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Chapter 7 Bankruptcy After Closing Your Business – Factors to Consider

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Meta Description: Filing for Chapter 7 bankruptcy after shutting down your business may seem like the best option, but there are three key factors to consider: assets, taxes, and other non-dischargeable debts. Consult with a lawyer to determine what’s best for you.

Introduction:

Closing down a business can be a difficult and emotional experience. After all the hard work and effort put into making it successful, it can be tempting to file for Chapter 7 bankruptcy for a fresh start. However, it’s important to consider the consequences before making a decision. In this blog post, we will discuss three factors to consider when deciding whether Chapter 7 bankruptcy is the right choice for you after closing your business.

  1. Business Assets:

Chapter 7 bankruptcy is divided into two categories: “no asset” and “asset.” In a “no asset” case, the Chapter 7 trustee decides that none of your assets are worth taking and selling to pay creditors. On the other hand, if your recently closed business has assets that are not exempt and are worth the trustee’s effort to collect and liquidate, it’s important to discuss with a lawyer whether Chapter 7 is in your best interest compared to what would happen to those assets in a Chapter 13 case.

  1. Taxes:

Closed-business bankruptcy cases often involve tax debts. While some taxes can be discharged in a Chapter 7 case, most cannot. Chapter 13 is often a better way to deal with taxes as it will depend on the type of tax and a series of other factors such as the time the tax became due and whether a tax return was filed.

  1. Other Non-dischargeable Debts:

Closed-business bankruptcies can result in more creditor challenges to the discharge of debts compared to other bankruptcy cases. These challenges are usually based on allegations of fraud against the business owner. Depending on the nature of the allegations, Chapter 13 may give you certain legal and tactical advantages over Chapter 7.

Conclusion:

Filing for Chapter 7 bankruptcy after closing down your business may seem like the best option, but it’s important to consider all factors before making a decision. The three factors discussed in this blog post – business assets, taxes, and other non-dischargeable debts – can play a significant role in determining what is best for you. It’s recommended to consult with a lawyer to help you make an informed decision.

If you are considering bankruptcy, it’s worth discussing your options; make a free phone appointment with Jennifer N. Weil, Esq. by clicking here.

Bankruptcy helps avoid tax due on forgiven debt

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Introduction

Discovering that a debt, such as credit card balances, has been forgiven can be both a relief and a potential tax concern. The IRS terms this forgiven debt as “canceled debt” or “forgiveness of debt income.” Understanding the implications and exploring viable solutions is crucial to managing your financial landscape effectively.

Identifying Canceled Debt with Form 1099-C

Receiving a Form 1099-C, titled “Cancellation of Debt,” signals that one of your debts has been forgiven. The IRS mandates reporting the canceled debt amount on your annual tax return. This document serves as a key indicator that you need to be vigilant about your tax obligations.

Not All Canceled Debt Equals Immediate Tax Liability

While the arrival of a 1099-C might suggest additional income, it doesn’t automatically translate into owing more taxes. Various exceptions and exclusions exist, offering potential relief from counting canceled debt as income. Bankruptcy stands out as a powerful method to exclude this “extra income,” but timing is crucial – filing for bankruptcy must precede the debt cancellation.

Risk Factors of Canceled Debt: Debt Settlement and Negotiation

Debt settlement or negotiation poses a high risk of triggering canceled debt and, subsequently, a 1099-C. Engaging with companies that promise to eliminate your debt at a fraction of the cost or negotiating debt independently may lead to a canceled debt scenario. This realization underscores the importance of considering bankruptcy over debt settlement.

Bankruptcy as a Shield Against Tax Implications

Opting for bankruptcy instead of debt settlement emerges as a strategic move to shield yourself from potential tax liabilities. A bankruptcy consultation provides an opportunity to explore both bankruptcy and non-bankruptcy options, allowing you to make an informed decision aligned with your financial goals. There is more detailed information about cancellation of debt income and how the IRS views it on the IRS website.

Conclusion

In the realm of canceled debt and potential tax consequences, bankruptcy emerges as a reliable shield. It not only excludes canceled debt from taxable income but also offers a comprehensive approach to managing financial challenges. Consider a bankruptcy consultation to navigate your options wisely, ensuring a strategic and informed decision-making process. When was the last time a debt settlement company provided such a holistic perspective? [Answer: Never]

Schedule a free bankruptcy consultation with Jennifer Weil, a New Jersey bankruptcy attorney, to discuss your options.

Debts in bankruptcy and how they’re treated

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One of the most practical questions you’re likely to have if you’re considering bankruptcy is what will happen to certain  debts:  Will you still owe money to certain creditors? What if you want to keep debts, like a vehicle loan or a mortgage? How are  special debts, such as income taxes and child support, handled?

