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What Happens to Debts When Dissolving a Company?

January 24, 2020 | admin

Going out of business is a tough process regardless of the reasons. Whether a small business closes because of changes in the market or a massive corporation shuts down due to advances in technology, many businesses still have some outstanding debt or tax obligations when they cease operations.

Dissolving a company with debt is a tricky situation — even though the business isn’t planning to generate revenue, there is still work for management to complete and obligations that need to be met. Most businesses don’t have an exit strategy either, which means they don’t have a plan for taking care of these tasks.

Debt is one of the most common pain points for companies that are going out of business. The liabilities for outstanding debt will vary depending on a company’s structure and what type of debt they owe. Before dissolving a company with debt, review this list of questions and practical tips to determine what steps need to be taken to ensure all financial (and legal) obligations are met.

Common Types of Outstanding Debt for Dissolved Companies

While not every business will take on debt, many companies leverage debt as part of their financial strategy. This means certain types of businesses may have more debt than others, and certain industries may trend higher in a specific category of debt.

There are a few common types of debt that almost every company will encounter:

  • Equipment leases: Businesses that need large equipment and heavy machinery are likely to have equipment leases. Private schools and medical facilities are also familiar with leasing computer equipment and other technology. With equipment leases, businesses can generally return the equipment and lower their financial obligation to the lessor.
  • Secured debt: If a business receives a loan or other credit — like a credit card — because of specific assets or liquid collateral, they have secured debt. Though more uncommon than equipment leases and unsecured debt, some businesses are able to acquire secured credit options. As with equipment leases, secured debt may be reduced by surrendering the security deposit or collateral.
  • Unsecured debt: Arguably the most common type of debt that companies will have, unsecured debt is any lines of credit, loans, net 30 accounts, or unsecured credit cards a business may have. This can include things like inventory financing debt, as well. Unlike secured debt and equipment leases, the only way to satisfy an unsecured debt is through negotiating with creditors.
  • Tax obligations: Every business — even nonprofits — will have some type of tax obligation that, if unpaid, becomes a debt. This can be taxes owed at the local, state, or federal level, and the obligations remain on file for many years. Fortunately, most tax bodies offer payment arrangements for large balances. They may even offer to negotiate on the balance.

Debt is a relatively common instrument for managing business expenses. Even freelancers and self-employed individuals can incur debt on behalf of their business, though that debt is almost always personally guaranteed. How debt is handled if a company is dissolved, though, varies from entity to entity.

Questions Every Business Owner Needs to Ask Before Closing a Business

It can be tempting to close a business and just walk away but dissolving a company with debt requires a bit of effort from directors of the organization.

What Are the Legal Obligations to Dissolving a Company?

The company structure will determine how certain businesses dissolve, but there are common steps that apply to every organization. After a decision has been made to dissolve the business — either individually for a sole proprietorship or by a vote for an LLC or corporation — there may be steps to take at the state level to formally close the business. This varies by state and business structure.

Any fictitious business names, licenses, and permits should be canceled to avoid being billed in the future for them. At this point, a business should have a solid idea of what it owes for debts, payroll, and taxes. The last thing to do is inform creditors and employees, as well as any customers or clients.

Can a Company Dissolve Itself While it Still has Outstanding Debt?

Businesses incur tax obligations until they formally file to dissolve the company with their local, state, and federal governments. When business file, creditors are notified that the company is dissolved so no other credit is extended. This also ends any further payroll tax obligations.

Since dissolving a company is a government action, a company can close itself while there is still outstanding debt. This is good practice to avoid having any fraudulent credit accounts opened during the closing process. This doesn’t mean a business doesn’t owe the debt, though.

Does a Dissolved Company Still Have to Pay Corporation Taxes?

Every business will have different tax liabilities. Businesses that have employees will have an obligation to submit payroll taxes through the end of operations, and any sales tax that has accrued will need to be paid, as well. A final income tax return should be filed to finalize any tax obligations.

There are serious repercussions for not paying taxes. The IRS has a broader reach for collecting outstanding debts, and directors and owners may have tax obligations. Ultimately, a dissolved company needs to pay any taxes it’s incurred to avoid personal financial issues.

What Happens to Creditors if a Company is Dissolved with Outstanding Debt?

Dissolving a company with debt can be detrimental to creditors. Creditors have taken a financial risk and can potentially harm their own organization if a company doesn’t meet its debt obligations. This means creditors are motivated to collect on businesses, even if they have dissolved.

Creditors have different rights depending on the state they are in. If a company is unwilling to negotiate a settlement with their creditors, they may be subject to further collection activities, up to and including a civil lawsuit. This can increase the amount of debt a company owes.

