Apply for Debt Relief: 6 Documents and Decisions Before Enrollment

If you’re considering a debt settlement program to alleviate the pressure of what your business owes, there are six things to think about beforehand. First, decide what you want to achieve for the business. Gather your financial records, including bank statements. List every debt and creditor, and prepare your contracts, leases and legal notices. Be ready to disclose recent transactions. And prepare questions about fees, risks, taxes and alternatives. You should have your finances and paperwork together, so that you can: assess the offer fairly, prepare for hidden costs or risks, ask good questions and compare alternatives.

What do you want to happen to the business? Are you looking to close the business, or revitalize it? That might be that the company becomes stronger, lives on or does a wind-down or controlled dissolution. If you haven’t decided how you’d like to see this end, then it’s difficult to measure success or failure. You’ll need to know what you’re negotiating for, why you’re doing this and how you would like it to end.

Which creditors, which debts or which problems are immediate, urgent or pressing? Are you trying to avoid a lawsuit from a particular creditor? Do you have an important upcoming court appearance, execution or deadline? Is there a statutory and finite timeline which is running, that would be impacted by your next steps?

The Small Business Administration has a COVID hardship accommodation for Economic Injury Disaster Loan (EIDL) recipients, who can reduce their monthly payments in half for six months, but interest still accrues. If you have one, you need to ask for the Hardship Accommodation before the loan is past due for 90 days. After 120 days past due, the loan can go to Treasury Offset. Once it reaches Treasury Cross-Servicing, SBA can’t assist with the debt.

Financial Records

You’ll need to have your current financial statements, P&L statements, your balance sheet, bank statements or other financial records. Having them together will help you to see how your business is doing now, what debts need to be paid and, also, what you can live with or without. Bring your cash-flow reports, tax returns, receivables and payables, payroll records and a list of major assets.

List all of your creditors. Create a matrix or spreadsheet, with one column for the name of the creditor, and the amount owed. How much do you owe for leases on capital equipment or production lines? Are there outstanding balances on business credit cards or lines of credit? Is there a security interest? Do they have a lien? When was your last payment? Show the missed payment dates, and when the debt entered collections.

If you personally guaranteed any debt, include that information. Your personal guarantee gives the creditor leverage to pursue you personally, rather than to demand repayment only from the business entity. Where does the business debt end and your personal liability begin?

What leases or contracts are most important to your operations, or to the potential for ongoing business? For example, would it be worth settling other business debts, if you could keep a long-term lease of equipment that your business couldn’t function without? By knowing which agreements are your most difficult contracts or leases, you’ll know which ones you need to learn about, negotiate and resolve. You’ll also need to know about any court documents or legal notices which have been received. It’s always helpful to show the copies of suit papers, collection letters, notices of default and similar.

Sales, transfers or liquidation of business assets need to be disclosed. Were any assets transferred or sold? Did you do any refinance or loan-restructuring transactions? You’ll want to know any intermingling of funds, debts paid to vendors or partners, or transfers out of the business accounts. Anyone who represents you will need full disclosure on that information. You should not transfer funds or make gifts without discussing the potential implications beforehand with your financial and legal advisors.

Fees and Terms

A debt-settlement company must tell you their fees and terms before you sign up. How many months or years will pass until it makes an offer to each creditor? How much must you save before making each offer? If the strategy is to stop payments, ask about the harm of ending payments.

Under federal law, if you enroll through a phone sales pitch, a debt-relief program can’t charge any fee until at least one debt is reduced or resolved, you agree to the result, and you make a payment to that creditor. If the fee is a percentage, the percentage must be the same, for every debt, from the amount enrolled.

A debt-settlement company’s required savings account must be yours. The money and interest stays yours until a payment is made to the creditor. A neutral administrator must run it, independently, and there can’t be any referral fees paid to that administrator. You must be able to withdraw your funds at any time, without any penalty.

Creditors don’t have to negotiate, and might not. Collectors may continue to call or sue. A settlement program can take years. But, if you drop out, you might lose the fees paid on settled debts.

Canceled Debts Are Generally Treated as Income

If the lender forgives or cancels $600 or more of your debt, it must report the canceled amount to the IRS on a Form 1099-C. You may owe tax on this amount, because canceled debts are generally treated as income. However, if the debt was discharged in bankruptcy, or to the extent that you were insolvent when the debt was discharged, some or all of the canceled debt may be excluded from your income. This is reported on Form 982, which reduces certain losses, credits and asset basis. IRS Publication 4681 has an insolvency worksheet. The exclusion is capped at the amount that your liabilities exceeded the fair market value of your assets just before the cancellation. Compare that tax cost with the benefit.

Weigh the costs, risks, alternatives and time. Does the business need to file for bankruptcy? If so, which chapter of bankruptcy is best: Chapter 11 reorganization or Chapter 7 liquidation? Can the company keep operating during bankruptcy? How does a bankruptcy filing affect assets and property? What about any personal guarantees? What will the bankruptcy court require? Each bankruptcy alternative creates its own set of consequences.