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New Year Resolution #9: Keep Operating Your Promising Business While Protecting Both It and You from Creditors

Would your small business thrive if you could just get some relief from your creditors? Especially the tax collectors? Consider Chapter 13.


Make the Tough Decision Whether Your Self-Employment or Small Business Can Thrive

If you are operating a small business by yourself, or with a partner and/or spouse, and it’s bringing in some money but not enough, deciding whether to put more time and effort into it or instead to close it down can be an incredibly difficult decision.

If you have already decided to close it down, see our very last blog post about how either Chapter 7 “straight bankruptcy” or Chapter 13 “adjustment of debts” can help you get a fresh financial start after leaving a business behind.

But if you are still hopeful about your business, keep reading here. If your business is bringing in enough money to meet its operating expenses and your immediate living expenses, but not enough to pay its or your past debts, there may be a solution for you worth considering under the federal bankruptcy laws.

If you look at your business’ finances clearly and objectively, does it truly have the potential to support you and your family as you need it to? Is the core of the business sound, but you simply can’t get ahead because of the burden of business and personal debts? Maybe particularly the relentless pressure of past years’ income tax and/or unpaid employee withholding taxes? Would your business succeed if you could just get some reasonable relief from your creditors so that you could concentrate on running your business?

Wouldn’t It Be Nice If… ?

Would your business succeed:

  • if all of your personal and business creditors would immediately stop all their collection actions against you and your business—all phone calls and collection letter, lawsuits and garnishments, tax levies and tax liens—and you didn’t have to worry constantly about when you’d be hit with these disruptions;
  • if you would be given enough time to pay debts that you wanted to pay—like your vehicle loan, home mortgage, and business equipment loans;
  • if you would also be given enough time to pay debts that the law required you to pay no matter what, like past-due income taxes, employee withholding taxes, and back child/spousal support payments; and
  • if you would only have to pay other personal and business debts based on what you could afford, so that you did not have to worry about having enough money to run your business and to afford your and your family’s basic living expenses.

Why Chapter 7 “Straight Bankruptcy” Will Often Not Give You the Right Help

Generally, Chapter 7 is for situations in which you want to permanently write off (“discharge”) all or most of your debts, both business-derived and personal, and then deal directly with any debts that aren’t discharged. In most consumer Chapter 7 cases, the person filing the case does not lose any of their assets because they are protected by property “exemptions”—categories of property usually up to certain dollar amount.

But there are three main problems with Chapter 7 for most people operating a business:

  1. Businesses often have assets that are not protected at all or only protected in part by the available property exemptions. Business assets such as receivables (money owed to the business and paid over time for prior sales or services), business equipment, and inventory may be unprotected. Crucial business intangibles such as intellectual property (like software developed by the business), trade secrets, the business’ name, its website, its customer list, could potentially be taken the Chapter 7 trustee and sold to anyone willing to buy it, including a business competitor.
  2. In a Chapter 7 case, technically all your assets—including your ownership interest in your business—becomes part of the “bankruptcy estate”—a new legal entity that is, at least for a couple months, under the control of your assigned Chapter 7 trustee. If your business has no value to anyone other than yourself (including the potential tangible and intangible assets mentioned above), the trustee may have absolutely no interest in taking control of any aspect of the business.  But because he or she is essentially its owner, even if only for a couple months, he or she will likely be concerned about any liability risks the business is incurring during its ongoing operation while it belongs to the “bankruptcy estate.” Depending on the nature of the business—how prone it is to liability risk—and on how good liability insurance coverage you have on the business, the trustee may want to shut down the business to avoid the risks.
  3. If you owe a lot of income or payroll taxes—or any other obligation, business or personal—that would not be discharged in a Chapter 7 case, you would only have three or four months of protection from the IRS and other creditors. You may not need more protection if the amount of surviving debt is manageable, if, for example, you would be able to afford a monthly payment arrangement with the IRS to pay off the debt within a reasonable time and while being able to pay business and household expenses. But if you need ongoing protection from the taxing authorities or other surviving creditor(s), Chapter 7 will not provide that.

Chapter 13—#1: Gives You Time to Deal with Income/Payroll Taxes and Other Special Debts

A 3-to-5-year Chapter 13 payment plan does provide that ongoing protection. The “automatic stay”—the law that requires creditors to immediately stop all their collection actions against you—all phone calls and collection letter, lawsuits and garnishments, tax levies and tax liens—lasts the full length of the case (unless you don’t do what you are required to do and the court gives a creditor permission to pursue you). During the length of the case, the IRS and all other special creditors that you do have to pay or want to pay are all required to wait until you pay them based on a plan you proposed and is approved by the bankruptcy court.

That plan is based on your business and personal budget, and usually requires some of those important creditors to let other creditors be paid ahead of them. For example, the IRS may have to wait until you caught up on a child support arrearage. Chapter 13 gives you tremendous flexibility in prioritizing the important debts, and in buying time. You do have to pay certain debts, but that’s usually by paying other debts much less. And at the end of the case you are usually tax-free and—except for long-term debt like your home mortgage and/or student loan debts—debt-free.

Chapter 13—#2: Preserves and Protects Your Business, Its Assets, and Its Revenue

In contrast to Chapter 7, Chapter 13 is not about liquidating assets but rather preserving them. You are almost always allowed to continue operating a business. The value of your business may affect how much you have to pay your creditors. And if you don’t have liability insurance for the business, or an inadequate amount, you would probably be wise to put that into your budget. And if your business makes more money during the life of the case you may have to pay more of what you owe to your creditors.

But under Chapter 13 nobody will be trying to down your business either to sell it or some of its components, or to avoid risk. You will instead be given the opportunity to run your business without the pressures of being chased non-stop by your creditors.

Chapter 13—#3: Deals with Both Personal and Business Issues Together, Giving Both a Fresh Financial Start

Everything in this blog post so far assumes that you (and maybe a spouse or partner) operate your business as a sole proprietorship, instead of as a corporation or some other legally distinct entity. As a sole proprietorship, the business is legally just part of you—its assets are your assets and its debts are your debts. In contrast, a business set up as a corporation is its own legal entity—with its own assets and its own debts. As a result, your personal Chapter 13 filing will not directly protect the corporate business. So the situation is more complicated, possibly even requiring a separate bankruptcy for the corporation.

But otherwise, if your business is a sole proprietorship one of the advantages of Chapter 13 is that it covers both you individually and the business in one package. At the end of it, those business and personal debts that had to be paid would have been paid, those that you wanted to pay like home and vehicle and support arrearage (and that the law allows you to favor) would have been paid, other debts would have been paid to the extent your budget allowed, your business and personal assets would have been preserved, you would have had years of relative calm from creditor pressures, and you and your business would be tax-free and essentially debt-free.

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