One of the most basic principles of bankruptcy is that it treats all creditors in each legal category the same as all the other creditors in that category. There are three main categories of debts. Not everyone has debts in each of the three categories, but many people do. You should be able to start dividing your debts among the three categories. Then bankruptcy and how it deals with each of your creditors will begin to make more sense.

The three categories of debts are: Secured debt; general unsecured debt; and priority debt.

Secured debt

All debts are either secured by collateral or not. Whether a debt is secured is often straightforward, such as with a vehicle loan in which the vehicle’s title specifies your lender as the lienholder. The lien on that title, together with the documents you signed with the lender, gives that lender certain rights as to that collateral, such as the right to repossess it if you fail to make payments as agreed.

In the case of every secured debt, there is a legally prescribed way to attach the debt’s collateral to the debt. In the case of the vehicle loan, the lender and you have to jump through certain hoops for the lender to become a lienholder on the title. If those aren’t done right, the vehicle might not attach as collateral to your loan.

Debts can be fully secured or only partially secured. If you owe $10,000 on a vehicle worth only $8,000, the debt is only partially secured—secured as to $8,000, and unsecured as to the remaining $2,000.

Debts can be voluntarily or involuntarily secured. Examples of the latter are judgment liens on your home, IRS income tax liens on all your personal property, and a mechanic’s or repairman’s lien on a vehicle that’s been repaired and the repair bill not paid.

General unsecured debts

All debts that are not legally secured by collateral are unsecured. And “general” unsecured debts are those that don’t belong to any of the categories of “priority” debts, discussed below. General unsecured debt is a default category—it applies if a debt is unsecured and non-priority. This includes every imaginable type of debt or claim. Common ones include most credit cards, medical bills, personal loans with no collateral, bounced checks, most payday loans (although those sometimes have collateral), unpaid back rent and utilities, balances left over after a vehicle is repossessed, many personal loans, and uninsured or underinsured motor accident claims against you.

Sometimes debts that used to be secured can become unsecured, and vice versa. An example of the first: once you’ve surrendered all the collateral—such as a car on a car loan—any leftover debt is unsecured. And an example of the second: an unsecured medical bill can become secured after a lawsuit is filed against you and a judgment is entered that results in a judgment lien attached to your real estate.

Priority debts

Priority debts are special because the law treats them as better than general unsecured debts. There are specific levels of priority among all the priority debts.

It’s all about who gets paid first (which often means who gets paid at all), which comes up in two main ways:

First, most Chapter 7 cases don’t involve the trustee receiving any of your assets for distribution to your creditors (known as “no-asset cases”). But in those cases where there are non-exempt assets (known as “asset cases”), the priority creditors are paid in full before the general unsecured ones receive anything. And the higher priority creditors are paid in full before the lower priority ones.

Second, in a Chapter 13 case, your plan must show that you will pay all priority debts before the completion of your case and then you must actually do so before you are allowed to complete the plan.

The most common priority debts for consumers or small business owners are the following, in order starting from the highest priority:

• Child and spousal support—amounts owed as of the time of the filing of the bankruptcy case;

• The administrative costs of the bankruptcy case—trustee fees and costs, and in some cases attorney fees;

• Wages and other forms of compensation owed to employees—maximum of $10,000 per employee, for work done in the final 180 days before the bankruptcy filing or close of business, whichever was first; and

• Certain income taxes, and some other kinds of taxes—some are priority but others are general unsecured if they are old enough and meet some other conditions.

Reading over and thinking about these categories of debts can give you a good sense of where your debts fall in the grand scheme of things if you were to file for bankruptcy.

 

Pre-Bankruptcy Tax Strategies

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taxes-646511_1280Get the maximum benefit from your bankruptcy against your taxes by following these sophisticated strategies.

Pre-bankruptcy planning to position a debtor in the best way for discharging or for otherwise favorably dealing with tax debts is one of the more complicated tasks handled by a bankruptcy attorney. Do NOT attempt these strategies, including the five mentioned here, without an attorney, indeed frankly without an attorney who focuses his or her law practice on bankruptcy. Elsewhere in this website I make clear that you cannot take anything in this website, including what I write in these blogs, as legal advice. That’s especially true in this very sophisticated area. Also, I could write a chapter in a book on each of these five strategies, so all I’m doing here is introducing you to them, to begin the discussion when you come in to see me.

1st:  Wait out the appropriate legal periods before the filing of your bankruptcy case.

