Business owners who can't afford to pay back their creditors often look to filing 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 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 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 applies to family farmers and fishermen.
The following resources provide some basic information about bankruptcy law:
The Internal Revenue Service (IRS) Publication 908 - Bankruptcy Tax Guide discusses 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.
There are services that can assist small business owners with staying out of bankruptcy and repairing their credit rating after declaring bankruptcy. SCORE also has formed an alliance with Corporate Turnaround (formerly known as Commercial Credit Counseling Services, Inc.) to reach out to small businesses experiencing financial difficulties.