Your Bankruptcy Options If You Owe Income Taxes After Closing Your Business

Most people who close down a failed small business owe income taxes. Chapter 7 and Chapter 13 provide two very different solutions.

 

Here are the two options:

Chapter 7 “Straight Bankruptcy”

File a Chapter 7 case to discharge (permanently write off) all the other debts that you can, and sometimes some or even all of your income taxes. If you cannot discharge all of your taxes, right after your Chapter 7 is completed you (or your attorney or accountant) would arrange for you either to make monthly payments to pay off those remaining taxes or to enter into a settlement with the taxing authority(ies).

Chapter 13 “Adjustment of Debts”

File a Chapter 13 case to discharge all the other debts that you can, and sometimes some or even all the taxes. If you cannot discharge any of your taxes, you then pay the remaining taxes through your Chapter 13 plan, while under continuous protection against the IRS’s or state’s collection efforts.

The Income Tax Factor in Deciding Between Chapter 7 and 13

In real life, especially after a complicated process like closing a business, often many factors come into play in deciding between Chapter 7 and Chapter 13. But focusing here only on the income taxes you owe, the choice could be summarize with this key question: Would the amount of tax that you would still owe after completing a Chapter 7 case (if any) be small enough so that you could reliably make workable arrangements with the IRS/state to pay off or settle that obligation within a reasonable time?

As just mentioned, in a Chapter 7 case you deal with the IRS/state about any remaining taxes after that Chapter 7 case is completed, when the protection against tax collection efforts against you have expired. In contrast Chapter 13 protects you from such tax collection during the three to five years while you are in the Chapter 13 case. 

Being in a Chapter 7 case only makes sense if you don’t need that ongoing protection.

Crucial Information from Your Attorney

To find out whether you need Chapter 13 protection, you need to find out from your attorney the answers to two questions:

1) What tax debts will not be discharged in a Chapter 7 case?

2) What payment or settlement arrangements will you likely be able to make to take care of those remaining taxes?

How reliably your attorney (or anyone else) can predict how a particular taxing authority will allow a tax debt to be paid or settled depends on the circumstances. For example, the IRS has some rather straightforward policies about how long a taxpayer can make monthly payments to pay off income tax obligation in full—and thus how much those monthly payments would have to be—as long as the balance owed is less than a certain amount. In contrast, predicting whether or not the IRS/state will accept a particular “offer-in-compromise” to settle a debt can be much more difficult to predict.  Your attorney (or tax accountant) should tell you the likely success of any proposed game plan.

When in doubt about whether you would be able to pay what the taxing authorities would require after a Chapter 7 case, or in doubt about some other way of resolving the tax debt, you may well be better off under the protections of Chapter 13.

Conclusion

Once you know how much in tax you would still owe after filing a Chapter 7 case, do you have a reasonable and reliable means of paying it off or settling it within a sensible length of time? If so, file a Chapter 7 case. Otherwise, take advantage of the greater protection of Chapter 13.  

 

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The Benefits of Both “Asset” and “No Asset” Chapter 7 After Closing Down a Business

A Chapter 7 case will wipe out all or most of your personal liability from a closed sole proprietorship, corporation, LLC, or partnership.

 

If you have closed down a business, or are about to do so, filing a Chapter 7 “straight bankruptcy” case can be the best way of putting the debts of that business permanently behind you.

That Chapter 7 case will likely be a simpler one if you have a “no asset” case instead of an “asset” one. But an “asset case” may be worth the extra time it would likely take.

“Asset” and “No Asset” Chapter 7

Chapter 7 is sometimes called the liquidation form of bankruptcy. That usually does NOT mean that if you file a Chapter 7 case something you own will be liquidated, or sold. Most of the time you can keep everything you own. That’s if everything you own is “exempt”—included within a set of property “exemptions,” those types and amounts of property that are protected from your creditors. If everything is exempt, you would have a “no asset” case, so-called because the Chapter 7 trustee has no assets to collect.

In contrast, if you own something that is not exempt, and the trustee decides that it is worth liquidating and using the proceeds to pay a portion of your debts, then your case is an “asset case.”

