Whether or Not to Close Shop or File Bankruptcy
Most small-business owners in the United States in 2026 whose business is not salvageable do not need to file for bankruptcy for the company itself. The best path forward for them is to close the business in an orderly manner, then separately determine whether bankruptcy protection is the right path for the owner personally. Filing for business bankruptcy is primarily needed when either (1) the business is salvageable and can restructure its debts (usually under Subchapter V of Chapter 11), or (2) the business is under pressure from lawsuits, asset seizures, or allegations of owner misconduct, and wants a court-supervised liquidation for order and cover. This decision largely depends on personal exposure, including signed guarantees, unpaid payroll taxes, and business legal structure.
A Chapter 7 bankruptcy filing on a failed LLC or corporation by an owner of the entity may not bring quite the result that one might expect. Section 727(a)(1) of the Bankruptcy Code limits the application of a Chapter 7 discharge to an “individual.” Thus, while a Chapter 7 trustee will liquidate whatever assets a business entity that filed a Chapter 7 has, the entity will not officially be “discharged” of its debts. That is, the company is simply done. There is nothing to collect from the company. A Chapter 7 entity filing costs $338 (court fee) plus attorney fees. The benefits of the automatic stay from creditors, neutral control of assets, and payment to creditors according to the priority set out by the Bankruptcy Code are a real benefit to a creditor that may feel that the owners are trying to prefer one creditor over another, or that the owners have applied the business’s assets to their own use.
Personally Liable
Guarantees are why the owner is more important than the business entity. When a business files bankruptcy, the owner’s guarantees of a business lease, bank loan or equipment financing are not forgiven. Simply closing the business doesn’t cancel out the guarantee either. One example is the many SBA loans granted due to the pandemic. If the COVID Economic Injury Disaster Loan is over $25,000, there is a blanket lien on business assets. If the loan is over $200,000 there is a personal guarantee. The guarantor does not get out of the guarantee by closing the business. If the business fails to make loan payments for 120 days, the Treasury Department will take over collection and impose a 30% collection fee and can garnish wages and tax refunds. Owners whose business debts make up the majority of their debt are exempt from the Chapter 7 means test, so a personal Chapter 7 can usually discharge the guarantee.
Unpaid payroll taxes are the most dangerous debt in any closing. Under Internal Revenue Code section 6672, the IRS can make any responsible person personally liable for 100% of the income tax withheld from employees’ paychecks plus the employees’ share of Social Security and Medicare tax. The employer’s matching share is not part of the penalty. Liability turns on actual control over which bills get paid and on willfulness. Choosing to pay other creditors while knowing the taxes are unpaid can be enough. The penalty is treated as a priority tax under sections 507(a)(8)(C) and 523(a)(1)(A), so personal bankruptcy does not discharge it. The penalty also survives the company’s closure.
In Warnement v. United States, the Court of Federal Claims described the payroll-tax penalty. INgage Networks was a software development and consulting firm that withheld taxes from its employees’ paychecks during seven consecutive quarters from July 2012 through March 2014. It never paid over the withheld funds to the IRS. The liability ultimately totaled more than $609,000. The Court held its CEO was willful because he was aware of the unpaid taxes while the company continued to issue raises and hires, and continued to pay other bills. His status as a responsible person is in dispute because there is conflicting evidence regarding his control over the business, and that will be determined at trial.
Invalidate Some Prior Actions
Timing is key for any choice of action, however, because the bankruptcy code may invalidate some prior actions. Section 547 of the code allows a trustee to claw back payments made within 90 days prior to bankruptcy that gave a creditor more than it would have received in a liquidation. In the case of insiders like owners, officers and their relatives, this clawback period is extended to one year. Section 548 of the code allows a trustee to invalidate any transfer made within two years of bankruptcy where the company was insolvent at the time and received less than fair value or where the transfer was intended to defraud creditors. State fraudulent-transfer laws often allow clawback actions up to four or even six years. If, for example, an owner pays back a personal loan to the company, or transfers equipment to a new business, prior to a subsequent bankruptcy, he or she could have to disgorge the money or property.
