The Small Company Tax Disaster

Small companies that never "got off the ground" or died a fast death can be a financial death trap years later. Today, people are paying tens of thousands of dollars all because of fines levied by the IRS.

Small companies that never “got off the ground” or died a fast death after “opening their doors” can be a financial death trap years later. Today, people are paying tens of thousands of dollars for the association they had with these little companies that “disappeared” years ago all because of a new trick by the IRS.

The set up

Doctors often get involved in small companies very innocently as a silent partner. It isn’t unusual for them to get talked into being a partner or shareholder in some new business venture that their relative or buddy is starting. Today, the buddy is long gone, and the relative is now on Skid Row.

Sometimes doctors decide they are going to create their own business. It isn’t unusual for the tax sharks or, worse yet, the legal sharks to talk a doctor into setting up a family limited partnership (FLP) or limited liability company (LLC) to shift income to family members, lease equipment or hold the building they practice in.

There are lots of great reasons to start a little business. In fact, your small business is your most important tax shelter. There are many tax tips that will cut your adjusted gross income and actually cut your whole tax bill. The catch is every one of them requires the help of a small business. You can set up your own company, or hire it out.

The lawyer, Nevada experts or LegalDoom that set up the company dutifully filed all the papers with the state and filed for a tax ID number. Everything is well intended, but the final purpose of the little company is never realized, and the company is just ignored.

Failure to launch or survive

The little company never made money. In fact, it never did any type of business. Maybe a tax return was filed for the first year, but since nothing ever happened with the little company, no more tax returns were ever filed. If the company never even got off the ground, it’s likely no tax returns were ever filed.

The doctor was told that the company would die if no state fees were paid, so he just quit filing the annual form with the state and paying the state’s fees. Pretty soon a notice came from the state saying the company was “terminated” with the state, and that was the last thought anyone gave to the company.

Some folks like to keep the company alive so that they will have an “aged” company someday. It is a lot easier to deal with banks and creditors if the company has been around for a long time. So, there are reasons to keep a dead company around and keep paying the state fees.

The IRS trap

You may be aging your company, the company may have never gotten off the ground, or it may have died with the state. Whatever condition your company is in, if it hasn’t had a stake driven through its heart on the IRS record, you’ve got a problem. Prior to 1979, things were fine, but today the IRS has a little surprise (it may actually be a big surprise) for the owners of the “dead” or “dormant” company.

In addition to any back taxes that may be owed, in 1979 the IRS started to impose a fee for a company’s failure to timely file tax returns — whether or not any taxes were owed. The fee started out at $50 and climbed to $89 per month per “owner.” Since 2009 the fee has been $195 per month multiplied by the number of partners or shareholders in the company. For a little company with five partners or shareholders, that’s a fine of $975 per month or $11,700 per year for every year the tax returns weren’t filed.

Since President Obama has more than doubled the number of IRS agents, and the IRS has gotten rid of its warm and fuzzy side in the last few years, they are now starting to go through their records and levy these fines. People are stunned (and possibly bankrupt) when they get a bill from the IRS for tens of thousands of dollars for a company they thought was killed or put into mothballs long ago.

The fines apply to partnerships, limited partnerships, and S corporations (IRC Sections 6698 and 6699 respectively). Not to be out done, business-impossible California has enacted its own fines (R&TC Section 19172 and 19172.5). Other states may follow, but it isn’t likely in most states.

What’s the answer?

The IRS is dead serious. Some folks are trying to fight the fines, but their success rate is low. The statute says that “unless it is shown that such failure is due to reasonable cause” the fees have to be paid. The letter I saw from the IRS defined “reasonable cause” as death. The letter added that since there were other owners, it was the other owners’ responsibility to file. No filing equals a big penalty.

There isn’t any easy answer if you are involved with a company that hasn’t been filing. Each taxpayer/owner is responsible for the full amount. Because you’re a doctor, I know where the IRS will look first for its money.

I have collected a number of “recommendations” to help you out of the IRS gun sights or at least minimize the damage when they pull the trigger. Email me Lee@LegaLees.com, with a subject line “IRS penalties for not filing,” and I will ping you back with an email of the possible solutions. You should then discuss them with your CPA.

Lee R. Phillips is a United States Supreme Court Counselor who for the past 30 years has helped high income individuals control their taxes and protect their assets. Call (800) 806-1998 or visit LegaLees.com. For a free copy of Lee’s set of practical tax ideas, go here.