The Quick “No Asset” and the Drawn Out “Asset” Case

Generally, a “no asset case” is simpler and quicker than an “asset case” because it avoids the asset liquidation and distribution-to-creditors process.

A simple “no asset” case can be completed in about three to four months after it is filed (assuming no other complications arise).  That’s in contrast to an “asset” case which always takes at least a few months more, easily a year or so, sometimes even multiple years.

Why does an “asset” case take so long? Because it can take time for a trustee to locate and take possession of an asset, sell it in a fair and open manner with notice to all interested parties, give creditors the opportunity to file claims to get paid out of the sale proceeds, for the trustee to object to any inappropriate claims, and then to distribute the funds as the law provides.  Each of these steps can take extra time. Especially if you have unusual or intangible asset, such as a disputed claim against a third party—a claim arising from an auto accident, for example—it can take a few years for the trustee to resolve and convert such a claim into cash, keeping the bankruptcy case open throughout this time.

The Potential Benefits of an “Asset” Case

If the trustee does have some asset(s) to collect from you, that can be turned to your advantages.  Two situations come to mind.

First, you may decide to close down your business and file a bankruptcy quite quickly after that in order to hand over to the trustee the headaches of collecting and liquidating the assets and paying the creditors in a fair and legally appropriate way. If you’ve been fighting for a long time to try to save your business, you may well find it not worth your effort to negotiate work-out terms with all the creditors. And you likely have no available money to pay an attorney to do this for you.

Second, you may particularly want your assets to go through the Chapter 7 liquidation process if the debts that the trustee will likely pay first out of your assets are ones that you especially want to be paid. The trustee pays creditors according to a legal list of priorities. For example, at the top of that list are child and spousal support arrearages, with certain tax claims not far behind. You may well want to take care of claims by your ex-spouse and/or children and the tax authorities. That’s especially true if you would continue to be personally liable on these obligations after the bankruptcy is over. 

 

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Choosing the Right Solution in a Closed-Business Bankruptcy Case

Whether to file under Chapter 7 or Chapter 13 depends largely on your business assets, taxes, and other nondischargeable debts.

 

Hoping to File a Chapter 7 “Straight Bankruptcy”

Once you’ve closed down your business and are considering bankruptcy, it would be understandable if you preferred to file under Chapter 7 instead of under a Chapter 13 “adjustment of debts.”

After all you’ve been through the last few years trying to keep your business afloat, you just want a fresh, clean start, as quickly as possible. You likely feel like just putting the debts behind you. The last thing you likely want is to do is stretch things out for the next three to five years that a Chapter 13 case would usually take.

Likely Can File Under Chapter 7 Under the “Means Test”

The “means test” determines whether, with your income and expenses, you can file a Chapter 7 case. In my last blog I described how you can avoid the “means test” altogether if more than half of your debts are business debts instead of consumer debts.

But even if that does not apply to you, the “means test” will still not likely be a problem if you closed down your business recently. That’s because the period of income that counts for the “means test” is the six full calendar months before your bankruptcy case is filed. An about-to-fail business usually isn’t generating much income. So, there is a very good chance that your income for “means test” purposes is less than the published median income amount for your family size, in your state. If your prior 6-month income is less than the median amount, by that fact alone you’ve passed the means test and qualified for Chapter 7.

Three Factors about Filing Chapter 7 vs. 13—Business Assets, Taxes, and Other Non-Discharged Debt

The following three factors seem to come up all the time when deciding between filing Chapter 7 or 13:

1. Business assets: A Chapter 7 case is either “asset” or “no asset.” In a “no asset” case, the Chapter 7 trustee decides—usually quite quickly—that all of your assets are exempt (protected by exemptions) and so cannot be taken from you to pay creditors.

If you had a recently closed business, there more likely are assets that are not exempt and are worth the trustee’s effort to collect and liquidate. If you have such collectable business assets, discuss with your attorney where the money from the proceeds of the Chapter 7 trustee’s sale of those assets would likely go, and whether that result is in your best interest compared to what would happen to those assets in a Chapter 13 case.

