to pay penalty are assessed, the failure to file penalty is reduced by the failure to pay penalty. It should be noted that the failure to file penalty maxes out after 5 months, but the smaller failure to pay penalty continues on.

Partnership Returns

Beginning in 2025, the amount of the late filing penalty is $245 per month multiplied by the number of partners and continues for up to 12 months. IRC §6698.

S Corporation Returns

Beginning in 2025, the amount of the late filing penalty is $245 per month multiplied by the number of shareholders and continues for up to 12 months. IRC §6699.

Interest is charged on penalties. You can potentially have a penalty abated if you can show that the late filing was due to reasonable cause. Not having the funds to pay on time is not reasonable cause. You can file for an extension, but a common misunderstanding is that an extension extends the time to file and the time to pay. That is not correct. It only extends the time to file. It does not extend the time to pay. If you owe a substantial amount and file for an extension, even if you pay in full within the extension period, your extension is likely to be denied and the failure to file penalty will be added for the months between the original due date of the return and when the return was actually filed.

Filing Tax Returns Late or Not Filing Them at All—States

Here is a sampling of the late filing and late payment penalties in a few states. All states have different rules.

New Jersey

The late filing penalty in New Jersey is 5% per month, up to 25% of the balance due. In certain circumstances, they also charge an additional $100 per month. NJ Rev Stat §54:49-4 (a). New Jersey also charges a late payment penalty of 5% of the tax due. When an account enters the collection phase, New Jersey often engages Pioneer Credit Recovery to collect unpaid tax. Once engaged, a Referral Cost Recovery Fee of 11% is charged.

As onerous as these fees may seem, they can generally be capped through the passage of time. Interest, however, continues until the liability is paid. New Jersey’s interest rate on unpaid balances is the prime rate + 3%. During 2024, New Jersey’s interest rate varied between 11.25% and 11.50%. As of this writing, the rate is 10.75%. These rates are compounded annually.

New York

Similarly, the late filing penalty in New York is 5% per month, up to 25% of the balance due. If the return is more than 60 days late, the penalty is the lesser of $100 or the total amount due on the return. New York also charges a late payment penalty of 0.5% of the tax due per month, up to a maximum of 25%. NY CLS §685.

New York uses several different interest rates depending on the type of tax that is late. To stay on point in this discussion, the rates for the first quarter of 2025 are as follows:

• Income Tax 9.5%
• Sales and Use Tax 14.5%
• Withholding Tax 11%
• Corporation Tax 11%

California

Individuals and Businesses: California’s late filing penalty is 5% per month, up to 25% of the amount due. For individuals only, if the balance due is $540 or less, the penalty is the lesser of $135 or 100% of the amount due. The late payment penalty is 5% of the amount due, plus 0.5% of the unpaid tax for each month for up to 40 months. Other cost recovery fees may apply.

S Corporations, Partnerships, and LLCs treated as Partnerships: $18 per month per partner or shareholder, up to 12 months.

The California Comprehensive Penalty Chart lists all related statutory citations.

California’s interest rates on personal and corporate unpaid taxes are 8% for the first half of 2025 and 7% for the second half.

The bottom line for federal and state tax returns for both you and your business? File all of the tax returns and file them honestly. It is far more cost-effective to file the tax returns with none of the taxes paid than to both not file and not pay the taxes.

Other Considerations

Annual Business Registration Fees

Many smaller entities neglect to register and pay the annual fees required by the state that they were organized in. While the annual fees are not onerous, if you ever want to terminate that business, and those fees have not been paid along the way, it is likely that all of those fees will all have to be paid, in addition to a penalty in some states. Better to stay on top of those fees and to terminate a business as soon as possible when it no longer serves a purpose.

Filing Status for Married Couples

If you are about to go into a period of time where you might well have tax issues with your business, particularly income tax issues, and your spouse is uninvolved in the business, consider filing separate returns. If you file a joint return with your spouse, both you and your spouse are jointly and severally liable for everything associated with that return.

To get relief from the joint and several liability that a joint return imposes, your spouse may be able to apply for innocent spouse relief under IRC §6015, but that is a process and by no means has a guaranteed outcome. Yes, filing separately tends to be more expensive, but better to not put your spouse in that position in the first place by filing jointly.

