Prioritizing Which Business Debts to Pay

Ignoring any business debt comes with consequences, but not paying some types of debt has worse consequences than not paying others. Paying certain bills and debts is vital to protecting your business -- and your personal assets. When your cash flow is tight and you have to delay paying some bills, here's what to pay first. You'll see some personal obligations on this list, such as child support and your mortgage, so you can see where they fall in order of payment priority.

Payroll Taxes

If you have employees and you withhold taxes from their paychecks, get those withheld amounts to the government on time, every time. It may be tempting to borrow from these funds, because after you collect the taxes, you usually have a few weeks before you must deposit them. Don't ever do it, no matter how behind you are on your bills or how angry your suppliers, landlord, or other creditors are getting. Here's why.

As an employer, you withhold money from your employees' pay to pay payroll taxes (Social Security and Medicare) and your employees' income tax withholding. If you don't pay withheld Social Security and Medicare taxes and federal income withholding taxes (called the "trust fund" portion of these taxes), you will owe a penalty equal to the entire amount of the unpaid trust fund taxes, plus interest. Some states impose similar penalties for failing to deposit state income tax withholding and sales taxes that you have collected.

The trust fund penalty can be imposed on any and every person who fails to see that the taxes are paid, including all owners and officers of the company, whether or not they normally pay the bills or monitor finances. Even directors and minority shareholders can be held personally liable if they were responsible or partially responsible for deciding to pay other pressing bills in lieu of the trust fund taxes. Even if your company is a corporation or LLC, you and your co-owners can be held personally liable for the trust fund taxes and the resulting penalty.

And that's not the worst part. To pay these trust fund taxes and the resulting penalty and interest, the feds can seize business equipment, money your creditors owe to you, and any property you own personally. The IRS can also garnish your wages (if you receive a paycheck) or pension plan payments and seize the assets in your individual retirement accounts (IRAs). Filing for bankruptcy will not protect you. Finally, the IRS can charge you with a crime for failing to deposit your payroll taxes. If your business is in such poor financial condition that you can't pay your payroll taxes, you might want to ask yoursef if it's time to close down. (See Nolo's checkup on when it's time to close your business.)

Payroll

Make sure you continue to pay your employees' wages on time. There are hefty state law penalties for not paying wages on the day they are due—some states charge a penalty of $1,000 per employee, per pay period; others charge a penalty of 30 days' wages per employee. And if you fail to pay wages for even a few weeks, the state labor commissioner can padlock your business. And worse, unpaid wages cannot be fully wiped out in bankruptcy.

Independent contractors' fees do not fall in the same category as wages (unless the contractors can successfully argue they were employees). Instead, a contractor has the same legal status as any other unsecured creditor, meaning that a contractor who didn't get paid would have to sue you to get a judgment before being able to seize your assets. (And if you're organized as an LLC or corporation, the contractor couldn't grab your personal property.)

Utility and Phone Bills

You obviously can't run a business without electricity and water. If you're behind on these bills, your utility provider probably has the legal right to cut you off without going to court. Try to negotiate a payment plan rather than not paying your bill. If you wait until your service is cut off, you'll have to pay a fee to get it turned back on, including, possibly, a large deposit.

And assuming you use a land line for business and plan to stay in business, this is another bill that should have priority, so customers can continue to reach you.

Child Support

Failing to pay child support can land you in jail if a court finds you are not destitute. Your wages or business income can also be grabbed by the state to pay it, without a court judgment. What's more, a child support debt never goes away—it is always collectible, and you can't wipe it out in bankruptcy. (If you truly can't make your payments, go to court and ask the judge to reduce your obligation. That's the only way you can change it.)

Loans for Which You're Personally Liable

If your business is a sole proprietorship or partnership, you're personally liable for all of your business debts. But if your business is a corporation or LLC, you'll be personally liable only for loans or agreements that you personally guaranteed. It follows that, to protect your personal assets, you'll want to pay the debts you personally guaranteed before other unsecured debts, which are obligations of your business only. Learn more about which business loans you're personally liable for.

Court Judgments

If a creditor has already gone to court and won a judgment against you, the creditor can pay to have a sheriff seize your property or garnish your wages (and in some circumstances, those of your spouse (see Nolo's article Spouse and Partner Liability for Jointly Owned Business Debt). Obviously it makes sense to make arrangements to pay court judgments before unsecured debts that you haven't yet been sued over.

Secured Loans

A debt is secured if a specific item of property (called collateral or security) is used to guarantee repayment of that debt. If you don't repay the debt, most states let the creditor take personal property without first suing you and getting a court judgment. If the property is something you or your business cannot live without, such as a forklift, truck, or cash register, stay current on your payments or expect the company to promptly repossess its property.

Your Mortgage

If you want to keep your house, you obviously need to keep paying your mortgage (and second mortgage, if you have one). If you don't, the lender can foreclose on the house because it is collateral for your mortgage. And if you pledged equity in your house as collateral for a home equity loan or line of credit, you'll need to keep current on those payments as well. (However, if there isn't enough equity in the house to cover the home equity loan, line of credit, or other second mortgage—meaning that the second mortgage is no longer secured—it might make sense to continue paying only the first mortgage, because the second mortgagor is unlikely to sue to recover the loan amount.)

