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Legal Advisor: Seven Mistakes That Can Ruin Your Bottom Line
By Fred S. Steingold
You work hard to make your business profitable. Obviously, you don’t
want to expose your business to unnecessary risks or jeopardize your personal
assets. So let’s review seven mistakes that are all too common.
Mistake # 1: Mingling Business and Personal Funds
Some business owners keep a single bank account for their business
and personal funds. That can cause problems. Let’s say your business is
a corporation or an LLC. Having a single bank account is evidence
you’re not treating the business as a separate entity. A creditor may
be able to disregard the entity and get at your personal assets.
Even if your business is a sole proprietorship or a partnership, it makes good
sense to open a separate business account. If you don’t, you’ll
have trouble knowing exactly how well your business is doing. And mixing
business and personal funds can create a nightmare when you prepare tax returns.
Mistake # 2: Putting Personal Assets at Risk
Doing business as a corporation or LLC limits your personal liability
for business debts. In most cases, business creditors can’t seize your
home, car or personal investments if your business runs out of money. But if
you’re not careful, you may find that your personal assets are at risk
anyhow. The following actions can be costly:
Guaranteeing business debts and contracts: If your business borrows money, the
lender may want you to personally guarantee repayment. And if your business
leases space, the landlord may ask you to personally guarantee that rent will
be paid. Going along with such requests puts your personal assets at risk. As
the owner of a small business, you may have to comply. But see if the bank,
landlord or other creditor will agree to a cap on your personal liability.
Putting your house on the line: Some creditors will want to place a lien on
your house through a mortgage or deed of trust. Resist doing so. If your
business goes bad, you don’t want to sacrifice the roof over your head.
Having your spouse co-sign: In many states, a creditor who gets a judgment
against you can only go after your own personal assets—not the assets
(such as a house) that you own jointly with your spouse. Knowing this, a
creditor may want your spouse to join you in guaranteeing payment of a
business obligation. Avoid this if possible.
Mistake # 3: Extending Credit Too Freely
Uncollected debts can hurt your bottom line. To avoid losses, require
customers to pay cash or use a credit card. With a credit card, the bank takes
the hit if the customer doesn’t pay. If you do extend credit, have the
customer fill out a credit application. Then—especially for major
purchases—get a credit report. Refuse to lend credit to deadbeats and
slow payers.
Mistake # 4: Paying Your Rent Late
If you don’t pay your rent on time, the landlord may have
grounds to evict you. This can be very disruptive. You can lose the advantage
of a favorable lease or a top-notch location.
Here’s another reason to pay rent on time: Your lease may give you an
option to extend your lease. Typically, to exercise your option, you have to
be in good standing under your lease. Paying rent late can jeopardize your
right to use the option to extend your lease.
Mistake #5: Winging It at a Tax Audit
A small business is a prime target for an IRS audit. It pays to know
the ropes before an audit begins.
The IRS may conduct either an office audit or a field audit. In an office
audit, you’re asked to come to the IRS office. The audit lasts from two
to four hours. For a field audit, the field auditors (“revenue
agents”) will usually come to your place, though you might request that
the audit be held elsewhere. A field audit is more intensive than an office
audit.
The IRS auditor will want to look at your business records. Examples include
check registers, bank statements, canceled checks, receipts, invoices and your
accounting books. The auditor may also contact your tax preparer or bank for
still more information.
You may be able to handle a routine office audit yourself. Still, you may be
better off bringing in a tax professional—especially if your records are
less complete than you’d like. And if you’re subjected to a more
intensive field audit, where the stakes can be much higher, it’s always
a good idea to bring in a tax pro.
Well before the audit starts, make sure you can show how you came up with your
numbers. Focus on any problem areas. Dig out the records you need to back up
your tax return. Having your data neatly organized is helpful. The auditor
won’t do the sorting out for you.
Mistake # 6: Stalling on Employment Taxes
As you know, you have to withhold income tax from an
employee’s paycheck, as well as Social Security and Medicare taxes. You
then deposit these withheld amounts—plus the employer’s share of
Social Security and Medicare taxes—with an authorized financial
institution. Typically, this is a bank.
If your business is in a cash bind, you may think about putting off the
deposits. That can be dangerous. What if your business never recovers its
financial footing? You can be personally liable for the un-deposited amounts.
And you can be hit with big penalties as well. Always deposit employment taxes
before paying any other bills.
Mistake # 7: Skimping on Insurance
For almost every business, insurance is a necessary expense. You can
protect against many costly risks.
You’ll probably want to buy property insurance in case your building,
equipment and goods are damaged or destroyed by fire, flood or windstorm. And
you’ll also want to buy liability insurance in case a customer gets
hurt while visiting your business.
Many businesses will need also product liability insurance. Any business with
employees will need workers compensation insurance. Also look into business
interruption insurance. It pays for temporary quarters if a fire or other
disaster forces you out of your normal business place.
To save money, increase the deductibles, and look into insurance packages that
bundle several coverages. A package can be cheaper than individual policies.
Fred S. Steingold practices law in Ann Arbor, Michigan. He is the author
of Legal Guide for Starting and Running a Small Business and The
Employer's Legal Handbook published by Nolo.
Legal strategies may vary depending on the state in which you live and the
specifics of your situation. See your lawyer for legal advice.
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