How Bankruptcy Handles . . . Income and Withholding Taxes You Owe as the Business Owner of a Sole Proprietorship
If you want to keep your business operating but owe too much in taxes, a Chapter 13 case will protect your business while buying you time.
Chapter 13 Protects Personal and Business Assets and Income
In contrast to Chapter 7 “straight bankruptcy,” Chapter 13 “adjustment of debts” is not about a quick liquidation of assets for the benefit of your creditors. Rather it’s about preserving assets and protecting your earning capacity so that you can pay debts that need to be paid—such as recent income taxes and all withholding taxes. And as necessary Chapter 13 reduces debts that legally don’t have to be paid—such as older income taxes.
So, if you file a Chapter 13 case you are almost always allowed to keep operating your business, and are protected from your tax (and other) creditors so that you can do so.
Protection beyond Property “Exemptions”
Your business assets are preserved even if they are not “exempt” property. Under a Chapter 7 case you can keep your personal and business assets only to the extent that they fit within legally proscribed property “exemptions.” But many kinds of business assets crucial to the successful operation of a business do not fit within the “exemption” categories—such as receivables or work-in-process. Or the maximum “exempt” amounts are too low to protect your business assets. Under Chapter 13 you can usually protect those not-“exempt” assets that you would lose in a Chapter 7 case.
Protection through the “Automatic Stay”
If your business is a sole proprietorship—where you personally directly own the business and are directly liable on the business debts—then you and your business will be protected from your creditors, including the IRS and your state tax agency, by the “automatic stay.” The “automatic stay” makes tax collection activity illegal while the “stay” is in effect, which is usually throughout the 3-to-5-year life of a Chapter 13 case. All phone calls and collection letters, tax levies on your bank accounts and receivables, and the recording of tax liens—all forbidden. You have the opportunity to run your business without being pressured constantly by the IRS/state.
Have Enough Time to Pay Necessary Income and Withholding Taxes
Because the “automatic stay” protects you from virtually all the collections actions by the IRS/state and other creditors, that gives you time to pay those tax debts that you must pay. During the length of the case, the IRS/state must wait until you pay them based on a plan you propose and which is approved by the bankruptcy court.
That plan is based on your business and personal budget, and often allows an important creditor or two to be paid ahead of some of your tax debts. For example, the IRS may have to wait until you get caught up on a child support arrearage or on a business vehicle loan. Chapter 13 gives you tremendous flexibility in prioritizing the important debts, and in buying time to pay all that you need to pay.
You are usually helped in the paying of the required tax debts by being allowed to pay other debts much less, and sometimes nothing at all.
Handling Both Personal and Business Debts Simultaneously
As long as your business is a sole proprietorship (not a corporation, limited liability company, or such), Chapter 13 covers both you individually and the business through a single legal proceeding. The “automatic stay” protects both personal and business assets from the collection of both personal and business tax debts. A single Chapter Plan outlines who you pay among all your creditors—both personal and business.
A Successful Chapter 13 Case
At the end of a Chapter 13 case, those tax (and other) debts that had to be paid in full (such as recent income taxes and all withholding taxes) will have been paid off. Other tax debts will have been paid to the extent your budget allowed. Also, your business and personal assets will have been preserved, and you and your business would then be tax-free and essentially debt-free.