There is approximately $1.31 trillion in outstanding student loan debt in this country, and according to data from the U.S. Department of Education, millions of Americans are late with payments or are defaulting. Student loan debt has reached crisis levels. But when small-business owners read the dire headlines, they likely don't realize that their own companies could be impacted by the crisis — and impacted significantly.
One serial entrepreneur told me he had been stunned to learn, when running a former business, that he became personally liable for more than $10,000 of loan debt an ex-employee had accumulated.
How is this possible? Because his company did not process a wage-garnishment order in the time frame mandated by New York State.
How wage garnishment works
Wage garnishment is the process of deducting money from an employee's compensation to repay a debt based upon a court order to do so.
Employees of all ages can be subject to wage garnishment, and for a variety of debts. A 2013 study by ADP found that the majority of garnishments were due to child support, and people between the ages of 35 and 44 had the highest rates of garnishment.
In recent years, student loan debt has become a fast-growing segment of wage garnishment, and creditors, including the U.S. government, have become increasingly aggressive in pursuing payment. During the last quarter of 2015, more than $167 million in wages were garnished from borrowers who had defaulted on their loan payment, according to the Department of Education.
When an employer receives a garnishment order, it's up to them to manage the process. If they do not, under federal law (as well as many state laws) that employer can be sued for the amount owed and may also have to pay interest, attorney fees and, in rare instances, even risk jail time.
When small businesses run afoul of wage-garnishment law, it is often due to one of two reasons.
First, the business may not receive or understand the importance of responding to an order. This is more of a problem for sole proprietors who are not incorporated (80 percent of small businesses in the United States) or who act as their own registered agent. Incorporated companies are required by law to have a registered agent who handles service of process, and professional registered agent services will ensure that legal documents such as garnishment orders receive proper attention. In businesses without a registered agent, a busy employee may receive an order but may not realize the importance of opening and processing it quickly.
Second, business owners may assume they do not need to respond to an order if the employee named no longer works for the company. Employers in some states may also find themselves responsible for garnishing amounts paid to independent contractors. The law requires employers to promptly respond to orders, even if only to check a "No longer an employee" box; otherwise, the headache and expense of unwinding a court order falls on their shoulders.
There are four steps a business owner can take:
1. Incorporate or form an LLC. As well as providing the safety net of a registered agent, incorporating separates personal from business assets. This means that if the business falls into debt due to a judgment (from, say, a mishandled garnishment order), the business must pay that debt, not the individual owner.
2. Respond — promptly — to all garnishment orders. Always respond to orders, even if the employee no longer works at your company. If you don't have a professional registered agent, train your employees who handle mail to know what a garnishment order looks like. And prompt response is key; some states require action in less than a week.
3. Ensure everything is in writing. Usually an employee will have been informed (by a court, the IRS, etc.) that garnishment is about to happen. But some HR experts recommend the employer send a formal memo to the employee advising of the garnishment, including a copy of the order the company received.
4. Know the laws in your state. Federal law protects employees from being fired because of garnishment for a single debt. However, in some states employers may cover administrative costs for garnishment by charging the employee a small fee. The bottom line is that garnishment laws differ from state to state, so it is important to consult with an attorney familiar with the employment laws in your state.
A better solution?
Recognizing the burden that student debt has become for some employees (as well as the opportunity for a recruitment tool), some businesses have begun offering student loan repayment benefits to employees, and some want Congress to make such benefits tax deductible.
Time will tell whether Congress, the courts and business can come together to find effective solutions to the crisis. In the meantime, and as the debt wave continues to escalate, small business owners who understand garnishment and its related liabilities can be confident they are prepared.
— By Jennifer Friedman, vice president of Wolters Kluwer's BizFilings, which provides online incorporation services for small businesses.