Closing a business isn’t easy, but when you’re also burdened with significant tax and operational debts, you have to navigate a legal and financial maze full of potential pitfalls.

The consequences of mishandling the closure can become quite costly. Missteps could lead you, the owner, to become personally liable for your business’s debts, face aggressive collection actions like liens and levies, and lose your leverage in negotiations. The key? Winding down smartly, with a clear plan that minimizes your risk and returns control to you.

This article provides a clear framework for accomplishing this process. We’ll break down which debts to prioritize, how to deal with the most “perilous” creditors (the tax authorities), and how to use negotiation strategies to settle your accounts without having to file for bankruptcy.

Key takeaways

• Prioritize tax debts. The IRS and NYS can hold business owners personally liable for some tax debts, regardless of the business’s structure.
• Beware of the Trust Fund Recovery Penalty (TFRP). The IRS can assess a 100% penalty against you personally for taxes withheld from employee wages but not sent to the government.
• New York’s “responsible person” liability. NYS can hold you personally liable for unpaid sales tax.
• Negotiation is key. You can often settle substantial tax and creditor debts without filing for bankruptcy.
• Professional help is essential. Closing a business is complex. Trying to do it yourself, especially with tax and creditor debt, can lead to costly mistakes.

Debts that can haunt you

When a business is failing, the debt can feel like a tangled mess. To untangle each thread and create a strategy requires understanding the hierarchy of your debts. Some creditors are more financially serious than others, and dealing with them in the wrong order can spell disaster.

1. 1. Tax debts to New York State and the IRS
      These debts are, without a doubt, your biggest priority. Why? Because while your business may have been a limited liability company (LLC) or corporation, the government can penetrate that corporate veil and hold you personally liable for certain unpaid taxes.
   2. Payroll tax liabilities and the Trust Fund Recovery Penalty (TFRP)
      This federal-level debt to the IRS is a big one. As an employer, you’re a trustee for the government when you withhold income, Social Security, and Medicare taxes from your employees’ paychecks. This money is called a “trust fund” tax because you’re legally obligated to hold it in trust until you remit it to the IRS. If you don’t, the IRS can come after you personally for a TFRP, which is equal to 100% of the unpaid trust fund portion of the payroll tax.

• Sales tax debts to NYS
  Much like the federal government, New York State holds a pretty aggressive stance on unpaid sales tax. It has the authority to assess a “responsible person” liability against owners, officers, and employees who had a duty to collect and remit sales tax. New York Tax Law’s Section 1131 defines anyone who collects tax for your business as a responsible person. 

• Secured loans and personal guarantees
  Many business loans, especially from banks or merchant cash advance lenders, are secured with collateral. Even if they’re not, you probably signed a personal guarantee, making you personally responsible for the debt if the business defaults. These creditors have a lot of leverage, so you need a plan to work with them.

• Vendor and supplier arrears
  This catch-all category refers to unsecured debts owed to suppliers, vendors, and your landlord. While these creditors can’t usually come after your personal assets immediately (unless you’ve personally guaranteed the contracts), they can sue the business, get a judgment, and put a lien on its assets. They can also file a lawsuit against you personally.

You may also have to deal with all of these types of debts if a business owner dies, and the right approach varies based on the business structure, success plans, and multiple other factors.

Why tax debts are the most dangerous

Tax agencies have a special kind of ability that other creditors — like your landlord or bank — don’t. The IRS and NYS can collect from you directly, even if your business is a corporation or LLC. These agencies’ powers bypass the protections your business entity provided. Here’s how:

New York’s Responsible Person assessments
When a business operating in New York fails to remit sales tax, the state can (and will) conduct an audit to determine who the responsible person was. In many cases, it’s not just the owner, but may also include the CFO, a manager, or anyone with the authority and ability to manage a business’s finances, sign tax returns, or oversee tax-related operations.

Failing to pay tax on time can trigger a series of aggressive penalties from the Department of Taxation and Finance. The state imposes statutory penalties (typically 10% of the unpaid tax for the first month, and 1% for each subsequent month up to a maximum of 30%) and charges interest that compounds daily. So, the debt can grow quickly.

Once the state makes an assessment and identifies the responsible person (or people), they become personally responsible for unpaid taxes, penalties, and interest. Each responsible person is “jointly and severally liable” (the state can pursue any single person for the entire debt, even if multiple people were involved).

The IRS’s Trust Fund Recovery Penalty
The IRS uses the TRFP to go after individuals (not the business) for unpaid trust fund taxes. To assess this penalty, the agency must prove two things: that you were a responsible person and that you acted willfully. The term “willful” in this context is pretty broad; it means you knew the taxes were due and chose to pay other creditors instead. Your decision doesn’t have to be malicious or fraudulent — just paying your vendors instead of the IRS can be enough.

