Small Business Bankruptcy and Personal Debts

Posted by on August 10, 2012 in Financial Services [ 0 Comments ]

bankruptcyNo matter the state of the economy, starting a new small business is difficult. If you’ve invested in a small business and it fails, recovering can be difficult. Whether your basic accounting wasn’t enough to manage the finances or you simply couldn’t turn a profit, bankruptcy might be on the table for consideration. Some business owners decide to turn to filing bankruptcy when their small business fails. Because most small businesses are unincorporated, the company debts are personal liabilities of the business owner. Michelle White, a professor at the University of California, San Diego and a senior economist for RAND, explains that when a small business owner acquires debts, thosebusiness debts are legally personal debts. White, along with a number of legal and tax advisors, suggest that small businesses should file bankruptcy under Chapter 7 of the United States Bankruptcy Code and many have taken that advice.

If you qualify for Chapter 7 and file, you’ll be provided with two forms of personal and professional protection. First, owners of failed businesses can file for personal bankruptcy. In doing so, their unsecured personal and business debts will be discharged. Their future earnings are exempt from the obligation to repay debt, so they can start new businesses or accept jobs without having their future earnings taxed to repay their pre-bankruptcy debt. Second, business owners must surrender current assets that are above an exemption level set by the state in which they live. Because exemptions vary by state, states with higher bankruptcy exemptions are more attractive to entrepreneurs.

If you’re considering filing for bankruptcy under Chapter 7, here are a few statistics about the filings and small business bankruptcy.

  • In 2001, some 70% of the 1.5 million bankruptcy filings were Chapter 7 cases.
  • Between 2008 and 2009, the number of bankruptcies rose 40 percent, from 43,546 to 60,837.
  • Chapter 7 filings totaled 992,332 in 2011, down 12.9 percent from the 1,139,601 Chapter 7 filings reported in the 2010 calendar year.
  • Research by bankruptcy scholars Robert Lawless and Elizabeth Warren suggests that filings related to a business failure make up close to 15%.

Filing for Chapter 7 isn’t as easy as many people think. As part of the bankruptcy law introduced in 2005, any bankruptcy petitioner filing Chapter 7 must first qualify under the bankruptcy means test, which looks at the debtor’s income, assets and expenses. Of course, there are court fees and document fees that are a part of the filing process. If you operate your business as a sole proprietorship, you and your business are one. The debts of both you and your business are personal debts. Therefore, if you are a proprietorship, you are required to include both your personal and business debts in your bankruptcy filing. This is one reason many small business owners file a personal bankruptcy when their business fails. Because the personal investment can be so great, the debts are often synonymous. Keep in mind that Chapter 7 filing involves total liquidation of assets and dissolution of your business and know that you’ll be released from debt in a matter of a few months if you’ve filed Chapter 7.

Chapter 7 bankruptcy is often a good option for owners of small businesses who have invested most of their money into the business. Not only will you be able to get a “fresh start” as an individual, but you’ll also be receiving a fresh start for the working world.  Many small businesses choose to file their business bankruptcy as a personal bankruptcy because as a business loses money, so does the individual who has invested time and money. If your businesses isn’t succeeding and has a negative cash flow, it may be time to consider filing for Chapter 7 bankruptcy.

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