Can Chapter 7 Bankruptcy Benefit Your Sole Proprietorship?

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Most people view bankruptcy as an extreme last resort, but it can often have real benefits for businesses with excessive debt. However, bankruptcy may seem complicated and fraught if you're a small business owner with a sole proprietorship. The lines between personal and business assets can become blurred in this arrangement, so how can Chapter 7 work for you?

The answer can be complicated, so it's usually best to work with a bankruptcy attorney to determine if a Chapter 7 filing is right for you. Still, there are many situations where filing for bankruptcy can help you eliminate your debt or even continue to operate your business. If you're still unsure, ask yourself these three questions to help determine if this process may benefit you.

1. Do You Have Substantial Personal Assets to Protect?

Chapter 7 bankruptcy does not distinguish between personal and business assets if you operate a sole proprietorship. One of the advantages and downsides of this business arrangement is that it acts as a "pass-through." In other words, there's little legal distinction between you and the business that you operate.

As a result, a Chapter 7 filing may put your personal assets at risk. If you have substantial personal assets exceeding your business debt, a bankruptcy trustee may be able to sell these. While Chapter 7 may still be the right choice for you, you should consult with an experienced attorney first to ensure that any critical assets are exempt from sale.

2. Does Your Business Require Minimal Operating Assets?

To continue operating your business, you'll need to retain sufficient assets. Unfortunately, the bankruptcy process will usually involve liquidating many of these items. The good news is that federal and state laws generally allow you to exempt certain property as "tools of the trade." The total exemption amounts will vary depending on where you live.

Although these exemptions generally don't allow you to keep substantial assets, they usually provide enough protection for businesses that don't require large amounts of machinery or equipment. For example, plumbers, contractors, and similar business owners can typically exempt many of their tools, allowing them to continue to operate their businesses.

3. Is Your Debt Primarily Business-Related?

One complication with Chapter 7 bankruptcy is the need to meet a means test. If your income is too high, you may not qualify for Chapter 7. However, the situation is often more complicated for small business owners. If a majority of your debt is related to your business, you may be able to qualify for Chapter 7 filing even if you wouldn't ordinarily pass the means test.

Since bankruptcy fraud can be a serious offense and many pitfalls are involved in filing, it's crucial to consult a qualified bankruptcy attorney before you file. Even if you believe your business debt qualifies you for an exemption to means testing, always work with a lawyer to confirm your calculations.

Reach out to a firm like McManus & Associates to learn more.