Bankruptcy for Business Debt: 7 Obligations a Filing May Not Erase

One of the most significant misconceptions that business owners have about bankruptcy is that their obligations will be wiped out. While this may be the case for many liabilities, there are several types of debt that are not discharged by bankruptcy. For an individual, federal law lists 19 specific types of debt that are not able to be discharged in bankruptcy. (Chapter 13 has a shorter list.) The exception often depends on what chapter of bankruptcy you are filing under, and the type of debt itself. For a business owner, there are seven debts in particular that a bankruptcy filing may not erase. If the company files a Chapter 7, the company’s obligations remain, and your guarantees stand. Payroll taxes withheld from employees can survive, and recent income taxes usually remain. Also excluded are fines and penalties owed to a government agency, along with debts from fraud or malicious injury. Liens on collateral are also carried over.

In a Chapter 7 filing for a corporation, LLC or partnership, a discharge will not be given. Only an individual gets one, so the business’s debts survive. If you owe personally, too, you may need to do your own bankruptcy to protect yourself.

In Chapter 11, a corporation can discharge its debts. Individual shareholders may still have liabilities of their own. Even then, money due to a government agency is kept in existence if they were from fraud, or if the tax stemmed from a fraudulent tax return or attempt to evade it. Note that the debt limit in Subchapter V, the small-business option, is $3,424,000 for cases filed since June 21, 2024. Prior to then, the limit was $7.5 million.

A Personal Guarantee

As a rule, owners sign personal guarantees for commercial leases, business loans and equipment financing. A personal guarantee makes you liable as if you borrowed the money yourself. An LLC, corporation or partnership can be set up to limit liability. These do not limit this liability.

Generally, even if the business is relieved of the debt, your own guarantee is not. Unless you also seek personal bankruptcy, the creditor can still enforce your personal guarantees. In most cases, filing a personal bankruptcy may wipe out your personal liability for the guarantee. In Chapter 13, if you are personally liable for some debts, these must be listed in the repayment plan. Chapter 13 may have a co-debtor stay during the three- or five-year plan, which holds off creditors chasing co-signers, but only for consumer debt, not business loan guarantees or business leases.

With payroll taxes, the business must hold back federal income taxes and Social Security taxes for each employee and send it to the IRS regularly. These are called the ”trust fund” taxes, and are the specific payroll taxes that have to be repaid, no matter what other steps are taken. In bankruptcy, these types of taxes take a high priority no matter how old they are, and are not dischargeable.

If an employer holds back payroll taxes from each worker, but does not send it in, the IRS may hold any ”responsible person” who willfully let that happen liable. One of these is a person who has significant control over the company’s finances, even if they have no formal title. Another is an officer of a corporation, or a member of an LLC. Personal obligations are for up to 100% of the amount the company failed to pay. The company’s bankruptcy does not stop the IRS from trying to collect the taxes from you individually.

Recent income taxes are next. These remain if they are too new, you hid from the tax collector, or if you filled out a fraudulent return. Too new means the return, counting extensions, was last due within 3 years before filing, or the tax was assessed within 240 days before filing, or a late return was filed less than 2 years before.

Fraud, Embezzlement or Malicious Injury

Any debt where the money was lent to you based on false statements or misrepresentations can be excluded. Any debts which came from ”willful and malicious injury” may also survive. This is where a deliberate harm to a person or their property was done by you. The creditor files what is called an adversary proceeding to complain. This is a separate lawsuit filed within the bankruptcy itself. In order for a creditor to have a chance at retaining a debt for fraud, embezzlement or malicious injury, the lender must file a complaint within 60 days after the first date set for the creditors’ meeting. If they miss that deadline (and are not given an extension), the debt is discharged.

Next, any debts arising from fines or penalties owed to a government agency typically do not go away, unless they pay back a real loss, rather than punishing you. A tax penalty can go if the tax itself is dischargeable, or the event behind it is more than 3 years old.

When a business borrows money and puts up collateral, the lender obtains a security interest in the item. While a bankruptcy can wipe out the obligation to repay a secured debt, a lien on collateral is not affected. If you still have it, the lender can still foreclose on the property, or repossess it.

Before filing, you need to sort the debts against these seven categories. The right choice of chapter also depends on your income and the means test, your assets and exemptions, and how much guaranteed debt you carry, and whether any exceptions apply.