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A Chapter 7 “Straight Bankruptcy” Can . . . Help You Deal with Taxes from Your Closed Business

A Chapter 7 Straight Bankruptcy can legally write off some business-related taxes, and put you in a good position to take care of the rest.


Although Chapter 13 can be the best way to handle taxes owed from running a business, not necessarily. Sometimes Chapter 7 is the better solution. Through it, you may be able to discharge some or all of your income tax debts, or maybe at least clean up your debts enough so that you can realistically take care of the remaining taxes.


If you own, or recently owned, a business that is failing or failed, you likely have a more complicated financial situation than people with just regular consumer debts. You may have heard that the Chapter 13 “adjustment of debts” type of bankruptcy often deals better with messy situations. But you’ve also heard that this option takes three to five years, and that doesn’t appeal to you. However you might also think that the comparatively quick and straightforward Chapter 7 is not up to the task. But it just might be.

In deciding whether a Chapter 7 is right for you in this kind of situation, the main considerations are the kind of debts and the kind of assets you have. We first get into the debt issues, starting today with taxes.

Business Debts…

Chapter 7 tends to be the better solution if most or all of your debts are of the kind that will be discharged—legally written off—leaving you with little or no debt. Chapter 13 is often better if you have debts that are NOT going to be discharged—especially taxes—because it can give you major leverage over those debts. It protects you from them while giving you a sensible way to pay them.  So let’s look at this in the context of tax debts.

… Personal Income and “Trust Fund” Taxes

It seems inevitable—people who been running a struggling business almost always owe back taxes. As a small business hangs in there month after month, year after year, often there just isn’t enough money for the self-employed owner to pay the quarterly estimated income taxes, and then not enough money to pay the tax when it’s time to file the annual tax return. Tax returns themselves may not be filed for a year or two or more.

And if the owner was being paid as an employee of the business, or if the business had any other employees, it may have withheld employee income tax and Social Security/Medicare from the paychecks but then did not pay those funds to the IRS and the state/local tax authority. These are the so-called “trust fund” taxes, for which the business owner is usually held liable, and which can never be discharged in bankruptcy.

If you have a significant amount of tax debt, and especially if it includes “trust fund” taxes, and/or the taxes you owe span a number of years, Chapter 13 may be better for a number of reasons. Mostly, it can protect you and your assets while you pay the IRS or other tax authority based on your actual ability to pay instead of according to whatever their rules dictate. And you often have the power to pay other higher-priority debts at the same time or even ahead of the taxes, allowing you to hang onto a vehicle or catch up on child support, and such.

But you don’t always need that kind of Chapter 13 help, so don’t take the Chapter 7 option off the table without considering it closely. Keep these two points in mind:

First, personal income taxes which are old enough and meet a number of other conditions can be discharged in Chapter 7.  That could either eliminate your tax debt—if you closed your business a while ago and your taxes are all from a few years ago—or at least reduce it to a more manageable amount.

Second, regardless whether you can discharge any taxes, if you know that you will continue owing income taxes after your Chapter 7 case is completed you may be pleasantly surprised how reasonable the tax authorities can be with their repayment terms. You will need to continue paying interest, and usually also a penalty—both of which would likely be avoided through Chapter 13.  But the interest rate right now—with the IRS at least—is quite low, and some penalties reach a cap and stop accruing after that. You do need to keep in mind that the taxing authorities may or may not be flexible about lowering the payments if your finances take a turn for the worse. So you should avoid entering into a tax installment payment agreement unless you have reliable income source.

So here’s what you need to do. Find out from your attorney whether Chapter 13 will give you any significant benefits other than helping you with your taxes. If not, look closely what would likely happen with your taxes if you filed a Chapter 7 instead. Find out from your attorney how much you would still owe in taxes after you filed a Chapter 7 case. Then get a good estimate of how much each taxing authority would require you to pay each month on that debt, how much interest and penalties would likely accrue, and roughly how long it would take to pay off the taxes. From this, decide whether you could realistically and reliably pay the amount that would be required each month. Then in light of that, together with the advice of your attorney, make your decision whether the simpler Chapter 7 option would work for you.  

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