Do you work from home? Are you an independent contractor working virtually? Are you an entrepreneur who monetized a hobby or craft and sells your product online?
If this sounds like you, and you are now struggling financially due to the coronavirus pandemic, filing bankruptcy might be the way to get free of bills and continue to operate your home business. This information is from the office of a noted bankruptcy lawyer in Philadelphia.
Can I File a Personal Bankruptcy and Discharge Business Debt?
Yes, if you are an independent contractor, a sole proprietor, or a single-member LLC.
Independent contractors are those who work on an hourly or per-project basis for someone. They are not considered employees and do not receive any benefits such as medical insurance, pension contributions, or group life insurance. Income tax and other federal, state, or local deductions are not taken from their wages.
Instead, independent contractors receive a 1099 from their employer as a record of their earnings for the year and pay state and federal taxes themselves. Some independent contractors earn enough to pay taxes on anticipated earnings quarterly.
Because independent contractors are responsible for paying income tax, they can also take deductions for business expenses such as office space, utilities, internet, office supplies, phone line, fax line, computers, and computer supplies.
What happens when work drops off and those monthly expenses remain to be paid? If an independent contractor has less work but the same or only slightly fewer expenses, they must make up the difference somehow. If they resort to credit cards to pay the bills each month and can afford to only pay the monthly minimum payment on the balance, the balance quickly spirals out of control and becomes unaffordable due to high-interest rates.
Filing bankruptcy can help independent contractors get back on their feet and continue to work as much as work is available, but it is only a temporary fix unless and until more work can be found, or there is a further round of government assistance in the form of stimulus checks and enhanced unemployment benefits.
Sole Proprietors and Single-Member LLCs
These business entities are “flow-through” entities in that the person and the business are considered one and the same for income tax purposes. For this reason, people who have organized their business as a sole proprietorship or an LLC can file a personal, or individual, bankruptcy case and have both business debt and personal debt discharged or reorganized.
These entrepreneurs can find themselves in the same situation as independent contractors. Perhaps there is less demand for their service or product due to the pandemic, or the cost of providing that service or product has risen. Bankruptcy can help you get back on track.
How Does Bankruptcy Work?
Filing bankruptcy under Chapter 13 of the federal Bankruptcy Code allows you to repay arrears on debt over your three-or five-year plan and get some unsecured debt discharged. This may be just what those with small businesses need to get out from under mounting debt and get back on their feet.
This is how Chapter 13 works: you disclose your income, expenses, assets, and debts in your Chapter 13 petition and schedules. You also file a proposed three- or five-year repayment plan. The length of the plan and how much you will pay depends upon how much disposable income you have, how much and what kind of debt you need to repay, and whether you are paying some or all of your attorney fee through your plan.
A Chapter 13 debtor has the power to do the following through their plan:
- Pay mortgage arrears;
- Pay car loan or lease arrears;
- Pay child or spousal support arrears;
- Pay income or sales tax arrears;
- Pay government fines or fees;
- Catch up with student loan payments;
- “Strip off” a HELOC or second mortgage as unsecured and get it discharged if the home is worth less than the amount owed on the first mortgage;
- “Cramdown” a car loan to the current retail value, and pay it off through the plan at prime plus 1-3% interest.
Once your plan is confirmed, you pay the Chapter 13 Trustee monthly until the three- or five-year term is up and you have fully funded your plan. Then, any remaining general unsecured debt is discharged, meaning, you are no longer responsible for paying it.
What is general unsecured debt? Most credit card debt and all medical debt are general unsecured debt that is eligible for discharge. Some credit cards’ contracts, especially those white-label credit cards from jewelry stores, appliance stores, and big-box stores grant the lender a security interest in whatever you purchased with that card. Be aware that that type of lender may want the collateral back or to negotiate a payoff for the collateral.
For many small businesses, getting unsecured personal and business debt discharged is enough help to allow them to get back on their feet. Perhaps unanticipated medical expenses due to COVID-19 caused the untenable debt or a temporary dip in demand for products or services due to pandemic restrictions affected your income. Regardless, before filing bankruptcy, you should know what is not considered general unsecured debt and cannot be discharged:
- Unpaid child support
- Unpaid alimony or spousal support
- Some unpaid income tax
- Unpaid sales tax
- Some unpaid government fines or fees
- Most student loans
What if I Just Can’t Continue Business Operations?
If you do not have a continuing income stream and cannot fund a Chapter 13 plan, you can still file bankruptcy under Chapter 7 and get free of debt. You must pass a “means test” to qualify to file Chapter 7 bankruptcy. The Chapter 7 means test evaluates your income and some expenses and determines whether you earn too much to file. Most people considering Chapter 7 pass the means test.
Chapter 7 is called “liquidation bankruptcy” because the Chapter 7 Trustee has the power to seize your assets and sell them for the benefit of your creditors. For independent contractors, sole proprietors, and single-member LLC, this includes both business and personal assets. Any remaining unpaid unsecured debt, both personal and business, is discharged in four to six months and the business ceases to exist.
Before considering whether filing Chapter 7 is right for you, evaluate the worth of your assets and determine whether you can “exempt” them from the bankruptcy estate and place them out of reach of the Chapter 7 Trustee. There are both federal and state exemption schemes, and in some states, you can choose between them. In this way, you can exempt the equity in your house, a vehicle, collectibles, sporting equipment, office equipment, household goods, jewelry, and other personal belongings.
Although your current business will cease to exist after your Chapter 7 case is discharged and closed, there is nothing preventing you from opening and running another business in the future, perhaps even doing the same work or producing the same product.
Hopefully, this is a temporary downturn in your business. If either Chapter 7 or Chapter 13 can help you discharge debt and move on, know that you can discharge or reorganize both your personal debt and your business debt in bankruptcy.
About the Author: Veronica Baxter is a legal assistant and blogger living and working in the great city of Philadelphia. She frequently works with David Offen, Esq., a busy Philadelphia bankruptcy lawyer.