A Chapter 7 “Straight Bankruptcy” Can . . . Help You Deal with Taxes from Your Closed Business

Posted by Kevin on October 12, 2014 under Bankruptcy Blog | Comments are off for this article

Chapter 7 can legally write off some business-related taxes, and put you in a good position to take care of the rest.

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Although Chapter 13 can be the best way to handle taxes owed from running a business, not necessarily. Sometimes Chapter 7 is the better solution. Through it, you may be able to discharge some or all of your income tax debts, or maybe at least clean up your debts enough so that you can realistically take care of the remaining taxes.

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If you own, or recently owned, a business that is failing or failed, you likely have a more complicated financial situation than people with just regular consumer debts. You may have heard that the Chapter 13 “adjustment of debts” type of bankruptcy often deals better with messy situations. But you’ve also heard that this option takes three to five years, and that doesn’t appeal to you. However you might also think that the comparatively quick and straightforward Chapter 7 is not up to the task. But it just might be.

In deciding whether a Chapter 7 is right for you in this kind of situation, the main considerations are the kind of debts and the kind of assets you have. We first get into the debt issues, starting today with taxes.

Business Debts…

Chapter 7 tends to be the better solution if most or all of your debts are of the kind that will be discharged—legally written off—leaving you with little or no debt. Chapter 13 is often better if you have debts that are NOT going to be discharged—especially taxes—because it can give you major leverage over those debts. It protects you from them while giving you a sensible way to pay them.  So let’s look at this in the context of tax debts.

… Personal Income and “Trust Fund” Taxes

It seems inevitable—people who been running a struggling business almost always owe back taxes. As a small business hangs in there month after month, year after year, often there just isn’t enough money for the self-employed owner to pay the quarterly estimated income taxes, and then not enough money to pay the tax when it’s time to file the annual tax return. Tax returns themselves may not be filed for a year or two or more.

And if the owner was being paid as an employee of the business, or if the business had any other employees, it may have withheld employee income tax and Social Security/Medicare from the paychecks but then did not pay those funds to the IRS and the state/local tax authority. These are the so-called “trust fund” taxes, for which the business owner is usually held liable, and which can never be discharged in bankruptcy.

If you have a significant amount of tax debt, and especially if it includes “trust fund” taxes, and/or the taxes you owe span a number of years, Chapter 13 may be better for a number of reasons. Mostly, it can protect you and your assets while you pay the IRS or other tax authority based on your actual ability to pay instead of according to whatever their rules dictate. And you often have the power to pay other higher-priority debts at the same time or even ahead of the taxes, allowing you to hang onto a vehicle or catch up on child support, and such.

But you don’t always need that kind of Chapter 13 help, so don’t take the Chapter 7 option off the table without considering it closely. Keep these two points in mind:

First, personal income taxes which are old enough and meet a number of other conditions can be discharged in Chapter 7.  That could either eliminate your tax debt—if you closed your business a while ago and your taxes are all from a few years ago—or at least reduce it to a more manageable amount.

Second, regardless whether you can discharge any taxes, if you know that you will continue owing income taxes after your Chapter 7 case is completed you may be pleasantly surprised how reasonable the tax authorities can be with their repayment terms. You will need to continue paying interest, and usually also a penalty—both of which would likely be avoided through Chapter 13.  But the interest rate right now—with the IRS at least—is quite low, and some penalties reach a cap and stop accruing after that. You do need to keep in mind that the taxing authorities may or may not be flexible about lowering the payments if your finances take a turn for the worse. So you should avoid entering into a tax installment payment agreement unless you have reliable income source.

A Chapter 7 “Straight Bankruptcy” Can . . . Help You Walk Away from Your Business

Posted by Kevin on October 1, 2014 under Bankruptcy Blog | Comments are off for this article

There are pros and cons to the above statement.  That is why we say “Can Help” as opposed to “Will Help”

What happens when a small business goes under.  It usually means that not enough money is coming in to pay bills and employees (much less the owner).  This can lead to collection efforts from vendors which go from holding back product to suing the business entity and perhaps even the owner for money.  Multiple, disgruntled vendors lead to multiple, usually unwinnable lawsuits. Ultimately, you realize that you cannot stay open any longer.

Shutting down a business can be very time consuming and emotionally draining, especially when the vendors are suing the company and you.  You have to deal with vendors and suppliers, advertisers, workers, customers, etc.  You may have physical plant  which will be subject to foreclosure or tenancy action.  You may have product that needs to be liquidated.  You may need to go after accounts receivable.  That is a lot of work, and your inclination is to put everything behind you and move on.

If your business is incorporated or an LLC, it cannot receive a discharge under Chapter 7.  For that reason, many of my colleagues at NACBA believe that you should not put a small corporation (sometimes called a close corporation) or an LLC in bankruptcy.  However, if the corporation is being sued by multiple creditors and needs to be liquidated in an orderly fashion, a Chapter 7 may be helpful.  The automatic stay will stop the lawsuits.  The trustee will be responsible for the liquidation.  This can free up the owner to move on to new pursuits. (In NJ, this process can be accomplished also but means of a State court Assignment for the Benefit  of Creditors.)

On the other hand, if the corporation or LLC  is service oriented as with few assets, bankruptcy may be an unnecessary expense.

Under either scenario, a possible issue can be what to do if the principal of the corporation or LLC finds himself as a defendant in multiple lawsuits.  If the principal guaranteed the obligation, then he is SOL.  Even if principal did not guarantee, a favorite tactic of NJ collection attorneys is to sue the entity and sue the principal under theory of piercing the corporate veil.  This is usually a bogus lawsuit but requires that you interpose an answer and move for summary judgment.  This can be a major expense especially if you get sued by 10-12 aggressive creditors and may lead to consideration of filing a individual 7.  This decision, however, would have to be made on a case by case basis.

If the business entity is a sole proprietorship (d/b/a), then the debtor is really the owner.  d/b/a’s can fail for  the same reasons that close corporations or LLC’s fail.  But, in this case, it is the owner of the business that is on the hook so the owner files the Chapter 7.  Filing a Chapter 7 will stop most collection actions because of the automatic stay, and the owner/debtor can receive a discharge.  Of course, the bankruptcy will include both the business assets and the personal assets.  Most, if not all, of the business assets will probably be sold and the proceeds will be used to pay the trustee and the creditors.  The debtor is able to utilize his or her exemptions to save many of his or her personal assets such as the house, car, household furniture and furnishings, clothing and other things.

If you are running a small business that is failing, you need to speak with your accountant first, and then an experienced bankruptcy attorney.

In the next few blogs we will discuss this issue: after closing down a business and filing bankruptcy, when would Chapter 7 be adequate vs. when the extra power of Chapter 13 would be needed, in dealing with particular debt and asset issues. We’ll start the next blog on dealing with taxes.