Business vs Personal Bankruptcy: Which Should You File?

You formed an LLC or corporation to separate your business from your personal life. But when it comes to bankruptcy, that separation isn't as clear as you think.

The harsh reality: Business bankruptcy does NOT discharge your personal guarantees. If you want relief from business debt you personally guaranteed, you need personal bankruptcy—not business bankruptcy.

This guide explains the critical differences and helps you choose the right option.

The Critical Distinction

Business Bankruptcy

• Who files: The business entity (LLC, corporation, partnership)
• What's discharged: Business debts only
• Your personal liability: NOT discharged if you signed personal guarantees
• Your personal credit: Not directly affected (but creditors can still sue you personally)
• Typical chapters: Chapter 7 (liquidation) or Chapter 11 (reorganization)

Personal Bankruptcy

• Who files: You as an individual
• What's discharged: Your personal liability for debts (including personal guarantees on business debts)
• The business: Not directly affected if separate entity (LLC/corporation). Affected if sole proprietorship.
• Your personal credit: Severely impacted (7-10 years on credit report)
• Typical chapters: Chapter 7 (discharge) or Chapter 13 (repayment plan)

The Personal Guarantee Problem

This is the #1 misunderstanding:

Business owner thinks: "I'll file business bankruptcy and my business debts go away."

Reality:

1. Business files Chapter 7
2. Business debts are discharged
3. Business entity closes
4. Creditors turn to you personally for debts you guaranteed
5. You're still on the hook for 100% of guaranteed debts
6. Creditors sue you, garnish wages, lien your home

The Solution: If you personally guaranteed business debts, you need personal bankruptcy to discharge your liability.

See our Personal Guarantee guide for detailed explanation.

Decision Tree: Which Bankruptcy to File?

Scenario 1: Sole Proprietorship

Legal Structure: You and the business are the same legal entity (no LLC, no corporation)

Answer: Personal bankruptcy only (Chapter 7 or 13)

Why: There's no separate business entity to file bankruptcy. Your personal bankruptcy includes all business assets and debts automatically.

What Happens:

• You file Chapter 7 or Chapter 13 personally
• All business debts are included
• Business assets become part of bankruptcy estate
• Trustee may sell inventory, equipment (unless exempt)
• Business typically closes
• You get fresh start, can start new business after discharge

Scenario 2: LLC/Corporation, No Personal Guarantees

Legal Structure: Separate entity (LLC or corporation)

Personal Guarantees: None

Answer: Business bankruptcy only (Chapter 7 or 11)

Why: You have no personal liability. Business bankruptcy handles business debts. You're protected.

What Happens:

• Business files Chapter 7 (liquidation) or Chapter 11 (reorganization)
• Business debts discharged
• Your personal credit unaffected
• Your personal assets protected
• You can start new business immediately

Note: This scenario is RARE. Most business loans require personal guarantees.

Scenario 3: LLC/Corporation, With Personal Guarantees, Want to Keep Business

Legal Structure: Separate entity

Personal Guarantees: Yes

Goal: Discharge personal liability but keep business operating

Answer: Personal bankruptcy only (Chapter 7 or 13)

Why: Personal bankruptcy discharges your guarantee liability, but business entity continues.

What Happens:

• You file personal Chapter 7 or 13
• Your personal guarantee liability is discharged
• Business entity is NOT in bankruptcy
• Business continues operating
• Creditors can still pursue the business entity for the debt, but not you personally

Practical Result: If business has no assets and you were the only guarantor, creditors often write off the debt. Business survives, you're free of personal liability.

Scenario 4: LLC/Corporation, With Personal Guarantees, Business Closing

Legal Structure: Separate entity

Personal Guarantees: Yes

Goal: Close business, discharge all debts

Answer: Personal bankruptcy (business doesn't need to file)

Why: If business is closing and has no assets, there's no point in filing business bankruptcy. Just let it dissolve. File personal bankruptcy to discharge your guarantee liability.

What Happens:

• Close business (stop operations, dissolve entity with state)
• File personal Chapter 7
• Personal guarantee debts discharged
• No assets for creditors to pursue
• Clean slate

Cost Savings: Personal Chapter 7 costs $1,500-3,500. Business bankruptcy costs $15,000-75,000. Why pay for business bankruptcy when the entity is dead anyway?

Scenario 5: LLC/Corporation, Significant Assets, Want to Reorganize

Legal Structure: Separate entity

Business Assets: Real estate, equipment, inventory worth keeping

Goal: Restructure debt, keep business operating

Answer: Business Chapter 11 (possibly also personal Chapter 13)

Why: Business has value worth preserving. Chapter 11 lets business restructure debts while continuing operations.

What Happens:

• Business files Chapter 11
• Automatic stay stops all collections
• Business continues operating under court supervision
• Debts restructured via reorganization plan (pay 40-60% over 3-5 years)
• If you guaranteed debts: You may also need personal Chapter 13 to discharge your personal liability

See our Chapter 11 guide for detailed process.

Chapter Options Compared

Business Bankruptcy Options

Personal Bankruptcy Options

Filing Both Business and Personal Bankruptcy

Sometimes you need to file BOTH:

When You File Both:

• Business has significant assets that need orderly liquidation (Chapter 7 business)
• You have personal guarantees (Chapter 7 personal to discharge)
• Business is worth saving (Chapter 11 business) + You have substantial personal debt (Chapter 13 personal)

Which to File First?

