S Corp Bankruptcy Personal Liability: Everything You Need to Know
S corp bankruptcy personal liability is when a single proprietor of a small business files for bankruptcy. 3 min read updated on January 01, 2024
Updated June 25, 2020:
S corp bankruptcy personal liability is when a single proprietor of a small business files for bankruptcy. When it comes to small business owners, their liability differs from other types of business bankruptcy liabilities. A shareholder of an S corporation that is filing for bankruptcy has a personal liability for all the liabilities of that corporation. Thus, it would be important for an owner or a shareholder of the small business to understand certain important considerations entailed with filing S corporation bankruptcy.
An S corporation is a business that is classified according to the subchapter S of Chapter One of the Internal Revenue Code. The singular reason for making a business an S corporation is for federal income tax purposes. S corporations don't pay federal income taxes because the business' income or losses are equally divided between and distributed among its shareholders. It's the shareholders' responsibility to report the loss or income of the company on their own individual income tax returns.
What Is an S Corporation?
An S corporation is a small business which has a single proprietor or a small partnership. The number of shareholders of the S corporation is small, and the shareholders must be people with some exceptions.
To be an S corporation, eligibility consists of these requirements:
- It cannot have more than 75 shareholders.
- Shareholders are all people with except tax-exempt organizations, estates, and trusts.
- No nonresident aliens can be shareholders.
- It has only one class of stock.
Rules for S Corp Filing for Bankruptcy
When debts and liabilities surpass all assets and it's no longer possible to meet the financial obligations, a corporation has the option to file for bankruptcy. Classified as a small business, business income passes through the owner, or owners, and the shareholders. In the event of a bankruptcy, an S corporation isn't treated any differently from any other type of corporation.
When the owners of a business file for bankruptcy, an automatic stay is instantly put in place to prevent any attempts by creditors to collect money owed to them by the company. All of the business's creditors must cease all letters, phone calls, and any other methods of contact for the purpose of collecting the debt that the business owes them. This stay is active until the owner of the company has the chance to produce detailed financial information concerning the company's present situation to the bankruptcy court.
When the conclusion is that bankruptcy is the only solution, the business owner has to determine whether to file a Chapter 11 or Chapter 7 bankruptcy. The decision to file bankruptcy under Chapter 7 or 11 is based on the circumstances of the business's financial position and if the business can or can't move forward. If it seems that it's possible to continue operating and advancing further, company owners could file to have their business reorganized under the Chapter 11 bankruptcy.
Chapter 7 bankruptcy entails a liquidation of all company assets with those proceeds going toward paying the company's outstanding debts to the creditors. Bankruptcy court decides which of the creditors will get compensation, when they're paid, and how much. Usually, the company's debts that are not capable of repayment become discharged, and the business closes.
Chapter 11 bankruptcy is a good alternative for the business that has a means to reorganize and continue its operation. When filing for Chapter 11 bankruptcy, the completion of a reorganization strategy is done for presentation to the bankruptcy court for authorization. If the choice is to file Chapter 11, a payment plan is an integral part of the reorganization strategy. If the bankruptcy court doesn't accept the reorganization strategy, the business will have no other option but to file for Chapter 7 bankruptcy.
S Corp Bankruptcy Personal Liability Questions
S corp bankruptcy personal liability occurs when owners of an S Corporation file for bankruptcy. If you are facing possible bankruptcy with an S corp that you own or are a shareholder of, you may have questions regarding how to proceed with an S corp bankruptcy and what your personal liability is. If that's the case, a lawyer would be essential in advising you on what you need to do.
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