These days, many businesses are wrestling with finances or even struggling to stay afloat. The recession has hit small and mid-sized business especially hard. Along the way, some owners have been surprised to learn that they’re personally liable for business debts. Their personal assets — home, car and savings — are at risk.
Other owners have planned ahead. If their businesses falter, their personal liability is limited. So how can you protect your own assets?
Form an LLC?
For starters, look at the structure of your business. Is it a sole proprietorship? If so, you’re personally responsible for all business debts, whether based on a contract or the result of someone being injured on your property or by a business vehicle.
The same is true if your business is a partnership. And here, each partner is personally liable for the business debts incurred by the other partners.
This is a good time to consider changing your business to a corporation or limited liability company, or LLC. Each of these formats will greatly limit your personal liability. Nowadays, most small businesses prefer to operate as an LLC. An LLC is easier to create, involves less paperwork, and gives you more flexibility. Your lawyer can help you decide whether a corporation or an LLC is best for you.
Even with a corporation or an LLC, you’re not completely free of personal liability. For example, you’ll be liable if you personally cause injury to someone or damage the person’s property. The same is true if you personally guarantee a bank loan given to the business.
You can, of course, buy insurance to cover injury or property damage claims. And you can do your best to avoid giving personal guarantees, though that’s tough to do if you need a bank loan. Banks fear that small businesses may run out of money.
Having a corporation or LLC won’t protect you if you’re careless in observing the distinction between yourself and your business. You can open the door to liability if you don’t use the correct business name. And you’re looking for trouble if you sign contracts for the business without stating that you’re acting as an officer or agent of the business.
You also stand to lose if you pledge your home or car as security for a business debt. If your business doesn’t pay the debt, the creditor may seize the property.
Assign priorities
If your business is running low on cash, you’ll need to decide which bills to pay first. Give your highest priority to payroll taxes — the sums you withhold from employee paychecks to cover income, and Social Security and Medicare taxes. Owners and officers of a business are personally liable for paying these taxes, called “trust fund” taxes.
Slip up, and you’ll owe a penalty equal to the unpaid trust taxes, plus interest. If you don’t pay the trust fund taxes, the IRS can seize not only your business’s equipment, but also your personal assets. In some cases, the IRS can even charge you with a crime for failing to deposit the payroll taxes.
Your next highest priority is to see that your employees get their paychecks on time. If you get behind by even a few weeks, state law may give the government the right to close your business. There can be hefty penalties as well, for which you’ll be personally liable if you’re a sole proprietor or a partner.
Don’t hide anything
No matter how tough things get, don’t try to hide your business or personal assets. For example, don’t transfer them to friends or relatives. Doing so can sometimes lead to fraud charges, both civil and criminal.
And never, never lie on loan applications. If your financial troubles are deep, you may be tempted to conceal the financial condition of your business. This would be a huge mistake. Again, you would open yourself to fraud charges. And if you seek to have the debt canceled through a bankruptcy action, that won’t happen. So tell it like it is.
To learn more about avoiding personal liability for business debts, read the new book, Save Your Small Business: 10 Crucial Strategies to Survive Hard Times, published by Nolo. Authors Ralph Warner and Bethany Laurence cover this and many other timely topics that can help a struggling business.