Typically: Business first, then personal

Why:

• Business bankruptcy automatic stay stops creditor lawsuits against business
• After business bankruptcy resolves, file personal to discharge guarantee liability
• Cleaner process, avoids conflicts between two cases

Alternative: File simultaneously

• Can file both on same day
• Coordinated approach
• Requires experienced attorney
• Higher legal fees

What Each Bankruptcy Discharges

Business Chapter 7 Discharges:

• Unsecured business debts (vendor invoices, business credit cards not personally guaranteed)
• Lease obligations (business can reject unfavorable leases)
• Business contracts

Business Chapter 7 Does NOT Discharge:

• Personal guarantees: You're still liable personally
• Trust fund payroll taxes (personal liability of owners/officers)

Personal Chapter 7 Discharges:

• Personal guarantees on business loans ← Most important
• Business credit cards you personally signed for
• Personal credit cards
• Medical bills
• Personal loans
• Deficiency balances (after repossession/foreclosure)
• Old income taxes (3+ years, meeting specific criteria)

Personal Chapter 7 Does NOT Discharge:

• Trust fund payroll taxes: NEVER dischargeable
• Recent taxes (under 3 years old)
• Student loans (rare exceptions)
• Child support, alimony
• Debts from fraud or willful injury
• DUI-related debts

Impact on Your Credit

Business Bankruptcy

• Business credit: Business credit score destroyed, but business is closing anyway
• Personal credit: No direct impact on personal credit report
• BUT: If business debts become personal judgments (via guarantees), those DO report to personal credit

Personal Bankruptcy

• Chapter 7: Stays on credit report for 10 years
• Chapter 13: Stays on credit report for 7 years
• Credit score: Drops 130-200+ points initially
• Recovery: Can rebuild to 650+ within 2 years with secured cards, on-time payments
• Mortgage: Can qualify in 2-4 years (FHA/VA) or 4-7 years (conventional)

Common Scenarios: Real Examples

Example 1: Restaurant Owner, Personally Guaranteed SBA Loan

Facts:

• Restaurant LLC (separate entity)
• $300K SBA loan, personally guaranteed
• Restaurant closed (COVID)
• Owner has $80K equity in home, $40K in retirement

Wrong Approach: Business files Chapter 7

• Restaurant LLC debts discharged
• Owner still owes $300K personally (guarantee)
• SBA sues owner personally
• Liens home, garnishes wages

Right Approach: Owner files personal Chapter 7 (business doesn't file)

• Restaurant closes (just dissolve with state, no bankruptcy needed)
• Owner files personal Chapter 7
• $300K personal guarantee discharged
• Home and retirement protected by exemptions
• Cost: $2,500 vs $15,000 for business bankruptcy
• Result: Clean slate in 6 months

Example 2: Manufacturing Business, Wants to Reorganize

Facts:

• Corporation with $2M revenue
• $800K debt ($400K equipment loans, $400K vendor debt)
• Equipment worth $600K
• All loans personally guaranteed
• Business is viable if debt restructured

Solution: Business Chapter 11 + Personal Chapter 13

• Corporation files Chapter 11
• Cramdown equipment loans to $600K (fair market value)
• Pay vendors 40% over 5 years
• Owner files personal Chapter 13
• Discharges personal guarantee liability while restructuring business
• Result: Business survives, owner protected, creditors get more than in liquidation

Example 3: Sole Proprietor Contractor

Facts:

• Operates as sole proprietor (no LLC)
• $150K business credit card debt
• $50K equipment financing debt
• $200K total business debt

Solution: Personal Chapter 7 only

• No separate business entity exists
• Files personal Chapter 7
• All business debts included automatically
• Equipment may be surrendered or exempted
• $200K debt discharged
• Can start new business (as LLC this time) after discharge

Strategic Considerations

Timing: When to File

• File before judgments: Bankruptcy discharges debts easily. Judgments create liens that survive bankruptcy in some cases.
• File before wage garnishment: Automatic stay stops garnishment immediately
• File before asset transfers: Transferring assets right before bankruptcy = fraud. Wait 2+ years after transfers.
• Business first, personal later: Resolve business, then discharge personal guarantees (within 4 years to avoid restrictions)

Asset Protection

Before filing personal bankruptcy:

• Maximize exempt assets (retirement contributions, homestead)
• Don't hide or transfer assets (bankruptcy fraud)
• Document legitimate transfers (paying rent, utilities is fine)
• Consult attorney about state-specific exemptions

Tax Consequences

• Debt forgiveness = taxable income: If you settle or discharge debt, IRS sends 1099-C
• Bankruptcy exception: Debts discharged in bankruptcy are NOT taxable income
• Insolvency exception: If you're insolvent (debts exceed assets) when debt is forgiven, it's not taxable

This is a huge advantage of bankruptcy over settlement. $100K settled debt = $25K tax bill. $100K discharged in bankruptcy = $0 tax bill.

When You Don't Need Bankruptcy

Bankruptcy isn't always necessary. Consider alternatives:

Business Is Solvent

• Try negotiation first
• Debt restructuring with existing lenders
• Refinancing at better terms

Debt Is Small

• Under $50K: Settlement may be cheaper than bankruptcy
• Under $25K: Payment plans, hardship programs

You're Judgment-Proof

• No assets, no income above exemption limits
• Creditors can't collect anything from you anyway
• Wait for statute of limitations to expire (3-6 years)

One Major Creditor

• Negotiate directly (SBA Offer in Compromise, settlement)
• Bankruptcy costs $3K+, settlement might cost less

Frequently Asked Questions