Bankruptcy Options for the Colorado Small Business Owner

July 30, 2012

By: David M. Serafin

As a Denver and Aurora, Colorado tax and bankruptcy lawyer, I regularly represent entrepreneurs who own and manage a small business – typically a one or two person LLC or S Corporation. Many small business owners, in today’s tough economy, have seen skyrocketing debt combined with a loss of revenue and have personally guaranteed substantial business debt. For the overwhelming majority of Colorado business owners overwhelmed by debt, a chapter 7 or chapter 13 personal bankruptcy filing makes the most sense for several reasons.

First, only individuals and not corporations or partnerships are eligible for a discharge of debt. A small business owner who is personally liable for business debt can eliminate some or all liability for such debt in personal bankruptcy while winding up the business operations of the corporation or partnership in lieu of a business bankruptcy. Conversely, because discharge is not available to a corporation or partnership, a business filing only makes sense in the case of a high amount of payroll taxes owed or if it’s easier to appoint a trustee to deal with a high number of creditors who need to be stopped from collecting against the corporate debtor.

A business owner with primarily non-consumer debt is eligible for chapter 7 relief regardless of income and expenses. Non-consumer debt includes business credit cards and lines of credit, and even personal income and payroll taxes. Whether mortgage debt from a rental property is classified as non-consumer debt may hinge on whether such property has ever been used for personal reasons. Bankruptcy debtors with at least 50% non-consumer debt are not required to complete Form 22A (e.g. the Means Test).

For those with mainly consumer debt (e.g. personal mortgage, credit card debt and medical bills), the Form 22A will determine whether chapter 7 can be filed in Colorado. With self-employed debtors, a Profit and Loss Statement and Balance Sheet will determine which chapter is available or appropriate. From a monthly income/expense standpoint, the Profit and Loss Statement information can be imputed into the Form 22A in calculating median family income under Colorado guidelines.

But, even if the small business owner qualifies for chapter 7 (regardless of whether the Means Test is completed), a next question arises as to whether it is more advisable to file chapter 13. If the Balance Sheet indicates that the business has value or equity (in excess of liabilities) regardless of income, a chapter 7 filing will lead to the trustee (acting on behalf of the best interests of unsecured creditors) seizing the assets or requiring that the asset’s value be paid to the Bankruptcy Estate. Chapter 13, particularly for those with valuable inventory or equipment used for operations, allows the debtor to keep and pay back the non-protected value of the property over a three to five year plan, while staving off creditors. Chapter 13 also allows for the curing or pay back of a commercial or investment property mortgage to stop foreclosure.

Chapter 13 is also more advantageous from an income and employment tax perspective (unless the debtor can get rid of a large income tax liability for older years in chapter 7). Many small business owners in Colorado fall behind on estimated tax payments and payroll then run into problems with the Internal Revenue Service or State of Colorado for recent tax years which cannot be discharged. For non-discharged taxes, chapter 13 stops the further addition of interest and penalties to allow the debtor to pay these back for up to five years. Those who are held personally liable for the Trust Fund Recovery Penalty portion of payroll taxes can also pay this back without additional interest and penalties.