When a Company Goes Out of Business, Do You Still Owe? 6 Answers Depending on Who Signed

Closing a business doesn’t make its debts disappear. Whatever it owes is still owed. Whether you personally still owe it depends on what you signed and how the business was set up. If you were a sole owner or a partner, you generally owe it. If it was an LLC, you usually don’t. But many people sign personal guarantees, which take the company out of the middle and make you directly liable for its debts.

Can Be Held Personally Liable

A limited liability company or corporation is a separate legal entity. The debts the business incurs are generally its own, not the owners’ - unless an owner personally signed a loan or lease and agreed to be liable. On the other hand, when a business is clearly the owners’ alter ego, a judge may pierce the corporate veil and find them personally liable. Usually, it results from hiding personal finances under the business, starting with too little capital, or other improper conduct that makes the entity seem like a false front for its owners.

For sole proprietors, owner and business are not legally separate, so the owner can be held personally liable for its debts. With partnerships, the general partners have unlimited personal liability for all debts and obligations of the business. Limited partnerships reduce owner liability, though the general partner’s stays unlimited.

A personal guarantee overrides LLC liability protection. If the lender is an SBA lender, it generally requires all members with a 20% or higher stake in the LLC to sign a personal guarantee. That’s usually Form 148, an unlimited guarantee to repay the full balance. Some banks use Form 148L, a guarantee capped at a dollar amount or percentage. Guarantees aren’t out the door just because you dissolved your LLC. If you personally guaranteed the business debt, creditors can collect against you personally.

Cosigning is similar: a cosigner may have to pay up to the full debt amount, plus late fees or collection costs. In most cases, lenders don’t have to go after the borrower first - they can collect from the cosigner from the get-go. They can even sue or try to garnish wages.

When a business withholds payroll taxes but doesn’t pay them, the IRS can impose a Trust Fund Recovery Penalty on the responsible person. It’s 100% of the trust fund tax. It applies to anyone who ran the company or controlled the money, if they knew the taxes weren’t being paid, and voluntarily didn’t pay them. A business doesn’t have to close before the government comes after an officer or partner.

If You Do Owe an SBA Loan

Knowing what might come next can help you make a plan and protect yourself and your rights. The lender must liquidate pledged collateral before entering settlement talks. It could include equipment, inventory, furniture, and receivables, auctioned or sold privately. The lender has to be as careful as it would with loans they own. SBA loans over $350,000 often require your home as extra collateral. It becomes a lien on your house, with the lender holding a security interest. You may need to pay it the remaining equity to get a release, or be subject to foreclosure. When the proceeds fall short, the deficiency is the amount you still owe the lender.

You can try to settle the deficiency for less with an Offer in Compromise. An offer in compromise means you offer to repay a lesser sum, in exchange for release of the remaining balance. The SBA requires you to file SBA Form 770 Financial Statement of Debtor, with three years of tax returns and bank statements. Form 770 questions include your spouse’s annual income, and any property valued over $500, even if he or she is not on the loan. It requires an appraisal of any home or other real estate you own. The SBA can reject the offer in compromise if your financial information seems inaccurate or incomplete. Review by the SBA can take months. After a review, the SBA can accept, reject, or counter the offer. Once a final deal is reached, you have to pay exactly as agreed to get the guarantee released. If rejected, you may resubmit.

If you default, a government obligation is generally referred to Treasury by day 121 after payment due date. Then Treasury can seize your tax refund, federal salary, or Social Security benefits. There’s no court order required. Your payroll can get garnished up to 15% of disposable pay. The statute of limitations on the government is six years for a lawsuit. If you make a payment or other written acknowledgement of the debt within that time, it starts all over. Even if the government loses the ability to sue, it can still file claims against your tax refunds.

An SBA loan default appears on your credit report. It stays for up to seven years. It’s also listed in the federal CAIVRS database. An SBA loan default also generally bars new FHA or VA loans or another SBA loan until resolved.

If a debt is settled for less than what you owe, the forgiven amount generally becomes taxable income. If a creditor agrees to settle, they may send out Form 1099-C, Cancellation of Debt. Form 982 lets you claim exceptions, including bankruptcy or insolvency. Insolvency means your assets were worth less than your debts. If you were insolvent when the debt was forgiven, you generally aren’t liable for tax on the amount forgiven up to the amount you were insolvent. To claim an insolvency exclusion, you’ll need to document and value assets and liabilities carefully.

Chapter 7 Bankruptcy

A Chapter 7 bankruptcy discharge can eliminate your liability on the loan guarantee. You get an Automatic Stay that immediately stops most collection actions against you for your debts, including garnishment and offsets. If you misused loan proceeds or made a false representation on the application, the court can deny discharge on that debt. A Chapter 7 discharge is personal. It’s only for an individual who files, not for debts of a business.

Chapter 7 has a means test to make sure you’re eligible, and generally stays on your credit report for up to ten years. Chapter 13 can allow you to keep your assets, but usually requires a plan to repay your debts over three to five years. Before deciding which to file, get the advice of an experienced bankruptcy attorney.