Will a Business Bankruptcy Affect the Owner’s Credit?
Sometimes a business owner needs to have his business – and not the owner as an individual – file for bankruptcy protection. In those instances, I am often asked if a business bankruptcy filing will affect the owner’s personal credit. The answer to that question will depend on how the business was organized, whether the owner personally guaranteed some or all the business debts, and whether certain tax debts are at issue.
Type of Business Organization
How a business is organized will determine how the business debts are treated with respect to its owners. Generally speaking, there are three types of business organizations: sole proprietorships, partnerships, and incorporated businesses.
In a sole proprietorship, the business and the owner are considered as being the same entity. As a result, any business debts are also considered the personal debts of owner. The only way to eliminate the business debts is for the owner to file for personal bankruptcy protection. In these types of cases, the owner’s credit will be affected.
If the business is a general partnership, then the partners will be liable for the debts of the business. A partnership can file for bankruptcy as its own entity. Such a business bankruptcy will not show up on a partner’s credit report. That said, the partnership’s creditors can come after a partner’s personal assets to recover on a partnership debt and can report any delinquent partnership debt on a partner’s personal credit report. (Please note that limited liability partnerships are different from general partnerships and are beyond the scope of this article.)
Finally, if the business has been incorporated as a regular corporation or a limited liability company (LLC), the general rule is that the owners are not personally liable for the business debts. Furthermore, any business bankruptcy will not affect the owners’ credit in any way.
Owner as a Personal Guarantor of Business Debt
While owners are generally not liable for any of debts of an incorporated business, if the owner or owners personally guarantee a debt as a condition of the business receiving credit, then the owner or owners providing such a guarantee are personally liable on that business debt. That means that if liquidated business assets are not enough to cover a guaranteed business debt, then the owner or owners will be personally liable for any deficiency. In these instances, only a personal bankruptcy could potentially protect the individual owners.
Certain Types of Tax Debts
Certain taxes such as sales taxes or employee withholding taxes can become a personal liability for a business owner. If the business owner collected the sales taxes and withholding taxes and failed to transmit them to the appropriate taxing authority, the owner becomes personally liable for those balances even if business is incorporated.
Bottom line: The type of business organization, whether the owner personally guaranteed a business debt, and whether certain taxes are owed are factors that determine whether a business bankruptcy filing will affect the creditworthiness of the individual owners. If you have questions about whether your business’ debts may affect your credit as an individual, feel free to give our office a call. Initial consultations are always free.