By Stephen J. Dunn
Spouses generally do not make good business partners for many reasons. For example, when spouses work together in a business, it tends to dominate their personal life. But there’s one underappreciated reason not to go into business with your spouse: It can create dire and long-lasting problems with the Internal Revenue Service.
All too often, struggling small businesses fall behind in paying their federal payroll taxes. The business withholds income taxes and Social Security taxes from its employees’ paychecks, and then, short of cash, doesn’t send the cash to Uncle Sam. The business owners may plan to make good on the payment, but get farther and farther behind. Then, the business goes under.
These unpaid payroll taxes aren’t like any normal business debt. Even if the business is incorporated, the withheld portion of the tax–withheld income tax and withheld Social Security tax (this excludes employer matching Social Security tax)–can be assessed against a corporation’s “responsible persons”personally. Such an assessment is called a “trust fund recovery penalty.”
Who is a responsible person? It’s someone who controls how the business uses its available cash. The chief executive officer almost always is a responsible person. Check-signing authority is a telltale sign of responsible personhood, unless it is not exercised.
A business can have more than one responsible person and you don’t have to be the boss to be considered a responsible person. Say a couple works in a business. One of them is the CEO and the other a bookkeeper. If the business fails to pay its payroll taxes, the IRS could assert the trust fund recovery penalty against both the CEO and the bookkeeper. For this reason the bookkeeper should not have check signing authority for the business.
Once a trust fund recovery penalty is assessed, a lien (legal claim) for it arises against all of the responsible person’s property then owned or later acquired. The IRS can collect the lien by levy (seizure) of the responsible person’s property for 10 years to collect it. “Property” for this purpose includes real property, as well as wages, bank accounts, and other personal property.
Once a federal tax lien arises, the IRS will record notice of it against the responsible person in the register of deeds’ office in the responsible person’s county of residence. A recorded notice of federal tax lien impairs the responsible person’s ability to sell property, real or personal, or to obtain credit. Adverse credit can also affect an individual’s employability, especially in a financial industry.
A trust fund recovery penalty assessed against both spouses can have a devastating effect, impairing the credit and employability of both of them, and subjecting all of their property to federal tax lien and levy. But if the trust fund recovery penalty is assessed against only one of the spouses, their situation will be markedly better. A trust fund recovery penalty assessed against only one of the spouses will not impair the non-responsible spouse’s credit or employability and will not result in a lien against the non-responsible person’s separate property or more than half of their joint property.
Here’s another tax reason not to work with your spouse: When divorcing couples have worked together in a business, it is not uncommon for one spouse to use the other spouse’s alleged tax fraud to leverage a better divorce settlement.
In a typical case, the husband has founded a closely held business and is its driving force. The wife has worked as a bookkeeper for the business and knows that the business’ income tax returns have underreported income. She also knows that personal expenses of the couple were paid by the business, deducted on the business’ income tax return, and not reported as income to the couple on Forms W-2 or 1099. In the divorce negotiations, the wife’s attorney raises these issues to the husband’s attorney, implying or actually threatening disclosure to the IRS if the divorce settlement is not to the wife’s liking.
Won’t the wife get herself in trouble by going to the IRS? She might, but if she’s got a good divorce lawyer, who calls in a smart tax lawyer, she might get not only immunity from prosecution but also a share of the money recovered from husband as an informant’s reward.
Spouses really do not make good business partners.