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When A Small Business Fails, The Owner May Not Be Eligible For Unemployment

JANICE PODSADA

June 05, 2009

Last fall, Ron Reisner tried to save the upscale hot dog restaurant he'd worked so hard to create. "You start by not paying yourself. Then you cut every corner you can," said Reisner, the former owner of Rosco's Big Dog restaurant in downtown Hartford.

Despite his best efforts, Reisner in January was forced to close his 5-year-old business and lay off six employees.

In the back of his mind, Reisner — who paid state and federal taxes on his workers' wages, making them eligible for unemployment compensation — assumed that he, too, was eligible for jobless benefits.

But when he contacted the state Department of Labor, he found out that as the owner of a limited liability company paying taxes as a sole proprietorship, he was ineligible.

"Not only do you not have a business, but you do not have unemployment compensation," said Reisner, 44.

The recession has forced a record number of small businesses to close, leaving thousands of their owners, many of whom struggled even in good times to make ends meet, without a safety net. Like Reisner, many believed they would collect jobless benefits.

Their plight underscores the downside of a growing trend toward entrepreneurship as traditional jobs disappear and more individuals launch micro-businesses.

In fact, Reisner took the same course during the last recession. When he was laid off from CIGNA in 2002, he put his résumé away and drew up a business plan, opening Rosco's in 2003.

A significant number of small-business owners are asking whether they're eligible for unemployment benefits. It's a question that pops up all over the Internet. The answer isn't always clear-cut: An owner's eligibility can depend on how the business is structured — is it an LLC or a corporation?

If the owner is eligible, the next big hurdle is proving the business had to close its doors because of economic necessity.

The rules are stringent, officials say, because business owners could easily pocket tidy profits, close up shop, lay themselves off and then collect public benefits.

"Unemployment insurance is paid through a payroll tax, and what gets taxed are the wages of the employee," said Jerry Fleming, who was director of unemployment compensation for the state Department of Labor until his recent retirement. "Workers are entitled to unemployment benefits because they paid for it... a business owner is not an employee, so they don't pay the tax."

There are exceptions, however. If an LLC pays taxes as a corporation, or if a company is set up as a regular corporation, its owners may be eligible becausethe corporation is technically the employer.

In recent months, state labor department officials have encountered a raft of corporation owners who don't realize how tough it is to make a compelling case for jobless benefits, Fleming said.

If they were in bankruptcy, that sort of settles the matter in their favor, Fleming said. If they weren't, they would have to prove that they didn't milk the corporation by paying themselves a disproportionate salary, sell the business for a profit, or simply run it into the ground because of bad decisions.

"It all boils down to this: Did you create your own unemployment or did the economic situation force you to close due to economic necessity?" Fleming said.

And for some business owners the battle isn't worth the fight. "Collecting a hundred or so dollars a week wouldn't be bad, but is this going to cost me a year of legal fees to prove I'm eligible?" said Jim Moody, former owner of three Video Galaxy stores in Granby, Windsor and Southwick, Mass.

"You think you have all your ducks in a row and sometimes you miss certain things," Moody added. "Who sits there and opens their business and says, 'I'm looking forward to this closing, so and I can collect unemployment'?"

Moody, who operated as a corporation, closed his last store 18 months ago after his clientele dwindled.

"Business owners need to know that when they own their own business, they are assuming full responsibility for their unemployment insurance," said Hugh Curley, spokesman for the U.S. Small Business Administration in Hartford.

While many budding entrepreneurs are aware they'll have to provide their own health coverage, they don't always realize that if their business fails, it's unlikely they'll receive jobless benefits.

"It's one of those areas that isn't focused on enough in light of our current circumstance. You need to have your own reserve fund," Curley said.

Jobless benefits should be extended to small-business owners, said Scott O'Carroll, the former owner of a Farmington health care staffing agency.

O'Carroll sold the 20-year-old firm in March. "Luckily, there was another player in the same industry that we were in that bought it," O'Carroll said.

"Some people like me will plan and sell their business. But others will fail and have no parachute to help them through. If you're a business owner — it's the parallel of being unemployed," O'Carroll said. "The self-employed should be able to contribute to a fund that would allow them to collect in case of need."

In hindsight, Reisner, who has been working temporary jobs, said he wishes agencies like the Small Business Administration put more emphasis on the risks of self-employment.

"I took courses through the SBA," Reisner said. "You can find things out about health care, but they don't talk about unemployment. Their courses are about how to start a business, how to market yourself," he said. "To be smart, if you start a business you need a death plan."