By David Joseph and Lance E. Rothenberg
Short Answer: Painful. Very painful.
In these unprecedented times, it’s a real possibility that many small-to-medium-sized businesses will, despite every effort, be forced to close their business and declare bankruptcy. If these businesses had used the sales tax collected prior to closing their doors to sustain their business for a time, what will happen to that debt?
There is an urban myth among business owners that says something to the effect of: “Since I collect sales tax, I am entitled to use it as working capital.” However, this is simply wrong.
Sales tax that is collected by a business belongs – at every step of the way from the moment it’s collected – to the State. Businesses and business owners and operators have a legal and fiduciary responsibility to the State to hold sales tax funds secure and in trust. In fact, business owners and operators can be held personally liable for sales tax debts. To learn more about this, read this post about using sales tax to run your business.
There is never a good time for a pandemic, but COVID-19 could not have happened at a worse time for SMBs with regard to sales tax.
Consider this: Many businesses remit sales tax quarterly, meaning, for example, that all of the sales tax monies collected during the January, February and March months were due to the state on or around April 20th. If the business managed its sales taxes properly and set it aside during the whole quarter, they were potentially sitting on a nice piece of change when COVID-19 struck.
However, many of these same businesses subscribe to the urban myth mentioned above and have already used the sales tax funds collected during the first quarter of the year as working capital to keep things running during the early days of the COVID-19 crisis. Many of them did not have the ability to generate enough funds to make their April sales tax filing deadline. There is never a good time for a pandemic, but COVID-19 could not have happened at a worse time for SMBs with regard to sales tax.
Several states are extending sales tax filing deadlines or providing penalty and/or interest relief in certain circumstances. On the plus side, this may offer merchants the opportunity to hold off on making payments today. This gives them the opportunity to catch up on their payments when business returns to normal.
Extensions are an invitation by states to merchants to use the sales tax funds they’ve collected as a source of ready cash.
Unfortunately, there might be a negative side to these extensions. First off, states are quickly becoming strapped for cash, and it’s highly unlikely that they will be able to offer these extensions beyond July. On top of that, extensions may be improperly viewed by struggling merchants as an “invitation” to use the sales tax funds they’ve collected as a source of ready cash. When the new extension due dates come up, that money will still be due to the state, simply burdening the merchant at a later date and making it even harder to recover long term!
The worst-case scenario from all of this is a business that used sales tax revenue to stay afloat and then is forced to close its doors and claim bankruptcy. Sales tax is a personal liability to business owners and, unlike rent, business loans, equipment leases, credit cards, and accounts payable, when the business closes and declares bankruptcy, sales tax is not dischargeable in bankruptcy court. That’s right, 100% of the sales tax and related late fees and fines owed at the time of filing bankruptcy will follow the owner until it is paid to the state.
Luckily, due to the nature of the COVID-19 crisis, states will hopefully be lenient as far as penalties go. But the amount of sales tax collected and improperly used as working capital will be owed and there very likely will be a lien imposed against the owner/operator until the debt is satisfied.
In short, if a business declares bankruptcy in an effort to reorganize and restructure debt, past sales tax liabilities will still be owed. And having a lien placed against the owner/operator will vastly restrict their ability to do business. If you can do it, be sure to pay your sales tax on time to save yourself a mountain of headaches in the near future.
Disclaimer: The information contained in this article does not constitute tax advice and is for informational purposes only.
About DAVO Automated Sales Tax
DAVO Automated Sales Tax is here to help you through this difficult period. Feel free to contact me at firstname.lastname@example.org or call us at (888) 659-8432 with any questions and we will point you down the correct path.
About David Joseph
David Joseph is the co-founder of DAVO Technologies (davosalestax.com) and a former restaurant owner. DAVO Automated Sales Tax integrates with many popular POS systems to set aside sales tax daily and file and pay it when it’s due, on-time, and in-full. Put your sales tax on autopilot and never worry about it again. David can be reached at email@example.com or (888) 659-8432.
About Lance E. Rothenberg
Lance E. Rothenberg contributed to this post. Lance is a tax consultant with CohnReznick LLP in New York and New Jersey. Lance focuses on state and federal tax controversies and disputes, and he has experience assisting a wide range of businesses and business owners facing federal, state, local, and multistate tax issues, including sales-and-use taxes, corporate income taxes, personal income taxes, and excise taxes. You can reach him at firstname.lastname@example.org and on LinkedIn.com.