Potential Liabilities for Company Directors

Beyond the obligations a company has to its creditors, directors and business owners may be personally liable for outstanding debts depending on their company structure.

Are Directors Personally Liable for Debt in a Limited Liability Company?

In a limited liability company, executive directors are protected from debt obligations. The reason many small businesses form an LLC is so they can protect the interests of their executive team. However, if a member of an LLC signs a personal guarantee, they must settle those debts.

An LLC doesn’t protect its members from tax obligations. If a business closes and doesn’t pay its taxes, liens may be filed against the members. These liens are public record and show up on credit reports. The IRS may even have the ability to seize assets like bank accounts and personal property.

Are Directors Personally Liable for Debt in a Corporation?

As with an LLC, a corporation affords its directors some personal financial protection. Unless an executive director has signed a personal guarantee, they won’t be liable for outstanding debts. If creditors “pierce the corporate veil,” they may be able to take action against a corporation.

Executive directors are also liable for tax obligations in a corporation. While there are ways to limit a director’s liabilities to creditors through incorporating or filing for chapter 7 bankruptcy, unpaid tax obligations can remain on a credit report for a decade and bankruptcy doesn’t get rid of them.

What Are the Personal Liabilities for Sole Proprietorships?

A sole proprietorship is a business that doesn’t have a corporate entity. There is one owner that is operating as a self-employed individual. This means they are personally liable for any outstanding debts and all tax obligations when a company is dissolved, making it a risky financial venture.

Businesses that operate as a partnership are generally similar to sole proprietorships, though both a limited partnership and limited liability partnership may have at least one partner that takes on the business’s debt obligations. An LLP affords the most protection of the three types of partnerships.

Are Directors Personally Liable for Debt in a Nonprofit?

“Nonprofit” isn’t a company structure — it’s a tax designation provided by the IRS. That means a nonprofit can be either an LLC or a corporation, offering some protection to its executive directors. There are exceptions to the protections afforded to nonprofit members, however.

A nonprofit director can be held personally liable if they harm another person, personally guarantee a financial obligation, fail to ensure tax obligations are met, cause intentional harm or fraud, or if they mix personal with nonprofit funds. Ultimately, nonprofits require an extra level of personal responsibility.

Practical Tips to Avoid Dissolving a Company with Debt

The last thing most executive directors want to deal with after dissolving a company is paying off outstanding debt. If the business is closing because of poor revenue streams, it can seem like the debt is insurmountable. This can be especially frightening for small businesses and those with personal guarantees.

Dissolving a company with debt is a tedious challenge. The best way to avoid this is to follow these practical tips for keeping business expenses in check:

  • Create a detailed budget: It’s important to know every source of income and all expenses a business may have. Start with historical data or well-researched estimates, then forecast based on that information. Incorporate sales forecasting as well as expense forecasting to gain the most insight.
  • Reduce expenses where possible: Forecasting income can be tricky, but most businesses have a pretty firm grasp on their regular expenses. With a detailed budget, it’s easy to pinpoint which expenses can be lowered or eliminated. This step should be repeated annually.
  • Keep credit requests to a minimum: The less debt a company incurs while it is operating, the less debt it will owe if it goes out of business. Though credit applications are usually different for businesses, it’s still good practice to keep outstanding debt to a minimum.

Regardless of its structure and member liability, every business should try to maintain a healthy credit portfolio. This means making payments on-time and paying off debts as soon as possible.

Why Every Company with Outstanding Debt Should Have an Exit Strategy

Every business plans to succeed but going out of business can happen for a number of reasons. Even if a business is closing without any debt, an exit strategy is critical to ensure the business doesn’t have any lingering obligations. An exit strategy offers key benefits to all businesses:

  • An exit strategy provides a timeline for completing all closing procedures. It’s critical to file formal documents as soon as possible to end any further tax obligations and eliminate the ability for additional credit. A timeline also motivates directors to get things done quickly.
  • An exit strategy ensures all forms have been filed and all notifications have been sent. Even with a timeline, it can be easy to miss certain tasks. A checklist of all the forms and notifications that need to be sent can make the process go more smoothly. This should include turning off all systems.
  • An exit strategy offers a plan for paying all debt and tax obligations. With a plan for paying outstanding debts, businesses can reduce their personal liability for any debts they may have personally guaranteed or tax obligations that might otherwise be unpaid.

Dissolving a company with debt doesn’t have to be a painful task. With an efficient exit strategy, executive directors and business owners can reduce their personal liabilities and optimize their plan for handling any outstanding debt.