In our last blog post, we began discussing some of the factors that business owners must consider and investigate when deciding whether or not to personally guarantee a business’ financing. We mentioned the importance of determining one’s personal liabilities with regard to repayment if a business falls on hard times and defaults on a loan. We also discussed how one’s personal credit score can take a hit if a business fails to make credit card payments.
Business owners who qualify and are attempting to avoid double taxation, may choose to register a business as an S corporation. In addition to the tax-benefits involved with this type of designation, a business owner also enjoys certain protections with regard to financial liability.
While S corporation owners can “deduct their share of business losses that are passed through to them,” the amount that can be deducted is limited to their financial investment in a company related to “stock and debt.” If a business owner provides a financial guarantee to a business, he or she is allowed to deduct losses on a personal tax return. It’s important to note, however, that the amount which can be deducted is determined by one’s basis or the amount of stock and debt he or she has invested in a company. Therefore, to take full advantage of tax deductions related to debts paid on behalf of a business, an individual must have a sufficient basis within the company.
Prior to making any personal financial guarantees, it’s also important to investigate if and how an individual can be released from default repayment obligations. In many cases, this simply isn’t possible and a personal guarantee stands even when an individual sells his or her stake in a company. There are, however, times when one can be released from this and other related financial obligations.
As any business owner knows, there is always a certain amount of risk involved when it comes to securing business financing and growing a business. For those who are considering personally guaranteeing a business’ financing, prior to doing so, it’s wise to consult with an attorney and gain a clear understanding of one’s full obligations.
Source: SBA.gov, “5 Things to Know About Guaranteeing Your Company’s Debt,” Barbara Weltman, Jan. 15, 2015