However, if you know you can't afford your mortgage payments because your business is doing poorly, and you have equity in your house, in the medium term you might be better off selling your home (if you can), renting a moderately priced place, and the money left over to pay your debts.

On the other hand, if you can't sell your house for more than you owe and you can't make the payments, your best bet may be to stop making payments and let the house be foreclosed on -- stay in it for as long as possible without making payments and use the money you save to pay other critical bills. For more information on this strategy, see Nolo's Foreclosure section.

Vehicle Payments

If you need a vehicle to continue your business or keep your job, do what you can to make the payments. Otherwise your vehicle will be quickly repossessed. But if you're paying for a more expensive car than you need, consider selling it and buying a cheaper one. This will save you a bundle in the long run—even if it costs you a few dollars to pay off the difference between what you owe and what you sell your car for. If your car is leased, websites like swapalease.com and leasetrader.com may be able to get you out of your lease and into something cheaper.

If you're already late on your car loan payments, consider voluntarily turning the vehicle over to avoid repossession—even though you will legally owe any difference between what the lender can sell the car for and what you owed on the loan. If the deficiency is not too large, try to negotiate with the lender before you surrender the property, to get the lender to cancel the entire debt—in writing—in exchange for your cooperation. But understand that a voluntary surrender might still show up as a repossession on your credit report.

Accounts Sent to Collection

After several months of trying and failing to collect a debt, many creditors turn their debts over to a collection agency, which will immediately launch a steady stream of scary letters and phone calls. The next step could be a letter from a collection attorney or a lawsuit, if the creditor or collection agency believes you have enough assets to make it worthwhile to sue you.

Collection agencies often collect a percentage of whatever they recover, so they are often willing to agree to a cash settlement for less than the amount owed—especially if they believe that you otherwise plan to file for bankruptcy.

Business Rent

If you plan to keep your current commercial space, pay your rent. If you don't, the landlord is sure to start eviction proceedings against you fairly promptly. But if you can survive without your commercial space or office by moving to a much smaller space or even into a spare room in your house, consider trying to get out of your lease. But remember that if you move out when you have time remaining on a lease, your landlord can sue you in court for the remaining months' rent if the landlord is not able to rerent the space. Learn more about getting out of your business lease early.

Insurance Premiums

Premiums should be further down on your list, but you don't want to pile a liability claim on top of all your other financial problems because your premises liability or auto insurance ran out and you're not covered for a slip-and-fall lawsuit or a car accident. (And remember, if you are operating as a sole proprietor or partnership, the costs of any mishap not covered by insurance will be a personal debt.) Instead of letting coverage lapse, try to reduce your premiums by trimming unneeded insurance coverage and raising deductibles.

Suppliers' Bills

If you're a sole proprietor or partner, you're personally liable for supplier's bills, but a creditor must sue you and get a judgment before threatening your personal assets. For this reason, suppliers' bills generally have a fairly low priority, unless of course you need to order more goods or supplies from the same supplier. If you do need to keep ordering goods from a supplier, try to make payment arrangements with the supplier. If you don't, you risk having them cut you off, or at the very least require you to pay COD.

If your business is a corporation or LLC and you haven't guaranteed suppliers' debts with your personal signature, these bills are an even lower priority unless, again, you need to order from the same supplier.

Credit Cards

Credit card balances are normally unsecured, personal debts, even if the card is in the name of a business organized as a corporation or an LLC. But because the creditor can't grab your property without first suing and getting a judgment against you, and because credit card debt is easily dischargeable in bankruptcy, credit card balances are a lower legal priority to pay. But remember that penalties and interest on credit cards add up fast, so unless you're considering bankruptcy, failing to make at least the minimum payments will quickly put you in a big debt hole that it will be hard to get out of.

Estimated Taxes

If your business is in the toilet, chances are you can decrease or eliminate your usual estimated tax payments, if you haven't already. How? Most people base their estimated tax payments on their previous year's net income, but in a financially troubled year, your income is sure to be much lower than it wasin the previous year. As long as you end up making estimated payments equal to 90% of your income tax liability for each quarter, you won't be assessed a penalty. If you do underpay your estimated tax liability, there will be a small penalty, but if skimping on estimated tax payments allows you to pay other more critical bills, it may be worth it.

Other Business Debts

Your lowest payment priority is for run-of-the-mill bills for things like advertising, entertainment, dues and subscriptions, repairs and maintenance — and, on the personal side, medical bills. Though you may get hit with late fees if you don't pay, these unsecured creditors have to sue you and get a court judgment to be able to take your business or personal assets. Plus, most unsecured debts can be discharged in bankruptcy, if things take a turn for the worse. Do keep in mind that if you are 30 or more days late on a bill, the information can go on your business or personal (if you're a sole proprietor or partner) credit report.

For more information, see Nolo's article What Can Creditors Do If You Don't Pay?