If you owe back taxes but you’re getting ready to launch a new business, you might be unsure how to proceed – or if it’s even possible. Does your personal tax situation influence your ability to open a business? The short answer is: it depends. While your individual tax debt may not preclude you from opening a business, it can still negatively impact your ability to get approved for business loans. With that said, there are many variables involved that affect your business finances besides your taxes. Keep reading for a full explanation or navigate directly to the section that answers your question.
- Is it Possible to Incorporate Your Business?
- Financing Your Business (While You Owe Back Taxes)
- Resolving Your Unpaid Taxes
- Other Tax Considerations
Is it Possible to Incorporate Your Business?
Even if you owe taxes, you can still incorporate your business. Both corporations and LLC business structures allow business owners to separate and protect their personal assets. If you’re a business owner or if you’re about to become one, it’s important to have a clear distinction between you as an individual and the business. Incorporating or forming an LLC means that you can run your business without the threat of your personal assets being taken away to satisfy a business debt.
From a tax standpoint, it’s much easier to do your taxes if your expenses for your business are separated from your personal expenses. Business structures such as corporations and LLCs can deduct certain eligible expenses such as salaries and supplies. But when your expenses for your personal life and business are mixed, it can be a much more complicated tax process.
In order to make sure your business structure makes sense given the size and services of your business, it’s crucial to work with a financial advisor or tax professional to help you properly set up your company.
Financing Your Business (While You Owe Back Taxes)
It’s important to note that when you apply for financing for your business, your personal credit can affect your business loan application. Most lenders evaluate your personal credit and financial history when they’re deciding whether or not to grant a business loan.
In fact, your credit score is likely one of the highest weighted factors when it comes to your business loan application. If you have a high amount of tax debt or you haven’t paid your taxes, it can result in a fairly steep decrease in your credit score.
Specifically, if a tax lien is reported on your credit report, it stands out as a serious blemish and will remain on your credit report for up to 10 years. Even when you pay your tax lien, the record of it will remain for seven years from the filing date.
So, when a lender is determining your risk as a borrower, lenders who weigh credit scores heavily in their evaluation process could decide that your lower credit score makes you a riskier borrower. This is especially true if you are a new business owner and don’t have any business credit.
Luckily, not all lenders weigh your personal credit score as heavily as other factors. The weight of your credit score varies lender to lender, which is why it’s essential to shop around.
Here are a few of the financing options you can explore to raise capital for your business if you’re worried about your tax debt getting in the way:
- Accounts Receivable Financing: This type of loan is great for business owners who are waiting on unpaid invoices to pay business expenses. The invoices are used as collateral, so the rest of your business finances aren’t typically heavily investigated.
- Short-term Loans: If you don’t have great credit but your business has a sustainable cash flow, you might be able to qualify for a shorter-term loan. These kinds of loans place a greater emphasis on your company’s revenue rather than your credit score. Unfortunately, while they may be easier to qualify for, you’ll usually pay higher interest rates and face a shorter repayment period.
- Term loans: Term loans give you a lump sum of money you repay with a fixed interest rate. They require good personal credit to qualify for.
- SBA Loans: SBA loans are highly sought after because of their low interest rates coupled with longer repayment terms. With that said, they are more difficult to receive approval for because they typically only choose business owners with good personal credit.
Resolving Your Unpaid Taxes
When you owe back taxes to the IRS, the government has broad authority to collect, including seizing your property through a tax levy. A tax levy can allow the IRS to seize your wages, bank account balances, automobiles, retirement accounts, real estate, and other assets. With that said, owing back taxes wouldn’t stop you from incorporating a business because you’re still allowed to work and earn a living, even if it’s through your own business.
The IRS can work with you to resolve your unpaid taxes. If you’ve already negotiated with the IRS or you’re paying your debts using installment agreement, you can still start a business – as long as you continue to pay your debt.
Once the IRS starts collection activity through a levy, however, any money or any other assets you transfer into your business can be reversed by the IRS. If you try to hide your assets by using your business as a front to avoid paying back taxes, that’s illegal. Keep in mind that you also cannot purposely transfer money or property into your business to evade back taxes you owe.
Other Tax Considerations
There are four main types of business structures and each structure has a different influence on your business taxes.
If you choose to set up your business as a sole proprietorship, it means that from a legal standpoint, your business has no separation from yourself as an individual. In turn, your business doesn’t owe business income tax because the IRS simply requires you to report your self-employment income.
It’s common for small businesses to begin their companies as sole proprietors, but there are serious drawbacks to this arrangement. For example, all of your earnings are treated as personal income – which means you’re on the hook for twice the usual amount of self-employment taxes.
LLC stands for “limited liability company” and it’s a way for small business owners to incorporate their business. The LLC means your company gets its own identity and status separate from your personal identity. In turn, you receive more protections and financial benefits. For example, you can apply for a business bank account, a business credit card, and build credit for your business.
Again, an LLC does not have to pay a business income tax because the IRS doesn’t consider an LLC as separate from you for tax purposes, so you simply have to pay personal income tax.
Read Community Tax’s guide about how to form an LLC if you want to learn more about how this business structure can help you protect your business interests from your personal interests.
An S-Corporation is another business structure not liable for business income taxes because like an LLC, all of the business earnings pass through you, the business owner. Some businesses are set up as LLCs but file taxes as an S-Corp to take advantage of better tax breaks.
This is the only type of business structure specifically required to pay business income taxes. C-Corporations may be publicly traded companies, so when you’re still small, there’s no reason to file as a C-Corp. If your business is a fast-growing startup with the goal of being publicly traded, setting up your business as a C-Corp from the get-go might be the best choice.
When you owe taxes to the IRS, it doesn’t have to mean that you need to give up your dreams of starting own business. As long as you don’t ignore your tax obligation, you can still open up your business. It’s a good idea to contact a tax professional who can help you with specialized tax resolution services. Talking to the IRS on your own is intimidating, that’s where Community Tax comes in. With expert advice and comprehensive knowledge of the tax code, a Community Tax representative can help you set up an installment plan to pay your taxes to the IRS or get an Offer in Compromise, so you can pay a much more reasonable amount of your taxes. With these tips, you don’t have to be intimidated and can start your business on the right foot and a strong financial foundation.