Final Dissolution of an LLC or Corporation
(4) The procedure for the final dissolution of an LLC or corporation outside of the Bankruptcy Code is also a matter of state law, and compliance with that procedure will protect the principals from liability.
The Delaware corporate statute is a good illustration. A Delaware corporation in dissolution can follow either one of two processes. It can go through the court-supervised process under sections 280 and 281(a) of the statute, wherein it provides notice to potential claimants and obtains a court order confirming the adequacy of the reserves. It can also establish its own plan under section 281(b), which is sufficient if it is calculated to provide adequately for the claims that will come forward in the next 10 years. Directors who comply with either process are not liable to the company’s claimants under section 281(c). The latter procedure is easier, but more risky for directors if the reserves prove to be inadequate.
An assignment for the benefit of creditors is a middle option between an informal closing and Chapter 7. In an assignment for the benefit of creditors (ABC), a company transfers all its assets to an independent assignee chosen by the company. The assignee then liquidates those assets and pays the proceeds to creditors in the order in which the bankruptcy court would. ABC is often faster, cheaper and more private than the federal bankruptcy court system. Asset sales are often completed before customers and key employees can defect. There’s a tradeoff, though. An ABC does not automatically stay lawsuits by creditors, and owners remain liable under personal guarantees. There are state-law differences, too, with some states requiring more court intervention than others.
Federal Tax and Employment Law Obligations
Any closing, even without bankruptcy, involves federal tax and employment law obligations. At the end of the quarter of the last paychecks, the company must file a final Form 941 or 944 with the Internal Revenue Service. A box on the form must be checked to show the business is closed and there is a line for the date when the final wages were paid. The form requires an attached statement identifying who will retain the payroll records. A final Form 940 must be filed, and employee W-2s by the date the final 941 is due. The final income tax return must be designated final. Under the federal WARN Act, employers with 100 or more employees must generally give 60 days’ notice in writing of plant closings that would affect 50 or more employees at one location. Failure to provide the notice subjects the employer to back pay and benefits for up to 60 days. Some states impose similar obligations for smaller employers; Iowa’s law applies to employers with 25 employees and California’s applies to employers with 75.
Subchapter V is the right course of action for a business that is worth saving and it is becoming popular. Petitions to reorganize under Subchapter V rose 11 percent to 2,446 in 2025 and 50% to 1,663 in the first half of 2026. The plan must be filed in 90 days and only the debtor can file the plan. Payments are based on estimated disposable income for three to five years. As the absolute priority rule does not apply in Subchapter V, business owners don’t have to pay unsecured creditors in full to maintain their equity ownership in the company. Typically, there is no creditors’ committee, disclosure statement, or quarterly U.S. Trustee fees but a Subchapter V trustee is appointed and paid from the estate. The Chapter 11 filing fee is $1,738.
the current Subchapter V debt limit is $3,424,000 for cases filed on or after April 1, 2025. (The pandemic limits of $7.5 million expired on June 21, 2024, when the sunset of the $7.5 million limit took effect.) Congress passed the Bankruptcy Threshold Adjustment Act of 2026, H.R. 7730, in the House on September 16 and in the Senate on September 28. It is pending the President’s signature as of early October 2026. It would make the $7.5 million limit permanent with an inflation adjustment every three years, and make the Chapter 13 limits a single $2.75 million limit. The increased limits would only apply to cases filed on or after the date of the enactment of the law, so a company with debts in-between the two limits will want to take special note of the date of the law’s enactment.
For a Sole Proprietor
The answer to the question as to whether or not to close shop or file bankruptcy for a sole proprietor is the same as above: The debt of the business is the debt of the sole proprietor.
The debts of the business cannot be separated from the debts of the sole proprietor if the business closes. The sole proprietor may only obtain relief by filing a personal bankruptcy under Chapter 7 or Chapter 13 of the Bankruptcy Code. A sole proprietor may retain the assets under Chapter 13 and continue to operate the business and pay off business creditors over the course of three to five years. The current debt limits for Chapter 13 bankruptcy are $526,700 for unsecured debt and $1,580,125 for secured debt. If a service provider files for bankruptcy under Chapter 7 of the Bankruptcy Code, the owner may still be able to work. While the trustee may sell the assets of the business, the trustee cannot sell a person’s services.
