Business owners who can't afford to pay back their creditors often view filing for bankruptcy as a way to settle their debt and avoid costly legal action. When you file for bankruptcy, your creditors may be prevented from collecting on debts until the process is completed.
How much creditors can collect depends on how your business is structured. If your business is a sole proprietorship, your personal assets may be used to pay off business debts, depending on which form of bankruptcy is chosen. Corporations, limited liability companies, and some forms of partnerships protect personal assets from being used to pay off business debts. Not all bankruptcies are voluntary. Creditors can also petition for a business to declare bankruptcy.
Chapter 7 and Chapter 13 under the U.S. Bankruptcy Code apply primarily to individuals, but affect small business owners who operate as sole proprietorships. Under Chapter 7, the bankruptcy trustee will sell assets to satisfy outstanding debts and discharge debts that can't be satisfied with the available assets. Under Chapter 13, the trustee sets up a three- to five-year repayment plan for the debtor to repay debts from current income. The debtor is allowed to keep more assets under this plan.
Chapter 11 under the U.S. Bankruptcy Code applies to both individuals and small businesses. Small businesses who choose this option operate under increased scrutiny but may keep operating under a reorganization plan. Chapter 12 under the Code applies to family farmers and fishermen.
The following resources provide some basic information about bankruptcy law:
Bankruptcy Basics
Provides businesses that may be considering bankruptcy with a basic explanation of the different chapters under which a bankruptcy case may be filed and answers to some of the most commonly asked questions about the bankruptcy process. This information is offered by the U.S. Courts.
Chapter 11 - The Small Business Case and the Small Business Debtor
Explains rules pertaining to the small business debtor.
Bankruptcy Forms
Offers official and procedural forms used in the bankruptcy process.
Bankruptcy Information Sheet
Provides a U.S. Trustee Program fact sheet covering the bankruptcy process.
Corporate Bankruptcy: What Every Investor Should Know
Discusses what happens when a public company files for bankruptcy, who protects the interests of investors, and what happens to the value of old securities.
Handling Involuntary Bankruptcies: Part I
Supplies Part I of an article that discusses considerations for various parties relative to an involuntary bankruptcy.
Handling Involuntary Bankruptcies: Part II
Supplies Part II of an article that discusses considerations for various parties as they relate to an involuntary bankruptcy.
Tax Consequences of Bankruptcy
The Internal Revenue Service (IRS) Publication 908 - Bankruptcy Tax Guide outlines the tax consequences of bankruptcy. Debtors must continue to file appropriate tax forms and deposit payroll taxes withheld for employees.
The IRS holds business owners personally liable for unpaid payroll taxes. Payroll taxes include withheld state and federal income taxes, Medicare and Social Security taxes, and unemployment insurance taxes. When a business declares bankruptcy, the IRS can take personal assets to satisfy these debts.
The IRS provides a few options for settling unpaid taxes that are particularly appropriate in bankruptcy cases. In most cases, they set up an installment payment plan. In rare cases, the IRS will accept an offer for less than the total amount due.
Installment Agreements and Settlement Plans
Gives information on installment agreements for those who cannot resolve their tax debt immediately. An installment agreement can be a reasonable payment option because it allows for the full payment of the tax debt in smaller, more manageable amounts.
Offer in Compromise
Explains how offer in comprise (OIC) helps taxpayers if they are unable to pay a tax debt in full and an installment agreement is not an option. Generally, an OIC should be viewed as a last resort after taxpayers have explored all other available payment options. The IRS resolves less than one percent of all balance due accounts through the OIC program.
Staying Out of Bankruptcy
There are services that can assist small business owners with staying out of bankruptcy or repairing their credit rating after declaring bankruptcy. SCORE is a nonprofit association dedicated to educating entrepreneurs and helping small business start, grow and succeed nationwide. SCORE is a resource partner with the SBA. In addition, SCORE has formed an alliance with Corporate Turnaround (formerly known as Commercial Credit Counseling Services, Inc.) to reach out to small businesses experiencing financial difficulties.
