Nondischargeable Business Debts: 7 Categories Under §523 That Follow the Owner

Even if you file bankruptcy, there are some debts that come after you personally. The debts include taxes, payroll trust fund taxes, fraud, false financial statements, willful injury, government fines and embezzlement from a fiduciary position. The complete list is in §523. If your business closes, it is smart to have a plan in place so you can handle such a situation effectively.

It is a common misconception that companies can be discharged in a Chapter 7, like individuals. They cannot. An LLC or corporation bankruptcy case leaves you as good of a target as ever for any business debts you signed for. Even when a corporation “confirms” a Chapter 11 plan, it does not wipe out all debts or discharge everything. It keeps government fraud and taxes from fraudulent returns or evasion. If you file bankruptcy as an individual, the court can wipe out the debt, except for the specific §523 exceptions to discharge. Those exceptions still apply in a Chapter 7, 11 or 12 bankruptcy case.

Nondischargeable Business Debt

The 1st category to consider is taxes. If the income tax return was due within three years of filing bankruptcy, you are out of luck. The debt is not discharged. There are many flavors, and the tax debt may also be nondischargeable if the tax return is still not filed, the tax return was filed late within two years of bankruptcy filing, or the return was fraudulent. Don’t forget to file your return even if you have no money.

Next comes unpaid taxes withheld from employees. There is no age limit. These taxes survive bankruptcy, and the IRS hits up the owners or officers responsible for not paying the payroll taxes, personally. It is called the Trust Fund Recovery Penalty. The IRS cares nothing that the company no longer exists. Your involvement with the business will determine whether the IRS decides to whack you with the liability. The penalty equals the full unpaid trust fund balance. The IRS can aim it at any officer, partner or shareholder who willfully did not pay the taxes. No evil intent is needed. Even if the business is in deep financial trouble, do not borrow from payroll taxes.

Third, fraud. A debt for money, credit or services obtained by false pretenses, a lie or actual fraud is not wiped out. You can’t discharge debt for a business partner’s fraud, no matter how innocent you were, ruled the Supreme Court in 2023. To make it worse, the U.S. Supreme Court said in 2016 that actual fraud also counts when you run a scheme that drained assets at the expense of creditors. For these debts you cannot discharge the debt by filing bankruptcy if the creditor files papers with the bankruptcy court. The creditor must sue you by filing papers before the deadline to object, and win, to pursue collection. The creditor must move fast.

Fourth, a debt for a false written financial statement. The idea is that if you lie about your finances in writing, and a lender reasonably relied on that information and gave you the loan, and you meant to deceive the lender, that debt may survive.

Fifth: Fiduciary. If you are sued for fraud or defalcation while acting as a fiduciary, the debt you caused is not discharged. Debt for embezzlement or larceny is not discharged.

Sixth, willful and malicious injury. This one turns on your intent. If you meant to injure the other party, then that debt can outlast the bankruptcy. Otherwise, debts for careless or reckless conduct can still be discharged.

Seventh, a debt owed to the government to pay a fine, forfeiture or penalty that is not compensation for an actual money loss is not discharged. There is an exception for a tax penalty if the tax is dischargeable by another rule or if the event causing the penalty is over three years old.

Within 60 Days

In a Chapter 7 case, debts that come from fraud, fiduciary action or injury are discharged unless the creditor files a complaint in the bankruptcy case within 60 days after the date first set for your 341 meeting, though the court can extend that for cause. If the creditor does nothing, those debts are wiped out by your bankruptcy case.

The IRS letter proposing that the Trust Fund Recovery penalty be assessed gives you 60 days from the date on the letter to appeal, if you want to. Don’t ignore it. If you do nothing, the IRS will start whacking you down with the full amount.

All About Sorting and Timing

There is no one size fits all answer. It is all about sorting and timing. Before you pick a path, you must look at each debt you owe. Is it from a contract, an accident, fraud, an oral promise? Which of the seven categories does it fit in? Did you sign personally? You need to figure out what threats you have coming, and which deadlines are running.