Impact of Nonbusiness Losses

A solely owned, unincorporated business has no legal existence apart from its owner. Consequently, a large uninsured loss suffered by the owner can devastate the business. A business owner may be forced to sell business assets — or the business itself — to extinguish his or her debt.

Although different liability rules apply to businesses that are run as partnerships, corporations (including S corporations), and limited liability companies, a severe uncompensated loss to the business owner can prove as injurious to these types of businesses as losses experienced by a sole proprietorship.

Sole proprietors. If you are like many people who run a small business, you do so by way of the "single pocketbook," that is, as a sole proprietorship. Even though, hopefully, you keep separate records related to the business, as far as the law goes you and your business are one being. If an auto accident, an accident at home, or another unforeseen event causes a big economic loss to you personally (rather than to your business), your ability to profitably run your business may be in doubt, even if the cause of the loss had nothing to do with the business itself.

A guest in your home falls on a loose rug in your living room, which is not part of your business work area. His injuries require medical treatment that costs $10,000. If he sues you for this amount and wins, and you can't come up with it otherwise, there may be nothing to stop him from making you sell business assets to raise the $10,000 you owe him. Although the state that you live in may place some limitations on the ability of others to force you to sell your business property to pay off legal judgments, you shouldn't depend on these rules — they may not shield all of the equipment and inventory needed to run your business.

Corporations or LLCs. Even if you have taken steps to make your business a separate "person" in the eyes of the law, by creating a corporation or limited liability company, your personal economic losses may be detrimental to your business.

Backing your car out of your driveway, you accidentally hit a passing car. The collision did $2,500 in damages to the other car, and its driver incurred doctor and hospital bills totaling $5,000. She sues, and gets a legal judgment against you for $7,500. You are unable to pay off the debt.

In this example, there are legal and practical reasons why the injured driver probably won't be able to force you to sell off, or transfer to her, the corporate assets of your business. But this doesn't mean that you would be home free: you would probably find it hard for your corporation to obtain credit in the future.

Usually banks will not lend money to a small corporation unless the shareholder/operators agree to be personally liable for repayment of the money borrowed. If you have a large judgment outstanding against you, a bank may see your guarantee as having limited value.

Insurance coverage is essential. Insurance is a key way to protect yourself against the problems that may be caused by a nonbusiness loss. Remember, though, that insurance is only as good as the maximum of your policy's coverage limits. Remember also that certain losses may be excluded from coverage.