Can You Close a Business With Debt? 6 Steps for Winding Down an Insolvent Company

Yes you can. That doesn’t mean the business’ creditors, including the government if you have unpaid payroll taxes or sales taxes, will go away. The business’s assets have to be used to pay creditors first, and what’s unpaid generally stays with the company. But if you personally guaranteed the debt, or you took money out ahead of creditors, you’ll be on the hook for it. And if you owe payroll trust fund taxes, they can go after you personally.

What Kind of Debt It Is

At the end of the day, it really depends on what business entity you set up, how you wind it down, and what kind of debt it is. A merchant cash advance will turn out differently than a loan that you guaranteed personally.

List everything owed by the business. Which debts are secured? Which are guaranteed, and who guaranteed them? Which are taxes? Start reading through every loan document, lease and cash advance agreement.

If you signed a personal guarantee on a bank loan, SBA loan, lease, or merchant cash advance, you’re still on the hook for it. It’s a straight promise you made. You can’t just dissolve the business, and start a new one; the old guaranty remains. You got the benefit of the loan, and you’re still liable for it even if the company or the assets you put up as collateral disappear.

All the money you withheld from employees for their taxes is a ‘trust’ fund held for the government. If you don’t send it in, the IRS can impose a Trust Fund Recovery Penalty on you or any other responsible person for the full amount you owe. If you paid anyone before the IRS and knew you had unpaid payroll trust fund taxes, your decision counts as willful. Even if the business is an S-corp, LLC or a corporation, not paying withheld taxes can make you personally responsible, and the debts stay yours even if the business disappears. Sales tax is similar. Many states make you personally responsible for what you collected. Final wages and payroll taxes must also be paid. Employers who are covered by the federal Worker Adjustment and Retraining Notification (WARN) Act generally have to give workers 60 days’ notice before closing a plant.

Try not to take cash, accounts receivable, or equipment out of the closing business. The money’s legally the company’s. Taking cash, equipment, or even customers from a company with creditors, and trying to start a new business with them can be a ’fraudulent transfer’, one a court may order undone. Even if it’s an LLC, it can cost the business its liability protection. Paying your debts, including those you guaranteed, first can look like favoring yourself. Ask an attorney.

Limited liability is conditional. If business and personal money got mixed together, if required filings weren’t done, and if you didn’t maintain the entity’s paperwork, a court might not look at it as a separate entity, and might not give you the benefit of its protections.

To wind up properly, notify any known creditors. Sell or collect all the assets, and repay debts according to their priority (secured debts first, then others as your state rules require), and your owners last. If a loan is secured by equipment, inventory or receivables, that’s what the lender will try to get from the business. If the company’s assets won’t cover the debt, and you guaranteed the loan, you may owe the lender anything that falls short.

Formal Dissolution Papers with the State

To close a company, just shutting the doors is rarely enough. If it’s a corporation or LLC, you need to file formal dissolution papers with the state. A business that was never formally dissolved can still be sued. An LLC or corporation not dissolved in every state where it’s registered keeps owing taxes and filings. The IRS says you’ll need to file your final federal tax return, and file employment tax returns. If the business was a corporation, it also files Form 966, a notification of corporate dissolution or liquidation. It doesn’t get ‘retired’ until its EIN account is closed, after it’s filed all the returns due and paid all the taxes it owes. You need to keep employment tax records for at least four years.

Chapter 7

If the business owes more than it owns, just letting it go away may not be enough. Any business can file Chapter 7 whether it’s solvent or not. A corporation or partnership gets no discharge for its debts. Its assets get sold for the creditors, and that’s that. In a Chapter 7 business closing, court fees total $338. Employees’ unpaid wages, vacation, severance and sick pay get a priority, up to $17,150 each, if it was earned within 180 days of the bankruptcy filing or shutdown, whichever’s sooner. The Chapter 7 trustee can undo or ‘claw back’ any preferential transfers, such as payments or transfers the business made to creditors within 90 days before the filing. It’s called a preference, because it looked like the business favored some creditors at others’ expense.

If you get hit with a lawsuit for an old business debt after closing, you may be shocked, because you thought the business “doesn’t exist anymore.” That’s not enough to make the obligation disappear. A letter from a lawyer threatening to sue should never go in the trash. The company may still be liable for its contracts, leases, debts and taxes, and some states even allow a company to be brought back to life so those debts can be enforced.

The last step is to have the real numbers in front of you and to pick between a negotiated settlement, a formal dissolution and bankruptcy. Be sure you use the actual numbers, and not just what you think they were. Closing a business is a lot like the last stage of an illness: it feels like you’re at the end of the process, but the decisions you make now can make a big difference in what happens to you afterward.