Category: Funding

Smartco Corp is a 2-year old startup that recently started selling product to a few large customers. They have 30 employees and a $250K monthly payroll.

Recently, Smartco ran into a serious cash flow problem due to a late-paying customer.

Most startups will experience cash flow problems. They often rear their ugly head when the business just becomes cash flow positive and is no longer living off investor life support money. For many companies, especially if the investors and owners are tapped out after a long development stage, it can be the final straw.

Smartco was exactly at that juncture. Many years and millions of dollars to develop the product had finally come to an end. They had real customers and a working product. Cash flow was tight, but improving when a major customer went south on a large receivable that jeopardized Smartco’s future existence.

Like many tech startups, most of Smartco’s expenses were payroll. They did not want to lay off employees, though, but needed a temporary 20% reduction in payroll cost to survive.

Luckily, Smartco was located in a state (such as MA and about 25 other states) that have a Work Share program. These programs let a business reduce the hours of certain or all workers and allow the employee to collect Unemployment Compensation from the state for the hours cut.

So, Smartco temporarily reduced everyone’s pay to 4 days. They remained open 5 days, as they are able to dictate what day each employee can take off. Some of the hourly and lower paid employees actually received most or their entire regular payroll, as overtime plays into the benefit calculation. All of Smartco’s employees, though, were happy to collect for the other day and spend it skiing or at the beach.

The details of these Work Share programs vary by state, but can be incredibly valuable in retaining employees while going through cash flow problems. Recently, Congress passed a bill that federally funded these programs, so most states currently without a Work Share program will probably implement one soon.
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IRS Circular 230 Disclosure
To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.

Now, why is financing operations, when there is a cash flow problem, by not paying the IRS “the dumbest and most dangerous startup financing”?  Big companies often string out vendors to fund operations.  Plus, in a worst-case scenario, bankruptcy dissolves all debts and the corporate veil personally protects employees – right?  No one going to jail here – right?

Wrong and wrong.  Corporate bankruptcy will not discharge this type of IRS tax debt. Even personal bankruptcy will not discharge this type of IRS tax debt.  The IRS will chase you forever.  Plus, the corporate veil is pierced very easily by not paying the IRS.

For trust fund taxes (i.e., withheld payroll taxes), the IRS holds every “responsible person” personally and criminally liable for “willfully” failing to ensure that payroll taxes are paid.  They move very quickly when a quarterly payroll tax return is not filed or there is a payroll tax deficiency. They can demand full payment from any “responsible person” without first trying to collect the payment from the employer or other “responsible persons”.

Oh by the way, a “responsible person” is broadly defined as anyone with substantial authority over business operations even if somebody else has the ultimate authority over which bills get paid.  The IRS has successfully prosecuted CEOs to AP clerks under this “responsible person” definition.

The penalty becomes criminal when a “responsible person” intentionally violates a legal duty – knowingly not remitting withheld payroll taxes.

So, any “responsible person” at Dumbo who knew the IRS was not being paid while vendors, such as the landlord or electric company were being paid is personally and criminally liable.

The IRS process always starts with a notice.  If you receive one regarding payroll taxes – do not take it lightly, even if you never had a payroll.  Get professional help (preferably a CPA) to respond to the notice immediately.  The IRS acts very quickly, including personal visits to the business and bank account liens.

(One fool-proof way to avoid this temptation and a good business practice is never to do your own payroll.  Use a payroll service provider, such as Zen Payroll).

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IRS Circular 230 Disclosure

To ensure compliance with requirements imposed by the IRS, we inform you that any U.S. federal tax advice contained in this document is not intended or written to be used, and cannot be used, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing, or recommending to another party any transaction or matter that is contained in this document.