If you don’t pay the withholding and sales taxes your business owes, the agency can take several steps:

• Assess the tax due against you and other responsible parties individually. (The IRS can collect the money from any responsible party, and it doesn’t care who, as long as it gets paid.)
• Issue a tax warrant against you, individually.
• Seize the money in your bank account.
• Seize your personal assets to cover the owed amount.

Here’s a hypothetical: Let’s say you paid your employee $1,000. You withheld $176.50 for taxes. You also owe another $76.50 as the employer’s portion. The total tax bill your business owes, therefore, is $253.00. If you don’t send in this money you’ve held in trust for the government, your business would be on the hook for $253.00, and you could face a TFRP personally for $176.50.

Strategic tools to settle your tax liabilities

The tax authorities may be open to negotiation if you approach them with a well-documented, professional proposal to get back into compliance.

Offer in compromise (OIC): An OIC allows you to settle your tax debt for less than the full amount you owe. The IRS and NYS have their own OIC programs. The key to a successful OIC is convincing the tax authority that they’ll never be able to collect the full amount you owe, and it’s in their best interest to take a partial payment.

Making a compelling case requires you to provide a complete, convincing financial picture. You’ll want to compile the documents that help make your case. Those documents include:

• Current financials: A Profit & Loss (P&L) statement and Balance Sheet for the business.
• Bank statements: The last 12-24 months of statements for all personal and business accounts.
• Aged debt reports: A list of everyone the business owes money to and the age of the debt.
• IRS forms: Mock-up or completed IRS Forms 433-A (OIC for individuals) and 433-B (OIC for businesses) that show your inability to pay.

The most successful OICs hinge on the concept of reasonable collection potential (RCP), or what the government can reasonably expect to collect from you. Well-documented files allow you to control the narrative and prove that your RCP is low, even if your debts are high.

If an OIC isn’t an option, there are other ways to manage your debt. You may qualify for an installment agreement, which allows you to pay off your debt over a set number of months or years. Another option is to be placed in currently not collectible (CNC) status if you can prove that you cannot pay, even over a period of time.

Negotiating with other business creditors

The threat of insolvency is often your best leverage when dealing with other creditors. No landlord or vendor wants to be left with nothing. If you present your case strategically, they’ll see that a settlement is better than receiving nothing at all.

Sometimes, hinting at a Chapter 11 bankruptcy filing can be effective; it signals that a more formal, costly process is a real possibility and could incentivize them to settle. Above all, be proactive. Ignoring calls from creditors or vendors only makes things worse and could lead to lawsuits and liens on your assets.

When declaring bankruptcy makes sense

Companies use Chapter 11 as a reorganization tool, but small businesses can use it for liquidation. Filing for bankruptcy creates an automatic stay, immediately halting nearly all creditor collection efforts, including foreclosures and lawsuits.

Business owners can use a strategic Chapter 11 filing as a time-out from their creditors to get them to the negotiating table. Sometimes, a Chapter 7 liquidation is more appropriate to wipe out most unsecured debts. You may need to explore other options if you need to declare personal bankruptcy as well.

An important caveat: Bankruptcy doesn’t always discharge tax debts. You must coordinate with legal and tax counsel to make sure that if you file, you’re not blindsided by a tax debt, including trust fund taxes and the TFRP, that survives the bankruptcy.

Why professional help is non-negotiable

Attempting to navigate business tax problems on your own is a recipe for disaster. The tax codes are complex, negotiation tactics are nuanced, and the legal (and financial) risks are too high. One wrong move — like accidentally signing the wrong form — could jeopardize your personal assets.

A seasoned advisor, like a tax attorney, can coordinate the entire process by:

• Helping you organize and present your financial records.
• Liaising with the tax authorities.
• Negotiating with private creditors.
• Advising on whether bankruptcy is a necessary step.

If you need to dissolve a New York business with significant tax and creditor debt, contact Stephen Kass, a New York tax attorney with deep experience handling complex resolution strategies. He regularly works with companies facing sales tax and payroll tax issues, using negotiation and planning tools to reduce liability and minimize exposure.

Frequently Asked Questions

Can I settle NY sales tax debts if my business is closing?

Yes. You can pursue an offer in compromise (OIC) with the New York State Department of Taxation and Finance. You’ll have to show that your business is insolvent and/or that you, as a responsible person, have a limited (or nonexistent) way to pay the full debt.

What if I personally guaranteed business loans or vendor contracts?

When you personally guarantee a debt, you become personally liable if the business defaults on its obligations. Creditors can sue you directly to collect on those debts.

How does New York State determine who’s liable for unpaid business taxes?

NYS will audit the business and look for anyone who had the authority and responsibility to manage its finances, sign checks, or remit sales tax. It can hold multiple people “jointly and severally” liable, which means the agency can go after any of the responsible parties for the full amount.

Do I need to file for bankruptcy to negotiate tax or vendor debt?

Not necessarily. In many cases, a well-documented and professionally presented settlement proposal is enough to bring creditors to the table. However, the threat of bankruptcy can be a powerful negotiation tool.