If you are a sole proprietor, you may be able to wipe out both your personal and business debts by filing Chapter 7 bankruptcy. Read on to learn more about what a sole proprietor is and how a Chapter 7 bankruptcy might be able to help if you are struggling with business debt.
(For more articles on Chapter 7 and small business owners, see our Chapter 7 Bankruptcy for Small Businesses topic area.)
A sole proprietorship is an unincorporated business entity owned by a single individual. The owner is called the sole proprietor. In a sole proprietorship, the business is not a separate legal entity apart from its owner. Instead, the law treats the sole proprietor and the business as the same legal entity.
In a sole proprietorship, all business debts are also the personal obligations of the sole proprietor. This means that if you don’t pay the debt, the creditor can come after your business assets as well as your personal assets (such as your car or house) to collect it.
Because a sole proprietor’s business debts are treated like personal debts, they will be wiped out by his or her Chapter 7 discharge. Since all debts and assets of the business are also those of the sole proprietor, creditors can no longer collect from the owner or the business after discharge.
(To learn more about what debts are discharged in Chapter 7, see Which Debts Are Discharged in Chapter 7 Bankruptcy?)
Here's how Chapter 7 bankruptcy affects your business assets and income.
Since the sole proprietorship is not a separate legal entity, all business assets are treated as your personal assets and must be listed in the bankruptcy. This includes all tools, equipment, and machinery used in the business as well as any accounts receivable. The bankruptcy trustee may also require you to provide a balance sheet or an asset list.
As a result, you need to make sure that there are enough exemptions to cover all assets of the sole proprietorship. Otherwise, the bankruptcy trustee may be able to sell off all nonexempt assets which can shut down your business. However, most states have specific exemptions for equipment and tools of trade used in your business that you can use to help protect these assets.
All income earned by the sole proprietorship flows through to the individual owner. This means that you must disclose all income generated by your business in the bankruptcy. As a result, you will need to calculate and list your gross income and subtract your business expenses on the bankruptcy forms to arrive at the net income. The bankruptcy trustee will usually require supporting documentation in the form of profit and loss statements and business bank statements.
The answer depends on the amount of assets and debts the business has and whether you intend to continue operating it. It may be a good idea to file a Chapter 7 if you have a lot of business debt, no assets, and you intend to shut down the business. On the other hand, if you have a significant amount of assets and you intend to continue running the business, it may be more advantageous to consider Chapter 13 bankruptcy.