2. Taxes: It seems like every person who has recently closed a business and is considering bankruptcy has tax debts. Although some taxes can be discharged in a Chapter 7 case, many cannot. Especially in situations in which a lot of taxes would not be discharged, Chapter 13 is often a better way to deal with them. Which option is better depends on the precise kind of tax—personal income tax, employee withholding tax, sales tax—and on a series of other factors such as when the tax became due, whether a tax return was filed, if so when, and whether a tax lien was recorded.

3. Other nondischargeable debts: Bankruptcies involving former businesses get more than the usual amount of challenges by creditors. These challenges are usually by creditors trying to avoid the discharge (legal write-off) of its debts based on allegations of fraud or misrepresentation. The business owner may be accused of acting in some fraudulent fashion against a former business partner, his or her business landlord, or some other major creditor.  These kinds of disputes can greatly complicate a bankruptcy case, regardless whether occurring under Chapter 7 or 13. But in some situations Chapter 13 could give you certain legal and tactical advantages over Chapter 7.

These three factors will be the topics of my next three blogs. After reviewing them you will have a much better idea whether your business bankruptcy case should be in a Chapter 7 or Chapter 13.

 

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Close Down Your Small Business, Get a Fresh Financial Start

Closing down a business can leave you with huge debts and no income to pay them. Bankruptcy may be necessary, and be easier than you think.

 

A Business Bankruptcy Means a Messy One?

A bankruptcy cleaning up the financial fallout from a closed business can be more complicated than a consumer bankruptcy case. But is not necessarily so.

In the next few blog posts I will show how a business bankruptcy can be quite a simple and effective solution.

Today I present one way a business bankruptcy can actually be easier than a consumer one. 

How so? Because under certain conditions a business bankruptcy case can avoid the Chapter 7 “means test,” allowing you to legally write off (“discharge”) all your debts quickly.

The Purpose of the “Means Test”

The point of the means test is to require people who have the means to pay a meaningful amount to their creditors over a reasonable period of time to in fact do so. They aren’t allowed to simply discharge their debts.

Essentially this disqualifies people who do not pass the means test from going through a Chapter 7 case, which allows a quick discharge of most debts. Instead they must go through Chapter 13, which generally requires them to pay creditors all that they can afford to pay them over a 3-to-5-year period.

The Challenge of Passing the Means Test

To pass the means test requires either having a relatively low income (no more than the published median income amount for the person’s state and family size) or having enough allowed expenses so that little or no “disposable income” is left over. Again, otherwise you will be stuck in a 3-to-5-year Chapter 13 payment plan.

In many scenarios, a former business owner needing bankruptcy relief would not be able to pass the means test and so would have to go through Chapter 13. For example:

  • If, after closing his business, the owner of that business gets a well-paying job before filing bankruptcy, the income from that job may be larger than the “median income” applicable to her state and family size.
  • If the business was operated by one spouse while the other continued working and earned a good income, that employed spouse’s income alone may bump the couple above their applicable “median income” amount, thereby not passing the “means test.”
  • A former business owner who now earns more than median income can’t deduct monthly payments to secured creditors on business collateral she is surrendering—vehicles and equipment, for example—or for other business expenses, such as rent on the former business premises. This reduces the likelihood that she will have enough allowed expenses to pass the “means test.”

Skip the “Means Test” in Business Bankruptcies

The good news is that you do not have to pass the means test at all if your “debts are primarily consumer debts.” (Section 707(b)(1) of the Bankruptcy Code.) So if your debts are primarily business debts—more than 50%–you avoid the means test altogether.

Let’s be clear about the difference between these two types of debts. A “consumer debt is a “debt incurred by an individual primarily for a personal, family, or household purpose.” (Section 101(8).)  The focus is on the intent at the time the debt was incurred. So, for example, if you had taken out a second mortgage on your home for the clear purpose of financing your business, that second mortgage would likely be considered a business debt for this purpose.

Certainly there are times when the line between a business and consumer debt is not clear. Given what may be riding on this—the ability to discharge all or most of your debts in about four month under Chapter 7 vs. paying on them for up to 5 years under Chapter 13—be sure to discuss this thoroughly with your attorney. Find out if you can avoid the means test under this “primarily business debts” exception. 

 

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