How to protect your credit when your spouse starts a business
By Elaine Pofeldt | Published: April 29, 2016
Your spouse is pumped up about starting a new business. You’re trying to get excited, too. So why are you lying awake nights, worried about the new credit card charges your partner is running up to cover the startup’s launch?
It may be because you’ve seen the U.S. Small Business Administration’s statistic that only half of new businesses last five years. Only one-third are around after 10 years. Many entrepreneurs don’t pay attention to discouraging numbers like that for a good reason: Focusing on the negative will keep them from getting anything off the ground. “They are going to win and make everyone around them believe it,” says Jeff Anderson, a divorce and family law attorney in Dallas.
But their spouses can be a valuable reality check by encouraging them to make financial decisions that allow the business to take off without jeopardizing the whole household’s financial security, say experts.
“People going into marriage ought to be thinking about what happens if everything crashes and my husband or wife’s venture fails?” says Anderson.
Fortunately, it’s possible to protect yourself from some of the financial risks without being a buzz-kill. The secret is to maintain open communication with your spouse – ideally before you’re in a financial situation that’s making everyone miserable. Here are some strategies experts recommend.
Discuss how you’ll pay the bills. Many small-business owners live with families who will be affected if they can’t make a living in their new business. Nearly 70 percent of entrepreneurs were married when they started their business and 60 percent had at least one child, according to research released in 2009 by the Ewing Marion Kauffman Foundation, which promotes entrepreneurship and education.
If your spouse will be giving up a regular paycheck to start the business, you’ll need to find a new source to replace that money for at least six months to a year – such as liquid savings – and plan for the possibility that your mate’s income won’t return to what his or her present job paid for several years. That may mean you’ll assume the role of breadwinner, or the entrepreneur will run the business part time while holding down a steady job until it is generating enough money to replace his or her paycheck. Having enough personal cash flow will allow the entrepreneur to put money into the business when necessary, without running up giant cash advances on a credit card.
Laurie Itkin’s husband Dan took the latter approach. After dreaming up a business designing and manufacturing headphones for audiophiles, he started doing the legwork in the evenings, while he held down a full-time job. When he unexpectedly got laid off nine months later, he was already prepared for the launch. As a result, the couple made the financial transition smoothly. “He was able to become profitable in his business in six months,” says Itkin, a financial adviser at Coastwise Capital Group in La Jolla, California, who also continued working during that time.
Get professional advice. Entrepreneurs are often so caught up in launching their businesses that it can be hard for them to find time to work on a Plan B for their family. Arranging a session with a financial planner can speed things along – and perhaps offer a voice of reason to a risk-taker who isn’t paying attention to a spouse’s legitimate worries about financial security. “I highly recommend getting a third party in the picture – someone to sit down and talk through the plan for the business and be a mediator in the conversation,” says Melinda Kibler, a certified financial planner and portfolio manager with Palisades Hudson Financial Group in Fort Lauderdale, Florida.
Put up a wall. One of the most important ways to protect your family’s assets is for the entrepreneurial spouse to establish legal separation between the business and his or her personal finances – even if it’s only a part-time venture at the moment. To do that, your partner needs to set up a business entity such as an LLC or a corporation and to handle all financial matters of the business through a separate business bank account and credit card used only for the startup, say experts. “You always want to have a wall between yourself and the business,” says CPA Paul Gevertzman, a tax partner with accounting firm Anchin, Block & Anchin in New York City. A lawyer can do this or, if money is tight, there are many low-cost online services your spouse can use.
Protect your own personal credit. In most states, except the 10 community property states, creditors can’t go after you for credit card debt your spouse has racked up unless you co-signed for the cards or became a guarantor of the debt. Avoid making the mistake of doing so at all costs. “Then you’re saying, ‘I’m as much a debtor as my spouse,’” says Gevertzman. Putting both of your credit records at risk won’t help either one of you if the business suffers a setback.
Protect your home. All states other than Maryland, New Jersey, Pennsylvania and the District of Columbia offer the homestead exemption, which enables residents to protect some or all of the value of their primary residence from creditors. “They can’t force you to sell your home to have the liquid assets to pay the creditors,” says Kibler. Filing for the exemption is easy, says Kibler, and you and your spouse can submit the paperwork together when you buy a home or afterward.
Consider a postnuptial agreement. In some community property states, creditors can go after debtors’ homes. To protect their families, some entrepreneurs will set up prenuptial or postnuptial agreements that say their home belongs only to the nonentrepreneurial spouse, says Anderson. However, to maintain the agreement, the couple can’t commingle their funds by opening a joint bank account or buying a car together, he says.
Of course, not all entrepreneurs will want to put a major asset like a home in the name of their spouse. “Even in states where that works, it’s as good as the strength of the marriage,” says Gevertzman. If you’ve put some other smart safeguards in place, you may not need to go to this extreme anyway.
Make sure payroll taxes are paid. You probably don’t want to meddle in your spouse’s business, but there is one area where you absolutely need to know what is going on: Payroll taxes.
“My biggest fear of clients who go into business is they don’t pay payroll taxes,” says enrolled agent Crystal Stranger, president of 1st Tax in Honolulu and author of “The Small Business Tax Guide.” “If the business is not doing well, a lot of times that payroll tax money is sitting there. Entrepreneurs will think, ‘I can use a little bit.’ If you don’t pay your payroll taxes on time the IRS will automatically impose a 100 percent penalty. They will go after assets and do it quickly.”
If your spouse has W-2 employees, mark your calendar to check in at least quarterly to make sure the business is current on its payroll taxes – or volunteer to handle the tax paperwork for your spouse. “Either you have transparency or you’re on top of it with them,” says Stranger.
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