The easiest to overlook issues sometimes cause the biggest headaches. If any of the following scenarios seem familiar to you and your business, you should consider speaking with an attorney to address the issue sooner rather than later.
Scenario 1: “Last year I invested all the money we made back into the business, so I didn’t have any personal income. Well, except for the money I spent on food and personal emergencies.”
Issue: Personal Tax Liability
Explanation: The passion and commitment that drives entrepreneurs is critical to building a business. Many entrepreneurs get so wrapped up in growing their business that they sometimes overlook simple things. In this scenario, even though the business owner did not take a regular salary, the money she used to pay for personal expenses like food or emergencies counts is considered personal income.
If you carry on a trade or business as a sole proprietor, an independent contractor, a partner in a partnership, or are otherwise in business for yourself, you must pay self-employment tax. Self-employment tax is a Social Security and Medicare tax primarily for individuals who work for themselves. If you are employed by another company, this tax is normally taken out of your paycheck and paid by the company (along with the company’s portion). Self-employment tax is reported on Schedule SE (Form 1040) or Schedule K-1 (Form 1065).
In this scenario, the issue is that the business owner likely did not pay self-employment taxes on the money used to pay for food or other personal expenses because they did not realize it was personal income. This likely means they have some tax liability with the IRS and/or the Iowa Department of Revenue.
As a side note, even if this business owner is re-investing money in the business, she will still need to pay tax on it in some way. The entity the business owner has will determine how the tax will be paid on money that stays in the business.
This business owner should reach out to an attorney and an accountant to deal with any overlooked tax liabilities. We see a lot of clients after receiving notice from the IRS or the Iowa Department of Revenue for failure to report or pay taxes. You must take taxes seriously. Tax collectors will impose heavy fines if you do not follow the law. These fines will not go away in bankruptcy or if you have an LLC entity.
Scenario 2: “I let my business insurance lapse for a few months last year, but nothing bad happened so it’s no big deal.”
Issue: Future Claims Liability
Explanation: Many business owners forget that customers or employees with claims against the business may not report these issues until much later. In fact, sometimes issues with a product or service are not known until much later (think of faulty plumbing or construction, for example). When a claim comes up for a product or service provided years ago, you will want to draw on the insurance policy that was in place at that time to help defend against the claim and cover any liability. If you let your policy lapse or failed to have adequate coverage at the time the issue occurred, it is unlikely that the insurance company is going to pay for the claim. While this business owner might be in the clear right now, issues with work provided often are raised far beyond the timeframe when the work was done. For this reason, it is often a good idea to hang on to receipts of premium payments and copies of insurance policies for a few years after they were in place.
Additionally, failing to make a premium payment or to have adequate coverage could raise your rates with the insurance company or make them unlikely to underwrite a policy for you in the future.
This business owner should reinstate the insurance policy as soon as possible in order to protect themselves.
Scenario 3: “We have policies in place for how to handle that sort of issue, but we don’t really follow them.”
Issue: Future Claims Liability and Defeating the Purpose of the Policy
Explanation: The best thing you can do to protect your business (other than getting insurance) is to identify risk and hazards the business faces and come up with policies and procedures to mitigate them. For example, if you are concerned about employees stealing from your cash-only business, you should develop policies for cash handling, internal auditing, and whistleblowing procedures for employees to report concerns about misconduct. If you have a cash handling policy in place, but you do not enforce it, the policy becomes pointless. More than that, if your employees see that you do not enforce the policy, they may assume you do not enforce other policies, either. This can open your business up to additional liability if someone is hurt from an activity that you knew posed a risk, but you failed to address in a meaningful way by not enforcing the policy.
One example of this is in sexual harassment policies for employees. If you have policies and procedures in place to identify and remedy concerns about sexual harassment in your business but you fail to follow them, this may be worse than not having a policy to begin with! It shows that you knew there was a potential risk, but you failed to do anything about it.
The best thing you can do is get some policies in place, follow them, and train (and retrain) on them. The worst thing you can do is get some policies and then forget about them.
Iowa Legal Aid provides help to low-income Iowans.
To apply for help from Iowa Legal Aid:
- Call 800-532-1275.
- Iowans age 60 and over, call 800-992-8161.
- Apply online at iowalegalaid.org
If Iowa Legal Aid cannot help, look for an attorney on “Find A Lawyer” on the Iowa State Bar Association website iowabar.org. A private attorney there can talk with you for a fee of $25 for 30 minutes of legal advice.
As you read this information, remember this article is not a substitute for legal advice.