Small Business Bankruptcy for Sole Proprietors

When you are a small business owner, everything you do is intricately tied to your personal life, even if that is not your intention. If you need to file for bankruptcy due to the failure of your business, it will be no different. What many people fail to realize that if their business is a sole proprietorship, it is not a distinct legal entity from its owner. Thus, what starts out as a business bankruptcy can quickly turn into a long proceeding involving personal assets.

Which Chapter To File Under?

Depending on the size of your business, you will need to choose between filing under Chapter 7 or Chapter 13. (Chapter 11, the other area of the bankruptcy code that deals with business bankruptcy, is only available to partnerships, corporations and other businesses that have more than one proprietor, with very rare exceptions.)

Because a sole-proprietorship bankruptcy is basically a personal bankruptcy, the actual process of deciding what to file under will be heavily influenced by personal factors. As would be the case in a personal bankruptcy, if you have more unsecured debts than secured, a Chapter 7 filing is likely the best option. If your discharge is approved, your unsecured debts will be written off. Secured debts, like car loans or mortgages, are infinitely more difficult to eliminate without losing the property in question. If more of your debts are secured, a Chapter 13 filing is a better choice, because it gives you time to pay off the outstanding debt through reorganization, rather than simply taking the property.

One thing to be aware of is that usually an individual wishing to file Chapter 7 must take a means test in order to determine whether or not they fall under the maximum income permitted. This is not the case, however, when the bankruptcy involves a small business; in order to “encourage entrepreneurship,” Congress carved out an exception to the means test – in other words, if more than half of your debts stem from your business, you do not have to take the means test and can file for bankruptcy under Chapter 7, regardless of your income.

Tax Implications

The tax questions that crop up surrounding a bankruptcy can often be quite complex. A business owner is generally responsible for the taxes on all gross profit, no matter what might occur during the life of the business. However, the amount of tax debt that can be written off is going to differ depending on which chapter the sole proprietor files under.

In a Chapter 7 filing, tax debts can only be written off in three instances: if they were incurred in a tax year three or more years previous to the bankruptcy; if they were assessed against you more than 240 days before your filing occurred; or if you previously submitted tax returns for two or more years before filing. Conversely, under a Chapter 13 filing, there is no tax relief of any kind. It is assumed that if you have enough assets to work out a reorganization with your creditors, then in theory your tax debts are repayable.

Help Is Available

If you are a sole proprietor at sea in a wash of debt and confusion, we can assist. We are experienced attorneys with a wealth of knowledge and ability. We will do our best for you. Contact our New York City offices for a free initial consultation.