Close Down Your Small Business, Get a Fresh Financial Start
May 5, 2014
Closing down a business can leave you with huge debts and no income to pay them. Bankruptcy may be necessary and be easier than you think.
A Business Bankruptcy Means a Messy One?
A bankruptcy cleaning up the financial fallout from a closed business can be more complicated than a consumer bankruptcy case. But is not necessarily so.
In the next few blog posts I will show how a business bankruptcy can be quite a simple and effective solution.
Today I present one way a business bankruptcy can actually be easier than a consumer one.
How so? Because under certain conditions a business bankruptcy case can avoid the Chapter 7 “means test,” allowing you to legally write off (“discharge”) all your debts quickly.
The Purpose of the “Means Test”
The point of the means test is to require people who have the means to pay a meaningful amount to their creditors over a reasonable period of time to in fact do so. They aren’t allowed to simply discharge their debts.
Essentially this disqualifies people who do not pass the means test from going through a Chapter 7 case, which allows a quick discharge of most debts. Instead they must go through Chapter 13, which generally requires them to pay creditors all that they can afford to pay them over a 3-to-5-year period.
The Challenge of Passing the Means Test
To pass the means test requires either having a relatively low income (no more than the published median income amount for the person’s state and family size) or having enough allowed expenses so that little or no “disposable income” is left over. Again, otherwise you will be stuck in a 3-to-5-year Chapter 13 payment plan.
In many scenarios, a former business owner needing bankruptcy relief would not be able to pass the means test and so would have to go through Chapter 13. For example:
If, after closing his business, the owner of that business gets a well-paying job before filing bankruptcy, the income from that job may be larger than the “median income” applicable to her state and family size.
If the business was operated by one spouse while the other continued working and earned a good income, that employed spouse’s income alone may bump the couple above their applicable “median income” amount, thereby not passing the “means test.”
A former business owner who now earns more than median income can’t deduct monthly payments to secured creditors on business collateral she is surrendering—vehicles and equipment, for example—or for other business expenses, such as rent on the former business premises. This reduces the likelihood that she will have enough allowed expenses to pass the “means test.”
Skip the “Means Test” in Business Bankruptcies
The good news is that the means test only applies if your “debts are primarily consumer debts.” (Section 707(b)(1) of the Bankruptcy Code.) So if your debts are primarily business debts—more than 50%–you avoid the means test altogether.
Let’s be clear about the difference between these two types of debts. A “consumer debt is a “debt incurred by an individual primarily for a personal, family, or household purpose.” (Section 101(8).) The focus is on the intent at the time the debt was incurred. So, for example, if you had taken out a second mortgage on your home for the clear purpose of financing your business, that second mortgage would likely be considered a business debt for this purpose.
Certainly there are times when the line between a business and consumer debt is not clear. Given what may be riding on this—the ability to discharge all or most of your debts in about four month under Chapter 7 vs. paying on them for up to 5 years under Chapter 13—be sure to discuss this thoroughly with your attorney. Find out if you can avoid the means test under this “primarily business debts” exception.