The following is a list of seven hot tips of things you should or should not do to protect your personal assets from your business debts.
1. CREATE A CORPORATION OR LIMITED LIABILITY COMPANY.
By incorporating or forming a limited liability company, you create a separate legal entity that performs the business. If you properly act as a corporation and do not do some of the things discussed below, the corporation forms a shield to protect your personal assets. However, if you fail to act like a corporation, a creditor could “pierce” the corporate veil and you could expose your personal assets to claims by creditors of your business.
2. NOT USING YOUR CORPORATE DESIGNATION ON YOUR PAPERWORK.
Too often we see clients that have gone through the effort and expense of incorporating in order to protect their assets but, do not act like a corporation. Specifically, if your company is ABC, Inc., the Inc. must appear on all of your documents. Additionally, when you sign a document, you must sign it in your capacity as an officer of the corporation, such as, ”By: Joe Smith, President” and not just sign it as Joe Smith. If you sign just in your individual name, without the name of the corporation as well as your title with the company next to your name and appearing as part of the “signature block”, you may have just exposed yourself to personal liability. If you sign a contract to purchase $100,000 worth of supplies for the company without the proper corporate designation, you may be personally on the hook should the business go under and not be able to pay this bill.
3. COMINGLING OF BUSINESS AND PERSONAL FUNDS.
Often we see first time business owners not treat their business bank account as a separate and distinct bank account but, rather, use it not only to pay their business bills, but personal bills. You must remember that your business account is not your own private slush fund and if you fail to make a distinction between your business and personal accounts, it could form a legal basis for someone to pierce your corporate identity, and say that you do not hold yourself or act like a corporation to try to impose personal liability upon you.
4. NOT PAYING PAYROLL TAXES OR SALES TAXES.
Many business owners fail to realize that when you withhold taxes from employees’ paychecks, you are holding the funds as a trustee for the government. You are required to turn those funds over to the IRS. Those funds are your employees’ money, not yours. By failing to turn those funds over to the IRS within the timeframes required by law could not only expose you to civil liability but, also, possible criminal liability. Therefore, it is imperative that you pay all required tax withholding funds, as well as sales taxes to the state, in a timely fashion. You MAY NOT use the funds you are holding as your own private line of credit.
5. LEASING OF EQUIPMENT.
Just about every business owner leases some equipment. Whether it is a copier or, more sophisticated equipment for medical office, most businesses would not be able to start up without the ability to lease. However, what most individuals also do not realize is that in the fine print, they are personally guarantying the lease.
What this means is that if you are leasing the equipment for five years and the business goes under after two years, you are personally responsible for the balance of those lease payments. While you may not be able to avoid a personal guaranty, it is important that you be aware of the fine print in your lease contract if you need to negotiate the surrender of the equipment. Generally, leased equipment depreciates in value much quicker than the remaining balance due on the lease. Therefore, upon the surrender of the equipment, there can be a big deficiency owed to the leasing company. Your personal guaranty puts you on the hook for the balance owed if the company cannot satisfy the claim.
6. TAKING OUT A SECOND MORTGAGE ON YOUR HOMESTEAD.
In certain states, such as Florida, your home is protected from creditors of your business. Even if you personally guaranteed a debt, those business creditors cannot touch your homestead.
However, too often we see individuals who have taken out a second mortgage to pay off debts of the business. They have, therefore, converted an unsecured debt to a secured debt. For example, if you owed $100,000 to a supplier and took out a second mortgage to cover that invoice, the supplier is now paid and you gave a lender a secured debt against your home that could be foreclosed upon which can result in you losing your home. One of the exceptions to the homestead protections is a mortgage on your home. Had you not paid the supplier or worked out a payment arrangement with the supplier, you would not have exposed yourself to losing your home. Therefore, you should never use your homestead property as collateral for your business unless you are 100% certain you can pay off that mortgage loan.
7. TAKING MONEY OUT OF YOUR 401-K.
As with your homestead, your 401-K account is also protected from creditors under Florida law. Therefore, if you take money out of your 401-K, in addition to the penalties and taxes you will have to pay if it is an early withdrawal of the funds, you have also taken an asset which is protected from your creditors and used that to possibly pay off an unsecured debt. Your 401-K fund should be protected at all costs and should only be touched for food, medicine or shelter.
By following these seven tips, you will be able to avoid exposing your personal assets to business creditors. Before making any major decisions concerning financing, leasing or making major purchases, you should always consult with professionals.