No doubt, bankruptcy could be a life saver. It’s a great option to consider if your business keeps wallowing in a mire of debt and there seems to be no other way out. It could be your only resort if you keep accumulating more debt and have no way to pay off old ones. So, filing for a bankruptcy will allow you to dig yourself out of that mess. Those pesky collection agents will no longer call to harass you, and all other problems plaguing your life as a result of your business debts will stop as well.
But bankruptcy isn’t an easy way out of debt or a quick fix either. The procedure associated with filing for bankruptcy can be emotionally draining for many years. Following a bankruptcy, you will be ineligible for loans, credit cards, and other types of credit. And there are many other restrictions that you need to adhere to. In fact, you could also find it difficult to get a job. No employer wants to hire someone who cannot manage his finances well.
Bankruptcy is the worst negative record that can ever appear on your credit report. And its impact can last for many years. Because bankruptcy sends overt signals that you are not capable to repay obligations, you may not be able to get approved for credit or a loan at all during the couple of years following when you filed for bankruptcy.
Interestingly, however, not all cases of bankruptcy result in a bad credit score to the business owner. Whether a business bankruptcy will affect your personal credit depends on whether you are personally liable for your business debts under the law. This in turn depends on three factors:
- The type of business entity you registered your business as (sole proprietorship, partnership, etc)
- Whether you personally guaranteed the debts of the business
- The types of taxes owed by the business (if it owes any)
Now, let’s discuss these in more detail.
How your Chosen Type of Business Entity Affects Bankruptcy and Credit Worthiness
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a. Sole proprietorship
If you registered your business as a sole proprietorship, you will be liable for all your business debts because the law regards you and your business as the same entity. Since all the assets of the business belong to you and all the profits generated enters your pocket, then it’s not unfair to hold you responsible for the business debts.
If your business faces hard times and filing a bankruptcy is the only solution, you would have to file a personal bankruptcy. And this will affect your credit and reflect on your credit report for up to ten years.
b. General partnership
If you registered and operate your business as a partnership and are a general partner, you are personally responsible for all of the business debts along with your partners. Since the partnership owns the assets of the business and share the profits generated by the business, the partners remain responsible for any unpaid debts incurred by the business if the debts cannot be paid from the liquidation of the partnership property.
Even though a partnership bankruptcy can be reported in your name as one of the partners in the business, the fact that you once filed for bankruptcy should not show on your credit report since it was not a personal bankruptcy.
c. Limited Liability Company
If you operate your business as a corporation or limited liability company, you will, under most circumstances, not be held liable for your business debts. The business can file for bankruptcy in its own right, and your personal credit will not be affected in the least.
Except in very few cases, neither the business bankruptcy nor the business debts should show up on your credit report. However, there are instances when an LLC or corporation bankruptcy can affect your personal credit worthiness. For example, when your business is owing taxes and when you have signed a personal guaranty.
How Business Bankruptcy Affect Your Personal Credit Worthiness
1. Business taxes
Certain types of business taxes, if unpaid, may become your personal responsibility—even if your business is an LLC or a corporation. Sales taxes and other taxes that you withhold from your employees’ salaries or that you collect from others are often referred to trust fund taxes. While your business is expected to transmit these taxes to the government, the money used to pay the tax belonged to the employee or customer.
So, if you collect these taxes and fail to transmit them to the taxing authority, you will be charged with personal responsibility. And this will badly affect your personal credit score, especially if a tax lien is filed against you and recorded in public records.
2. Personal guarantees
Creditors usually require that owners or managers of a small business sign a personal warranty before issuing credit to the business. By signing such a guaranty, you are agreeing to be held responsible for the payment of the business debt. And if the business files for bankruptcy while the debt is not paid in full, you will need to pay the debt or have it recorded as an unpaid obligation against you. This will definitely affect your personal credit score.