Looking at this from the opposite side of the coin, there are many instances where one spouse has a business and the other spouse is a wage-earner who simply receives a W-2 that reports income and income tax withholdings. If you are that wage-earner, are uninvolved in your spouse’s business and have any doubts about your spouse’s business and tax reporting, you are well advised to insist that separate returns be filed.

W-2 or 1099?

Some business owners opt to treat certain workers as independent contractors (1099) rather than employees (W-2). Why might they do that when facing financial hardships? Two primary reasons. First, the burden of state and federal employment taxes is fully shifted from the employer to the worker. Second, the employer’s workers’ compensation burden may be reduced if the individual is not the employee of the employer.

What some may not realize is that the question of employee vs. independent contractor is not a simple matter of choice or preference. There are tests at both the state and federal level that are used to determine the status of a worker. There also exists an entire body of law generally called “employee misclassification.” If reading that title leaves you with the impression that there is a bias towards classifying workers as employees, you are correct. And the states are much more invested in this than the IRS. Almost no one comes out of a state employment tax audit unscathed.

The IRS uses tests in three categories to determine the degree of control the employer has over the worker and level of independence that the worker has from the employer. The three categories are explained reasonably well on the IRS website (IRS.gov) and are as follows:

1. Behavioral: Does the company control or have the right to control what the worker does and how the worker does his or her job?
2. Financial: Are the business aspects of the worker’s job controlled by the payer? (these include things like how worker is paid, whether expenses are reimbursed, who provides tools/supplies, etc.)
3. Type of relationship: Are there written contracts or employee type benefits (that is, pension plan, insurance, vacation pay, etc.)? Will the relationship continue and is the work performed a key aspect of the business?

As mentioned, the states play a larger role in misclassification issues. New Jersey, as an example, has a deceptively simple three-part test called the ABC test for both the Division of Taxation and the Division of Employer Accounts. Other states also use this test. Per New Jersey Unemployment Compensation Law, NJ Rev Stat §43:21-19(i)(6), a worker should be considered an employee unless all the following circumstances apply:

A. The individual has been and will continue to be free from control or direction over the performance of work performed, both under contract of service and in fact; and

B. The work is either outside the usual course of the business for which such service is performed, or the work is performed outside of all the places of business of the enterprise for which such service is performed; and

C. The individual is customarily engaged in an independently established trade, occupation, profession or business.

Put a bit more simply, “A” is a facts and circumstances test. You would generally fail “B” if you are a small construction company and hired a laborer as an independent contractor. You would generally pass “B” if you are a small construction company and the local signmaker made a sign for your business at his shop and came and installed it at your shop. “C” is quite simple. If you let this person go, would he or she be unemployed or does he or she have a completely separate business that stands on its own? Generally, a plumber that you would call to make a repair has his own business and would not be unemployed once you stop using him. That laborer? Looking for a new job if you let him go.

This is an area where any time I have a client who could be challenged by the state on the employee/independent contractor decisions that were made, the audit always comes back with an uncomfortable amount being owed to the state. They are very good at what they do, and they have a very large toolbox at their disposal when they work these issues.

Recordkeeping

Some people, some companies, are just better at record-keeping than others. If you take a deduction, you have the burden of proof to show that you are entitled to that deduction. Invoice, check, credit card statement, bank statement, Pay Pal statement. If you collect sales tax, each state requires that you keep records for a certain amount of time (four years in New Jersey, NJ Admin Code §18:24-2.3(a)) and they are very specific about what must be kept for that time period. Are these items recreated during the course of an audit on occasion? Yes. But you will never feel that it was worth your time and the attorney’s bill to go through that process.

In hard financial times, let go of your bookkeeper last. Do not have a bookkeeper? I have connected many companies with outside bookkeepers. They are not financially onerous. If anything comes up where you are audited at the state or federal level about expenses, sales tax, employment tax, etc., you will save an astonishing amount of time, aggravation, and money if you have kept good, organized records.

Wrap Up

There may be other topics that could have been covered in this article. However, what I hope emerges is a theme. Cutting certain corners in difficult times can lead to consequences that many times outweigh what the cost might have been to correctly comply or to take the appropriate action initially. Think through the potential consequences before you take action and if ever it would be helpful to bounce an idea or question off of your attorney or accountant, do that early and often.

Results may vary depending on your particular facts and legal circumstances.

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*** The original article was featured on Bloomberg Tax, April 28, 2025 — ***