LLC Bankruptcy: A Step-by-Step Guide

Posted on
A man blocking domino pieces from falling while holding up a red tile that says bankruptcy.

Estimated reading time: 5 minutes

If you’re reading this and have a growing pile of debt stacked up against your LLC, bankruptcy might be your best option. No business owner wants to have to do this, but if it’s done right, it’ll relieve a great burden from your shoulders.

In this blog post, we’ll break down what happens if an LLC files bankruptcy and how to formally dissolve your business, so you can move forward with a fresh start.

What happens when an LLC files bankruptcy?

If an LLC goes out of business because it can’t pay its debts, it files for bankruptcy. When this happens, the company’s assets are sold to pay off creditors, and any debts remaining are wiped clean. In most cases, you as the business owner are not personally responsible for any of the company’s debts. But there are instances where you would be personally responsible.

For example, landlords, banks, and other creditors often require personal guarantees when a business is just starting out. If you signed any of these guarantees, you may also need to file personal bankruptcy.

In short, when it comes to business bankruptcies, LLC owners agree that it’s the best course of action to get back on track.

Should my LLC file chapter 7 or Chapter 11 bankruptcy?

Because an LLC is a separate legal entity from its individual members, it can file a Chapter 7 or Chapter 11 bankruptcy in its own name. What’s the difference between the two?

Chapter 11 bankruptcy

Small business owners usually shy away from Chapter 11, because it’s expensive, risky, time-consuming, and extremely complex. But some choose it because chapter 11 is the only bankruptcy option that allows small business owners to continue in operation (if it is owned by a partnership, limited liability company, or corporation). Chapter 11 is also the only bankruptcy option for individual business debtors who want to reorganize but owe too much money to meet Chapter 13’s eligibility requirements.

Chapter 7 bankruptcy

This is the easiest and most commonly used form of bankruptcy for LLC owners—but it comes at a price. If the decision is made to file chapter 7, LLC owners can’t continue operation of their LLC. In short, filing this chapter will shut down the company for good. As we mentioned earlier, during this process, available assets are sold, and creditors are paid. Partnerships, limited liability companies, and corporations are all eligible to file bankruptcy under Chapter 7. And depending on their income, individuals who own and operate small businesses as sole proprietorships may also file bankruptcy under Chapter 7. 

What happens after the bankruptcy proceedings?

Filing for LLC bankruptcy (chapter 7) and finishing the proceedings doesn’t spell the end of your business. You must formally dissolve it, or it will continue to exist in the eyes of the state.

This is dangerous because (depending on the state), even after declaring bankruptcy, LLC owners may still be expected to file annual reports, pay fees, and minimum taxes.

By dissolving your LLC, you avoid these requirements, and it places any remaining creditors on notice that the LLC can no longer incur business debts.

So, now that you know you have to dissolve your business, what are the steps to dissolution?

  • After the dissolution is approved file the documents with your state.
  • Ensure that you file your specific state’s forms and closely follow its procedures.
  • File your completed documents (these documents are available through the Secretary of State). 
  • If required, get a certification from state tax authorities to show your LLC is current on its tax debt.
  • Notify any remaining creditors that your LLC is being dissolved.
  • If your business is registered in other states, you must file the dissolution documents in each state where the LLC is registered to conduct business.
  • Let the Internal Revenue Service (IRS) know that your LLC is closed and request to cancel the company’s Employer Identification Number (EIN).
  • Complete other tax-related steps as stipulated by the IRS.
  • If your LLC has a registered agent, notify them of your LLC bankruptcy and dissolution.
  • Notify licensing authorities and ask how you can surrender your business license.

You’ll also need to sell all tangible assets such as fixtures and equipment. You can then use the proceeds to pay debts, including outstanding taxes. It is important to get rid of all remaining LLC assets before formally dissolving the company.

In conclusion

The decision to file for bankruptcy and dissolve your business is both difficult and painful. Difficult because the process can be so time consuming, and painful because you put your heart and soul into your LLC—filing bankruptcy will feel like the end of world at first.

But remember, it’s not. There are resources available to help make this transition as smooth as possibly, and with a slight mindset change, you’ll see that this isn’t the end of the road—but the beginning of a whole new adventure!

Incorporating is the most powerful thing you can do to legitimize your startup. And at IncAuthority.com, our setup LLC services are 100% free. Always. So, don’t wait. Form your new LLC today and enjoy the protection due to you and your business under the law.

Related Articles:

Share this article: