What Happens If a Business Doesn’t Pay Taxes?

When a business fails to meet its tax obligations, the Internal Revenue Service (IRS) initiates a structured and escalating series of enforcement actions to collect the overdue funds. This process begins with financial repercussions that grow over time and can advance to more severe measures affecting a company’s assets, credit, and daily operations.

Initial Penalties and Interest

The first consequence of not paying business taxes is the automatic assessment of financial penalties and interest. The Failure to Pay penalty is 0.5% of the unpaid taxes for each month or part of a month the taxes remain unpaid. This penalty begins accruing the day after taxes are due and can accumulate to a maximum of 25% of the tax liability. The rate can be reduced to 0.25% per month if the business enters an approved IRS installment agreement.

If a business also fails to file its tax return on time, a separate Failure to File penalty applies. This penalty is 5% of the unpaid taxes for each month a return is late, also capped at 25%. When both penalties apply in the same month, the Failure to File portion is reduced by the Failure to Pay amount. After five months, the Failure to File penalty maxes out, but the Failure to Pay penalty continues until it reaches its own 25% cap.

In addition to these penalties, the IRS charges interest on the underpayment. This interest applies to the unpaid tax amount and the accruing penalties. The rate is determined quarterly and is calculated as the federal short-term rate plus three percentage points. This interest compounds daily, causing the total debt to grow at an accelerating pace.

For example, a business with a $20,000 unpaid tax liability would see its debt increase quickly. A Failure to Pay penalty would add $100 per month. If the return was also unfiled, the penalty for the first month would be $1,000. With daily compounding interest applied to both the tax and the penalties, the total amount owed can become substantially larger than the original tax debt.

The IRS Collection Process

Following the assessment of penalties, the IRS begins a formal collection process using a series of written communications. A business will first receive a notice, such as a CP14, which states the amount of tax owed, includes any penalties and interest, and demands payment. This initial letter is a bill, not yet a threat of enforcement.

If the business does not respond to the first notice, the IRS sends a sequence of increasingly urgent letters. These follow-up notices, such as the CP501 and CP503, serve as reminders of the outstanding liability and the continuing accrual of penalties and interest. Each letter provides a deadline for payment and information on how to resolve the debt.

The communication culminates in a final notice before the IRS escalates its actions. This letter, often a CP504, is a formal Notice of Intent to Levy. It warns the business that if the tax debt is not paid promptly, the IRS has the legal authority to seize assets. This notice marks the end of the preliminary warning stage.

Federal Tax Liens

If a business ignores the notices and demands for payment, the IRS may file a Notice of Federal Tax Lien. A lien is a legal claim against all of a business’s current and future property to secure the government’s interest in a tax debt. This includes physical property like real estate and equipment, as well as financial assets such as accounts receivable.

Filing a Notice of Federal Tax Lien makes the claim a public record, which alerts other creditors that the government has a primary claim to the company’s assets. This can damage the business’s credit rating, making it difficult to obtain loans or secure a new line of credit. The public nature of the lien can also harm the business’s reputation with customers and partners.

A lien encumbers business assets, complicating any attempt to sell or transfer property, as the tax debt must be satisfied before it can be sold with a clear title. It is a distinct action from a levy, which is the forceful seizure of property.

IRS Levies and Asset Seizure

After a final notice has been sent, the IRS can proceed with a levy, which is the actual seizure of property to satisfy an unpaid tax debt. Unlike a lien, which is a claim, a levy is the forceful taking of assets. The IRS has broad authority to levy different types of business property.

One of the most common forms of a levy is on a business’s bank account. The financial institution is required to freeze all funds up to the amount of the tax debt for 21 days. This period allows the business owner time to negotiate a resolution with the IRS. If no arrangement is made, the bank must forward the funds to the government.

Another levy is on accounts receivable. In this scenario, the IRS notifies a business’s customers that they must send payments owed to the business directly to the IRS instead. This action diverts the company’s incoming cash flow to the government until the tax liability is paid in full.

The IRS can also seize and sell physical business assets, including inventory, company vehicles, machinery, and commercial real estate. The process involves the physical seizure of the property, followed by a public auction. The cash from the sale is then applied toward the tax debt.

Personal Liability and Criminal Investigations

In certain situations, the consequences of unpaid business taxes can extend beyond the business entity and attach to individuals. This is most common with unpaid payroll taxes, which include federal income, Social Security, and Medicare taxes withheld from employee wages. These funds are held in trust for the government, and failure to remit them can trigger the Trust Fund Recovery Penalty (TFRP).

The TFRP allows the IRS to hold individuals deemed “responsible persons” personally liable for the unpaid trust fund taxes. A responsible person is not limited to the business owner; it can be an officer, director, or employee with the authority to decide which bills are paid. If a person had the power to direct funds to the IRS and willfully failed to do so, they can be assessed the TFRP, making their personal assets vulnerable to collection.

Beyond civil penalties, the IRS can pursue criminal investigations in cases involving willful tax evasion. This is reserved for cases where there is evidence of a deliberate attempt to defraud the government, such as hiding income or keeping fraudulent records. A criminal conviction can result in substantial fines, with penalties up to $500,000 for a corporation, and potential imprisonment for the individuals involved. The primary element in a criminal case is proving willfulness.