By: Lance T. Denha, Esq.
As the economic meltdown lingers, layoffs continue and jobs remain hard to come by for many. However, a silver lining exists for many of these individuals as they have turned to entrepreneurship. Obviously, the struggles of the entrepreneur are very real for many of these folks and they may still find it difficult to make ends meet. While it may be an opportunistic time to take one’s financial future into their own hands, it is also important to understand that self-employed individuals who fall on hard times at any point in the business process have several options. A common option sought by many in today’s environment is bankruptcy.
Deciding to file bankruptcy is a big step that might help alleviate the financial situation for a business owner, self-employed individual or a business. If you are self-employed, filing for bankruptcy is essentially the same for you as it is for the average employee. The only difference between the filing of bankruptcy for a business owner versus an employee is that that the self employed individual is required to document his or her income to the bankruptcy court. A bankruptcy trustee is generally more strict with respect to the self employed individual compared to the W-2 employee filing for personal bankruptcy as income and/or expenses could be manipulated.
As part of the bankruptcy filing, it’s important to provide the necessary documentation showing proof of income. There are many self-employed individuals who are facing financial difficulty and who are under a false assumption that they do not qualify under the new Chapter 7 and Chapter 13 bankruptcy laws. Being a self-employed individual can make your bankruptcy case more complex. If a self employed person wants to file Chapter 7 bankruptcy, a test known as the “means test” considers the amount of income the self employed person was paid from his business during the prior six months including salary and profit distributions. The “means test” does not look at the business’ gross income or business expenses. Whether you are filing for Chapter 7 or Chapter 13 bankruptcy, self employed individuals need to provide clear statements of their current monthly income.
The Bankruptcy Code defines current monthly income as the average income for the six months prior to your filing for bankruptcy. This can become a problem for the self-employed individual because it’s unlikely that any payroll so taken resulted in a check with a paystub being issued every month tracking such income. While the former may be problematic in terms of providing the proof needed for verification, profit and loss statements or bank statements are an effective and accepted method of accounting for income. Therefore, as a self-employed debtor, it is important to be disciplined about tracking expenses in order to take control of and benefit from a fresh start offered from a discharge in bankruptcy.
Self employed individuals who file for bankruptcy should understand that as a debtor, when one files for bankruptcy protection, creditors are prevented from collecting on debts until the bankruptcy process is completed. This is called the automatic stay which effectively requires all creditors to “stay.” Although creditors may request to have the courts lift the stay and proceed to collect judgments against the debtor, creditors must file a motion for relief from the stay, and such motion may be granted only after notice and a hearing and the showing of cause. The burden is on the creditor to make an initial showing of cause. Absent such showing, relief from the stay will be denied. The ultimate determination whether to lift a stay depends upon the facts underlying a given motion which will be determined by a bankruptcy judge.
We strongly recommend that if you are a business owner planning to file for bankruptcy, that you retain the following specialists: a Certified Public Accountant (C.P.A.) and Bankruptcy Attorney. The latter will help determine an accurate income calculation for you and your business. A C.P.A. can help the self-employed individual determine what are legitimate business expenses and can assist in calculating accurate Profit and Loss Statements which will be necessary in a bankruptcy case. How much creditors can collect against a self employed individual depends on the nature and structure of the business. Bankruptcy attorneys should work in conjunction with estate planning attorneys and corporate attorneys, in addition to C.P.A.’s. The reason for this working relationship is to understand the manner in which the business was structured initially. This teamwork with other professionals is highly advisable in order to ensure the highest level of representation on behalf of the business owner/debtor.