Small Business and Debt

Small business owners often make mistakes that may greatly impact how their money is spent. There are different rules that apply to small business that both help and hurt them. First of all, the most commonly made mistake by business owners is to take out a personal loan to pay off business expenses. Taking a loan or line of credit for your business can lead to some costly mistakes in the future. Taking on this personal debt can lead small business owners into a debt hole that is hard to come out of, and may affect their businesses for the worse, or even lead to bankruptcy.

Small businesses are unique in many ways. The profit from a small business goes through their payroll and then to the owner’s profit and loss accounts at the end of each year. The reason for this is end of the year profits must pay a corporate tax. Those profits get taxed again in the following year if that money is used as income.

Small business owners make the mistake of using personal loans or lines of credit to help finance their company or their own salaries. This mistake does more harm than good. In the end, the business owner who goes into debt for their company ends up paying even more than they originally borrowed, even with interest and fees.

Here’s an example, say that a small business owner borrows $1000 from a personal loan or line of credit. This line of credit has a 20% interest rate. In a year, that small business owner supposedly owes $1200. This, however, is not the case. The small business owner actually owes over $1500 to pay off their debt of $1200, even after interest and fees. Why is that?

Well, it depends on how much the small business owner earns in that year. You must also take into consideration giving yourself the income from the loan must also cover social security, unemployment, income tax, and Medicare, along with any other withholding. These expenses could be well over 30 to 50% of your income as a small business owner. The catch is that because you took the tax benefit in the year you spent the money, you don’t get the benefit again. The debt that is carried over from one year to another will cost 30 to 50% more to pay off, not including additional fees and interest payments.

The moral of this story is that even if you have only 20% interest on your credit card, you can still end up paying 50% to 70% in taxes and interest. If you’re a consumer without the tax benefits of a business, the consequences can be even higher. Don’t take on personal debt for your small business and don’t get caught up in spending more than your interest rates in fees and penalties. Personal debt can be an even bigger draw on your finances than just the interest rates.

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