Back taxes are taxes that taxpayers owe government authorities for a prior year. Back taxes accrue interest, penalties, and legal consequences until resolved.

An individual or business accumulates back taxes when they fail to fulfill their tax obligations for a specific tax year, such as not filing a tax return, underreporting income, or not paying the total taxes they owe.

Back taxes can occur at federal, state, and local levels. Regulations for back taxes vary worldwide, but the following guide discusses back taxes in the U.S.

Common reasons why businesses may owe back taxes

A business may owe back taxes for many reasons, such as financial difficulties, misunderstanding tax regulations, or intentional tax evasion. Some common reasons for employers owing back pay include the following:

  • Payroll calculation errors. An employer might miscalculate the employee’s pay rate or fail to pay overtime, impacting the amount of tax withholdings.
  • Tax calculation errors. A business may owe back taxes due to not paying the correct tax amount owed on an employee’s behalf. 
  • Tax return errors. An employer might neglect to file a tax return for a particular year or make any payments.
  • Worker misclassification. An employer incorrectly classifies an employee as an independent contractor, denying the employee their employment entitlements, including benefits and tax withholding.
  • Compliance issues. An employer fails to comply with local labor laws and tax regulations when hiring international talent in foreign countries. 
  • Permanent establishment. If a business triggers permanent establishment in another country, it is susceptible to corporate taxes in the foreign countries in which it operates and generates revenue.

Read more: Complete Guide to Employee Misclassification

What are the business consequences of back taxes?

If a U.S. business neglects to file a tax return, they are subject to penalties and interest in the unpaid taxes. These consequences of back taxes include the following:

  • Interest. The taxpayer may owe the Internal Revenue Service (IRS) interest on the unpaid or late taxes, which accrue over time and make the total amount owed significantly higher. The penalty for late tax payments ranges from 0.5% to 25% of the unpaid taxes per month.
  • Tax liens. The IRS may place a federal tax lien to seize the taxpayer’s assets and property.
  • Withheld tax refund. The government may withhold any tax refund until the business pays the back taxes with interest. 
  • Imprisonment. Failure to pay taxes may also result in imprisonment, depending on the severity of the circumstance. Purposely ignoring notices from the IRS or evading tax responsibilities can lead to arrest. 

What are tax liens?

A tax lien is a legal claim by a government entity to seize the taxpayer’s assets and property to pay the tax debt. Tax authorities may place a lien on the taxpayer's property or assets or initiate a levy to seize assets to collect the outstanding tax debt.

In severe cases, tax liens are the last resort to force a business to pay back taxes. The lien ensures that the tax authority has first to claim over other creditors vying for the business’ property or assets. A tax lien also prevents the taxpayer from selling or refinancing the assets until the company pays off the tax debt. 

How to file back tax returns

Resolving back taxes is crucial for a business to avoid further penalties, interest, and legal consequences. While back taxes have severe consequences, companies have several options to address their situation.

The following steps will help a business file back tax returns:

  • Hire a tax professional. A tax expert can review past tax documents and help the business determine why there are back taxes and how to pay them back.  
  • Pay back taxes. Taxpayers should file their return or pay the back taxes promptly to help eliminate or reduce additional back taxes.
  • Set up a payment plan. Taxpayers who cannot pay back taxes immediately in full can apply for a short-term or long-term payment plan with the IRS
  • Negotiate payment. If a taxpayer can't pay their total tax liability due to unique circumstances, they may be eligible for an offer in compromise that lets them settle their tax debt for less than the total amount they owe. 
  • Penalty relief. Taxpayers may qualify for penalty relief if they tried to comply with tax laws but could not do so due to circumstances beyond their control.

Businesses facing back tax issues should communicate with tax authorities, explore available resolution options, and seek professional guidance from a tax professional to address their specific situation.

How businesses can avoid back taxes

Taking a proactive approach to tax planning is crucial for any business to maintain compliance and financial stability. Companies can reduce the risk of back taxes and the resulting consequences by adopting the following key practices:

  • Keep accurate records. Maintain detailed records of all financial transactions. Well-maintained income, expenses, and deductions records will help ensure you provide the necessary documentation during tax filing.
  • Reconcile financial statements. Regularly reconcile bank statements, income statements, and balance sheets to identify any errors or discrepancies before tax season.
  • File on time. File all required tax returns accurately and on time to avoid penalties associated with late submissions. Request extensions if necessary and communicate with tax authorities. 
  • Understand tax laws. Stay informed about relevant tax laws and regulations that apply to your business to ensure compliance and utilize the available deductions and credits.
  • Work with tax professionals. Consider engaging with an accountant or tax advisor to ensure you understand your business’ tax obligations and compliance.
  • Utilize technology. Use accounting software and other technology tools to help streamline your financial record-keeping, reduce errors, and facilitate accurate tax preparation.
  • Monitor changes. Changes to the business structure may have tax implications, so you must keep track of any changes to your business operations, workforce, or location and adjust your tax strategy accordingly.
  • Review tax returns. Regularly review your previously filed tax returns to ensure accuracy and promptly address any identified errors by filing amended returns. 
  • Seek professional advice. Work with tax professionals to help guide you through the tax implications for complex transactions, mergers, acquisitions, or other significant financial changes. A global payroll partner can help you avoid payroll and tax errors when paying your distributed workforce.

Disclaimer: The intent of this document is solely to provide general and preliminary information for private use. Do not rely on it as an alternative to legal, financial, taxation, or accountancy advice from an appropriately qualified professional. © 2024 Velocity Global, LLC. All rights reserved.

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