One of the less savory aspects of running a small business is interacting with creditors, especially if you or someone you employ defaults on a debt. Wage garnishment is a subject no one wants to deal with, but failing to understand how your — or your employees’ — debts affect your small business can cost you thousands of dollars. The garnishment process is difficult to understand and can differ depending on the state (causing confusion that creditors can exploit to their advantage), but avoiding these common mistakes can help keep your small business from being torn apart by delinquent debt.
Being on the hook for an employee
A creditor can sue a business for an employee’s defaulted loan if the employer fails to comply with an order to garnish the employee’s wages properly. When a court orders a business to withhold a portion of an employee’s wages, the business becomes liable [PDF] for the debt as well as the employee. If the business doesn’t garnish the correct amount of an employee’s wages, a creditor can sue the business for the amount that was supposed to be garnished, as well as attorney fees and punitive damages.
Sole proprietors are particularly vulnerable. You are most likely a sole proprietor if you are the sole owner of a business and haven’t filed any paperwork with a state in order to operate. As a sole proprietor, you aren’t legally required to have a registered agent, an individual or company that receives the paperwork when a business is a party in a legal action including garnishment matters. Without the expertise of a registered agent, though, a sole proprietor doesn’t have much protection against lawsuits involving garnishment. Horror stories abound — one former consultant found himself owing a creditor more than $10,000 for a former employee and a Texas florist [PDF] had to pay a student loan creditor over $6,500 in uncollected garnishments for a delinquent employee.
As a sole proprietor, courts don’t differentiate between your business and personal assets, meaning creditors can come after your house or vehicle, for example. To avoid being liable, consider restructuring as an LLC or S Corporation. Although it doesn’t provide as much liability protection as incorporating, you can also opt to hire a registered agent as a sole proprietor.
Thinking you’re safe as a contractor
Although your wages can’t be garnished if you are an independent contractor (such as a freelance writer or self-employed plumber) since you don’t earn traditional wages, creditors can still come after your earnings. While creditors can only garnish a percentage of wages, they can come after larger swaths of assets at once if you are a contract worker. Rules change [PDF] for such “non-employees,” and it can mean creditors can go into your bank account to collect a defaulted debt you owe. A judge can rule that a creditor can levy a personal or business bank account; both can be at risk if your business is a sole proprietorship. Even if it leaves your account balance at zero, banks usually have to hand over up to 100 percent of your debt. If a creditor claims you owe $4,000 and you have $2,000 in an account, for instance, the court would order your bank to pay the creditor the entire $2,000. You may be eligible for some exemptions–federal law says creditors can’t take social security income and certain states have limits to what creditors can take from personal bank accounts (in Wisconsin, for example, the first $5,000 of a debtor’s depository accounts are protected).
If you find yourself in this situation, the worst tactic is to ignore the creditors and court orders. Although it might be a blow to your pride, declaring bankruptcy can stop a lawsuit from a creditor and prevent them from wiping your accounts clean — but you have to act before the lawsuit is decided.
Failing to respond correctly
The laws surrounding wage garnishment are undeniably byzantine. It can also be easy to ignore mail from creditors regarding former employees — a novice receptionist might even file such notices in the trash. While receiving a writ regarding an employee’s wage garnishment can be confusing and intimidating, failing to respond promptly and appropriately could mean your business is liable for the defaulted debt.
The garnishment notice is a court order, after all. The orders often demand an accurate and complete response from an employer within two weeks. If your business fails to do this, you might find yourself in court or worse — a judge could rule your business liable for the entire debt in question.
Firing an employee with debt
Because employers are responsible for calculating garnishment amounts on an employee’s paycheck, the whole process can make payroll accounting a pain. Therefore, it might be tempting just to fire the employee. But dismissing an employee just for having garnished wages is against federal law, and some states offer even more protection for employees. (If an employee has two or more different creditors attempting to garnish wages, though, an employer can legally discharge him or her, according to United States government.) Penalties for breaking these laws can range from reinstating the fired employee to jail time for the business owner.