Business Bankruptcy

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Today, we’ll be discussing bankruptcy and what it means for businesses, whether big or small. Bankruptcy is a legal process in which a person or business that cannot repay debts to creditors seek relief from some or all of their debts. Bankruptcies among both individuals and businesses have increased significantly due to the COVID-19 pandemic. There are six types of bankruptcy within the United States Bankruptcy Code. The right type of bankruptcy must be selected for the success of the filing. If you are interested in learning more about bankruptcy and what it can mean for a business, you’re in the right place.

Types of Bankruptcy

The six types of bankruptcy are known as Chapter 7, 9, 11, 12, 13, and 15. Chapters 7 and 13 are the most common types, but 13 is not available for businesses. Chapter 11 is fairly common among businesses. Because of these circumstances, we’ll be focusing on Chapters 7 and 11.

• Chapter 7 is sometimes referred to as a liquidation bankruptcy because the bankruptcy trustee will gather and sell the debtor’s non-exempt assets and use the proceeds to pay creditors. There are three types of assets: personal property (anything you own and can touch), real property (land or property connected to land, such as a house), and intangible property (life insurance policy, tax refund, etc). There are some federal exemptions that determine which assets can be sold. This can depend on the state you file for bankruptcy in.
• Chapter 11 is sometimes referred to as reorganizing bankruptcy. This is usually associated with businesses and partnerships. This type of bankruptcy involves a repayment plan. It aims to allow a business to stay operating while debts get paid to creditors over time. However, Chapter 11 filings tend to be the most costly and lengthy. Small businesses can file Chapter 11 bankruptcy under two different categories. Subchapter 5 was added in 2019 and went into effect in 2020 to give small businesses a better, more simplified chance at repaying their debts.

When should a business file for bankruptcy?

When a business realizes it is having trouble managing its debts, debt relief options should first be considered. Debt relief options can be loan refinancing, consolidation of debt, or interest rate reductions. Business owners should write up a business plan and estimate revenue– If you cannot identify enough future revenue to pay off debt, borrowing loans may make matters worse. Bankruptcy is generally considered a last resort, so if none of these options work, then a business should consider filing. Those filing for bankruptcy should be aware of the types that can be filed, as well as potential risks and benefits. 

How can I avoid bankruptcy?

Efficient tax preparation and accounting are necessary for keeping any business afloat. (You can read our previous blog on small business accounting here!) If you are struggling with finances, contacting an accountant immediately can be beneficial. Consider consolidating your balances, using business debt consolidation. This works much like personal debt consolidation, by replacing many types of debt with one loan. The potential downside to this is that you’ll need a high credit score. You will also need to go through an initial consultation, including an interview process, to determine if you are a good candidate for the process. Debt consolidation results in more manageable payments and improved cash flow to your business. Another step you can take is to prioritize your bills. Keep an eye on the spending behavior of your business, and pay the most important or essential bills first. This could be the key to getting back on track before you end up in too much debt. Hoods Tax & Accounting Services offers strategic business planning services as well as a comprehensive offering of accounting services. Contact us today to start getting all of your bookkeeping needs in order!

Do I still need to file/pay taxes before or after filing bankruptcy?

Yes! According to the IRS, before filing Chapter 7 or 11, the debtor must file tax returns for the last four tax periods. Post-petitioning of bankruptcy, the debtor must timely file income tax returns and pay the income tax due. Most taxes cannot be eliminated with bankruptcy filing.

What if my business was closed down during the pandemic?

Unfortunately, many small businesses were forced to close amid the coronavirus pandemic. Some of these businesses won’t be able to reopen, and business owners may turn to Chapter 7 to relieve business debt. A Chapter 7 discharge wipes out debt and erases many obligations. However, defunct businesses are not entitled to a Chapter 7 discharge. This means that even after declaring bankruptcy, debt remains. Chapter 7 may work if you can keep your business open during the filing. Sometimes a sole-proprietor can keep a business afloat amid Chapter 7. The debtor’s own labor must be the basis of the company, and the business must not rely heavily on inventory, products, tools, or equipment. Some bankruptcy trustees will not allow a business to stay open during a Chapter 7 bankruptcy. Others will let a business continue to operate as long as there is liability insurance in place. Even if your company was profitable before COVID-19, you may still qualify for Chapter 7. In most cases, whoever is personally responsible for paying business debt, such as a sole proprietor or shareholder, can file Chapter 7 individually to erase personal liability, as long as that debt is dischargeable. 

How do I know if Chapter 7 will work for me as an individual?

First, check whether the debts you want to erase are dischargeable. If they aren’t, Chapter 7 will not be beneficial to you. You should review your state exemption laws to see whether you can protect your property. In South Carolina, there are exemptions for personal property, motor vehicles, tools of the trade, and more. You can read more about South Carolina’s exemptions here. Additionally, you should check whether filing for bankruptcy will breach a partnership or other agreement. 

What does Chapter 11 mean for my business?

Under Chapter 11 bankruptcy, your business can continue to operate, and will hopefully come out in better financial condition. This type of bankruptcy resolves all debts and liabilities at once. There will also be an automatic stay of creditor actions, which allows your business to get some relief from creditors. If your business decides to sell assets or property as part of its restructuring, you can obtain court approval to sell free of liens or other interests on the property. This may result in an increased interest in purchasers and an overall better sale price.

Closing

Bankruptcy can sound ominous, but it can be a necessary step to either closing your business or keeping it afloat. Bankruptcy law is complicated, and every small business has its own needs, so consulting with an expert is best. Specifically, a local bankruptcy lawyer who specializes in small business. There are a variety of ways to avoid bankruptcy, such as debt consolidation. Speaking with an expert can also help you determine which steps will be the most beneficial to your business. We hope you found this article helpful, and we thank you for reading. As stated above, Hoods Tax & Accounting offers a variety of services including small business consulting, QuickBooks training, tax preparation, accounting, payroll, and more! Visit our website for more information, as well as helpful links to resources you may find useful. Thank you for reading and we hope to see you back next time to keep learning about various tax and accounting topics!