Personal Bankruptcy vs Business Bankruptcy: 5 Situations Where Only One Makes Sense

Should a bankrupt small business owner file personal bankruptcy, business bankruptcy, or both? The answer hinges on who owes the money. Your bankruptcy options mostly depend on whose names are on debts, who signs as personal guarantor on business debts, and what kind of business structure you’re using. Five common situations exist in which just one choice fits.

Personal Bankruptcy

Personal bankruptcy takes care of debts a person owes, usually by wiping them out through Chapter 7 or structuring payments through Chapter 13. Business bankruptcy, usually Chapter 7 or Chapter 11, takes care of debts owed by the business. The goal may be to reorganize and hold on to the business, or to liquidate it. It’s important to know that a business bankruptcy does not cover the owners’ personal debts, and that a personal bankruptcy doesn’t cover the debts of an LLC or corporation.

1. You’re a sole proprietor: When a business is a sole proprietorship, everything is in a person’s name: assets, debts, bank accounts, everything. The business has no legal entity of its own. For a sole proprietor, the only way to deal with business debts is to file personal bankruptcy. The kind of personal bankruptcy that works best may depend on your income and the kinds of debts you have. If you can manage three to five years of repayment, sole proprietors with regular income may choose Chapter 13 rather than Chapter 7. Unsecured debts must be under $526,700, but business operating expenses do not count as disposable income for your plan. Chapter 7, which liquidates and wipes out qualifying debts, is an alternative. If a debtor got a Chapter 7 or Chapter 11 discharge in a case filed within the previous 8 years, another personal Chapter 7 discharge may be unavailable.

2. Your LLC or corporation is closing, and you signed nothing personally: Any business debts you didn’t personally guarantee or cosign for are the legal responsibility of the business. In that case, you can let your LLC or corporation file bankruptcy without you filing personal bankruptcy. If you want to close a business that has its own debts, but they’re not yours, Chapter 7 business bankruptcy usually handles liquidation of the business debts. Chapter 7 lets the trustee take over and sell assets, then distribute the proceeds to creditors in order of priority. The major difference between a corporation or partnership filing Chapter 7 and an individual filing is that the company can’t get a discharge of debts. The company simply winds down. The owners usually stay out of Chapter 7, unless they’ve signed for a company debt personally.

3. The company can still be saved: If a company can get back on its feet, Chapter 11 lets it file bankruptcy without having to shut down. An LLC or corporation cannot use Chapter 13 because that’s for individuals only. The debtor gets to propose a plan to restructure its debts. The business continues operating during the reorganization. A Chapter 11 is generally more complex than a consumer bankruptcy. Subchapter V of Chapter 11 allows small businesses a streamlined form of bankruptcy. They may keep control of their companies, can file a plan in 90 days, and a trustee always oversees the process. Subchapter V is only for small businesses with less than $3,424,000 in debts. You don’t have to pay the U.S. Trustee quarterly fees.

4. You signed a personal guarantee: Depending on the bank, an LLC may not be enough. The owner may need to personally sign the loan or pledge personal property. If a business loan has your name on the dotted line as guarantor or cosigner, the debts are your responsibility. If the company can’t pay, the lender looks to you. When you’ve signed personally, a company bankruptcy alone won’t cover your personal liability. Your personal bankruptcy, however, can take care of the business debt. You may be able to discharge the debt through Chapter 7, or may include it in a Chapter 13 repayment plan. Chapter 13’s co-debtor stay protects co-signers on consumer debt but not on debts taken on in ordinary course of business.

Imagine you run a construction company LLC that borrows for equipment. A lender may ask that you personally guarantee the loan, which gives them the right to look to you for repayment if the company can’t pay. When the business falls behind, you step up to cover payments. That may mean using personal credit cards. When cash stops flowing and the business must close, the debts of the LLC remain. If you or others are guarantors or cosigners, the lender can collect from whoever signed. And any personal credit card balances generally remain yours to pay. A company bankruptcy might handle company assets and creditors, but any debts you signed for personally may need a personal bankruptcy.

5. You owe payroll taxes: If your business has employees and withholds Social Security, federal income taxes, and Medicare, it’s your responsibility to pay the withheld taxes to the IRS. The IRS considers these taxes to be trust funds until they’re paid over to the government. The IRS looks to “responsible persons” for those unpaid taxes. The person responsible for the company’s taxes, if they can be shown to have willfully failed to pay the taxes, can be held personally liable for 100 percent of the unpaid trust fund taxes. The IRS can require payment from personal assets, even while the business is operating.

Make the Decision to File for Bankruptcy

Is your problem a business problem, a personal problem, or both? Before you make the decision to file for bankruptcy, take time to list all your debts, assets, and income. Include every debt and list who signed it. Decide whether your company is viable, if you want to keep operating, and whether the debts are business or personal. The answer may be personal bankruptcy, business bankruptcy, or both.