As you may know from elsewhere in these blogs, most (but not all) forms of income tax become dischargeable after the passing of specific periods of time. Much of pre-bankruptcy tax strategy turns on figuring out precisely when each of your tax liabilities will become dischargeable, and then either waiting to file bankruptcy until all those liabilities are dischargeable, or, when under serious time pressure to file, at least when the maximum amount will be discharged as is possible under the circumstances.

2nd:  File past-due returns to start the clock running on those as soon as possible.

If you know you owe taxes for prior years and don’t have the money to pay them, your gut feeling may well be to avoid filing those tax returns in an attempt to “fly under the radar” as long as you can. But irrespective of any other rules, you cannot discharge a tax debt until two years after the pertinent tax return has been filed. Get good advice about how to deal with the IRS or other taxing authority during those two years so that you take appropriate steps to protect yourself and your assets. You deserve a rational basis for getting beyond your understandable fears about this.

3rd:  Try to stay in compliance with the new tax year(s) while you wait to file your bankruptcy case, by designating tax payments to the more recent tax years instead of older ones.

Because recent tax year tax liabilities cannot be discharged in a Chapter 7 case and must be paid in full as a priority debt in a Chapter 13 case, you want to try to stay current on your most recent tax debts. It’s also usually a necessary step in keeping the IRS and its ilk from taking aggressive action against you, thus allowing you to wait longer and discharge more taxes. With the IRS in particular you can and should explicitly designate which tax account any particular tax payments are to be applied to achieve this purpose.

4th:  Avoid tax fraud and evasion, and whenever possible, withholding taxes.

Simply put, you can’t ever discharge any taxes related to fraud, fraudulent tax returns, or tax evasion, so avoid these kinds of illegal behavior. If you have any doubt, talk to a knowledgeable tax accountant or attorney. Unpaid tax withholdings also cannot be discharged, so either try to avoid them from accruing, focus your resources on paying them off, or just recognize that they will either have to be paid after your Chapter 7 case or as a priority debt during your Chapter 13 case.

5th:  Be aware of tax liens.

Tax lien claims have to be paid in full in Chapter 13, with interest, and can survive a Chapter 7 discharge. So try to avoid having the taxing authority record a tax lien against you—admittedly sometimes easier said than done. Or if that is not possible, at least refrain from building up equity in possessions or real estate. That equity, although often exempt from the clutches of the bankruptcy trustee and most creditors, is still subject to a tax lien. So any built up equity just increases what you will have to pay to the taxing authority on debt you might otherwise been able to discharge completely.

How bankruptcy can help save your small business

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Bankruptcy isn’t just for winding up after the end of a business.  It can help keep your business around for longer.

Bankruptcy saves a lot of companies.  Companies can get out of a lot of debt, restructure their operations, and save a lot of jobs.  If you own and run a small business, bankruptcy may be able to save your job, too.

Let’s assume you have a small, simple business.  One so simple that you did not form a corporation or any other kind of legal entity when you set it up.  And let’s assume that you don’t have any partners – that is, you have a sole proprietorship.

In a sole proprietorship, you and your small business are treated as a single unit—unlike a corporation, which is legally separate from you and which owns its own assets and has its own debts.  In the right circumstances, a sole proprietorship can be easier to handle in a bankruptcy.

A Chapter 7 liquidation is seldom a good option if you own a business that you want to keep operating during and after the bankruptcy.  You can discharge your debts in return for liquidation—the surrender of your assets to the trustee to sell and distribute to your creditors. Except that in most Chapter 7 cases everything you own is protected–“exempt”—so that you lose nothing or very little. But if you own an ongoing business, you are likely to have some non-exempt assets.  So the Chapter 7 trustee could take some important parts of your business to sell off or otherwise shut down.

Instead, a Chapter 13 case— sometimes called a “wage-earner plan”—is much better designed to enable you keep your personal and business assets.  You get immediate relief from your creditors under the automatic stay, and for a much longer period of time, usually with a significant reduction in the amount of debt to be repaid.  So Chapter 13 can help both your immediate cash flow and your long-term prospects.  It is also a good way to address tax debt, which is often an issue for struggling businesses.  Overall, it can be a relatively inexpensive tool that combines the discipline of a court-approved payment plan with the flexibility of continuing the operation of your business.

Please understand that when you own ANY kind of business, solving your financial problems will be more complicated.  This is because you are  not dealing merely with the size and timing of a paycheck, but instead with all the financial and practical aspects of running a business.  In addition,  timing issues are often more important in business bankruptcy cases and they require more pre-bankruptcy planning to plot out the best path for you.  So, no matter how small your business, be sure to get thorough legal advice as soon as possible.

Photo by Ruben Schade.