Bankruptcy Options for the Self-Employed

Pondering the possibility of filing bankruptcy is never a pleasant thing. If you are at the point of considering this, you’ve likely already gone through an extended period of financial turmoil. It is difficult to make wise decisions after enduring a stressful financial setback, and this is especially true if you own your own business or are otherwise self-employed. Why? Because, as you’ve likely discovered by now, most financial transactions are more complex if you are self-employed because the simple act of proving your income is, well, no longer simple. Employed individuals can simply produce check stubs that show year-to-date earnings. Self-employed individuals have a lot more hoops to jump through.

Bankruptcy 101

Whether self-employed or working for a company, the basics of bankruptcy are the same. The most common personal bankruptcies fall under Chapter 7 or Chapter 13.

Chapter 7 bankruptcy is seen as wiping the slate clean because it discharges almost all debt and allows the individual a second chance at successfully managing their money. Your income level is considered, and if you make too much money, you may not qualify for Chapter 7 relief. But if you qualify and choose to pursue this course of action, there are a couple of things you need to be aware of. Chapter 7 requires the debtor to liquidate assets to pay creditors as much as possible and then wipes out any remaining debt with only limited exceptions. Such exceptions include, but are not limited to:

  • Child support
  • Alimony
  • Student loans
  • Debts resulting from wrongful death judgments
  • Debts resulting from willful injury judgments
  • Income Tax Liens
  • Debts resulting from fraudulent conduct

Chapter 13 bankruptcy is similar to Chapter 7, however, all qualifying assets are not liquidated and not all debts are discharged (or at least not nearly as many as are discharged in Chapter 7). Instead of wiping out most of the individual’s debt, under Chapter 13, debt is rearranged and managed so that some debts are paid off over time.

How Does Self-Employment Affect Bankruptcy?

Self-employed individuals have the same right to file for bankruptcy as any “other-employed” person, and the options are essentially the same. But because self-employed people are essentially self-reporting their own income, there are hoops they must jump through that don’t apply to others. In order to prepare for these proof-of-income hoops, here are some steps you should take as soon as you begin to even consider bankruptcy.

Separate and Organize All Financial Ledgers
The first thing that you want to do is make sure that your personal finances and your business finances are very clearly separated. This may be easier for some people than others. If you are a freelancer, chances are that your personal and professional accounts are somewhat mixed. If you have an actual, separate business, you may already have well-categorized records. Since this is something that self-employed people should always do, chances are good that you’ve already implemented an appropriate accounting system. But if you have not yet done this, do it immediately. You will need at least six months of records for the bankruptcy court, and you don’t want to present chaotic records that are impossible for the court to interpret.

Make sure that your records clearly show all income and expenditures for both you and your business. The clearer and more organized you are, the easier you make it on the court, and the easier you ultimately make it on yourself. You’ll have the respect of the court (which can only help you), and you’ll streamline your own case in the process.

Gather Debt Documentation
Organize all of your creditor information. This includes vendor contracts, loans, and any other debt for both you and your business. You don’t want to forget a creditor, because that will result in your debt to that creditor not being discharged. So be sure your records are complete.

Accurately Report Your Income
Under-reporting your income is dangerous. Obviously, this is exactly what courts are leery of when it comes to handling bankruptcy cases involving self-employed people. The opportunity and temptation to under-report is simply too great, so courts must insist on multiple records to verify claimed income amounts.

However, accurately calculating your income when you are self-employed can prove to be a daunting task. You don’t want to over-report, but you cannot under-report either because that can get your bankruptcy claim thrown out. The only way to know for sure that your figures are accurate is to use an accountant or attorney who is experienced at calculating an accurate income figure. The following is a list of documents you can use to verify and calculate your income:

Check stubs
If you work for a specific company or companies as an independent contractor, then chances are good that you receive some type of check from them. You should have or create a system to track these checks so you can use them to prove income.

Invoices and Employment contracts
If you routinely invoice your customers, then these documents are proof of income as well. If you rarely invoice your clients, you may want to consider beginning the practice. Alternatively, an employment contract can be used for the same purpose.

Bank Statements and Income Tax Returns
These days, it is easy to get bank statements by going online. Likewise, if your yearly income tax returns are filed electronically, pulling up these documents is as easy as the click of a mouse. These documents go a long way in verifying all income claims, particularly when the deposits line up with invoices and employment contracts.


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