Two Pitfalls for Small Businesses: Attorneys and the IRS

by Lance Stodghill & Courtney Cox 

Lance Stodghill (pictured left) is a partner at Stodghill & Allie, LLP– a tax controversy law firm located in Houston, Texas. Courtney Cox (pictured center) is an associate attorney at Stodghill & Allie.

Nobody likes lawyers – until they need one. Nobody likes to get a letter from the IRS – but how can you avoid them? Dealing with these two are typically inevitable for a startup or working business. Business owners need to understand how to deal with both to succeed and grow.  

Finding the Right Attorney 

Choosing the right attorney, in the right field, and at the right price can have a large impact on the overall cost and effectiveness of the representation.  

Simply starting the search for an attorney can be the most daunting task. Reaching out to professionals, family members and friends for a good referral is a good starting point. Still stuck after asking around? Many local and state Bar Associations have referral services that can direct you to an attorney. See www.texasbar.com/lris/ for the State Bar of Texas Lawyer Referral and Information Service and HLRS.org for the Houston Bar referral service.  

When looking for an attorney it is important to keep in mind the level of complexity of your issue and your budget for attorney’s fees.  

The legal field is comparable to the medical field in that there are general practitioners and specialists. If you have a routine issue – such as a contract review – a smaller firm or a solo practitioner will usually be more cost effective. If you have a more specific issue they are not familiar with, your fees may become higher as they learn on the go or they may refer you out to an attorney specialized in that area.  

Lawyers in cities tend to specialize in one area of the law, such as family law or corporate work. They will often have knowledge of areas frequently encountered in their specialties. For example, a family lawyer may also frequently litigate cases. In smaller markets where there are comparatively fewer lawyers, there may be more general practitioners who practice in several areas.   

Specialized or “boutique” law firms often focus on only one or two practice areas, such as tax controversy, estate planning or business transactions. If your issue is complex or involves a specific area of law, a specialist is likely the best choice. Continuing the medical analogy, if a tooth hurts you should see your dentist, not your foot doctor. 

Larger firms will often have lawyers practicing in many areas of the law. These firms may be better for large matters that involve several areas of the law or that may require several attorneys. For example, a large litigation case may almost certainly need more than one person to review documents, handle the paperwork and go to trial. The fee structures at these firms are typically higher, but also take into consideration the blended rate. Often, the work on a case will be handled by several attorneys who bill at different rates.  

Hiring the Right Attorney  

After finding an attorney, you need to consider fee options and execute an engagement agreement. Many attorneys bill on a fixed hourly rate. Many attorneys will request an upfront fee or retainer with this billing option. Be sure to review your attorney’s bill and ask questions if you have concerns about the amount of time being charged. 

Some attorneys request a fixed fee for a project, which has the benefit of predictability but could end up costing you more than an hourly billing rate. Some attorneys use a contingent fee structure where they get a percentage of any recovery, but this structure is not ideal for most routine business issues.  

Whatever fee structure you ultimately choose, make sure it is outlined in an engagement letter. The engagement letter should spell out how you will be billed and how often you will be billed. A monthly billing system is beneficial to keep track of the work performed on your case. Don’t assume the attorney will handle every legal issue you have, but instead detail the scope of work the attorney will handle in the engagement letter.  

Trust your gut. Do not choose an attorney based on fear, and don’t let time constraints rush you into hiring an attorney who is not the right fit for you. Don’t be afraid to have a call with a couple of attorneys to gauge their experience and to see if they are a good fit for your needs.  

Avoiding Issues with the IRS 

The best course of action to avoid problems with the IRS is to stay in compliance by making timely tax deposits and timely filing returns. The IRS is one of the few creditors who can pursue criminal action and can foreclose on your personal residence for business debts – though this typically only happens in extreme cases. This highlights why it is so important to stay on top of your financial responsibilities. 

One of the most common tax problems businesses encounter involves employment taxes. When a business pays an employee, it withholds the employee’s income taxes as well as Social Security and Medicare taxes. The employer must then send these funds to the IRS. If it does not, the persons at the company responsible for the accounting and payment can then be held personally liable for these amounts. The IRS will assume the owners of the company are responsible. This means the corporation or LLC structure will not protect the business owner’s personal assets.  

Problems with employment taxes often arise from problems with recordkeeping or cash flow. Having a payroll service and a bookkeeper might seem expensive, but could save you more in the long run if it prevents you from racking up substantial penalties with the IRS. Businesses with cash flow issues will often find that the quickest source of cash is to simply not remit the employment taxes to the government and hope to catch up in a few weeks. This course of action should be avoided at all costs.  

The IRS imposes the following penalties for failing to timely comply with employment tax obligations. Failing to timely make a deposit will incur a penalty of 2% if it is one day late, 5% if it is over 5 days late, and 10% if it is over 15 days late. Once the IRS sends a bill, the penalty can increase to 15%. Penalties for filing a return after the due date are 5% per month to a maximum of 25%. Penalties for failing to pay the tax due on a return are 0.5% per month to a maximum of 25%. These penalties accrue with interest and can substantially increase your business’s total liability to the IRS. While it may seem like an easy fix to a cash flow issue, this can be one of the most expensive forms of borrowing once penalties are calculated – significantly more than bank financing or a credit card. Penalties are not deductible as a business expense. 

The employee withholding and the employee portion of the Social Security and Medicare tax is called the trust fund portion of your business’s employment taxes. Once the IRS determines you are personally liable as a responsible person, the IRS can place liens on your assets and attempt to satisfy the trust fund liability by levying personal bank accounts and seizing other assets. 

Issues with the IRS can quickly spiral out of control, and correcting the problem is costly. Financial discipline is key in running and maintaining a successful business. Avoiding excessive costs when hiring an attorney or dealing with IRS issues can have a huge impact on your future success.  

This article is for informational purposes only. Please consult your tax professional for specific advice.  

Lance is a former senior attorney with the IRS Office of Chief Counsel. He has represented business owners and individuals in tax matters since 2007 and serves as outside general counsel for several clients. Lance is an assistant Scoutmaster who is usually training for some foolhardy escapade.  

Courtney’s practice focuses on assisting small business owners in IRS audit and collection matters. She is an active member of the super-secret Girl Attorney – Texas Facebook group. Don’t ask – she won’t tell. And yes, she knows about that actress with the same name.  

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