Filing Ch7 with an S-corp in the Picture

[MikeW]

Hi, first post here. I have a few questions about filing ch7 when a business is involved. I run a very small online store, which is an S-corp and I've always been the 100% owner. If I include my business property in the ch7, I will exceed the property exemptions available in Florida by about $2,000. I really have nothing personal property-wise that could be seized. I know they're not going to take my clothes and dishes. My real "seizable" property is all business property (office equipment and supplies) and product inventory. Well, I need this property to continue with the business. So I'm wondering if it's possible to protect it from seizure. Really, I would like to keep the business completely out of the picture. Is that possible? I just started purchasing from a good manufacturer, that offers 30 day net terms. The last thing I want to do is lump them in with the other creditors. If they receive a letter in the mail about my ch7, that would ruin the relationship. The same goes with the corporate credit card that I need it to make business purchases. The s-corp is over 10 years old now. I don't know if that would help me in terms of separating business property and debt from personal property and debt?

In order to make ends meet, I deliver pizza at night. My 2001 SUV is worth about $3,000. (You're allowed $1,000 auto equity in FL.) I'm wondering if there could be any protection available there, since like the business property, I rely on the vehicle to make a living. It doesn't just get me to and from my job. It IS my job.

As of 3 weeks ago, I stopped paying my mortgage, because I could no longer afford the payments and my credit cards are maxing out (about $20,000 owed on credit cards). When the time comes, I will be applying for a short sale. Realistically though, I realize that most short sales don't get approved. So there is a good chance that it will go to foreclosure. That is the main reason I'm considering ch7 - to protect myself from the mortgage company. If I do file ch7, I think I need to do it as soon as possible, while I'm still broke.

Thanks for reading and thanks BK Forum for providing this great resource! I'm learning alot already.

MikeW

[TheBajan]

Mike,
Welcome! We had an S-Corp that we closed last year. We sold the assets and shut it down. The income was disclosed and accounted for long before we filed which was this past February. Please take what I say as just my understanding and it can be flawed. I'm basing it on my understanding of tax law... not BK law. If the assets are owned [titled] to the S-Corp, then you don't own them. However... what you do have is 100% share of the corporation. The BK can look at the value of the corporation itself and add it's value to your personal assets, just as they would with any other stock or bond you might own. Does that make sense? I don't believe they can seize the business equipment and so-forth but they can seize your share of the company. So, if the corporation is worth $50K, they can make you buy back the non-exempt amount of that $50K.

If there is anyone out there with more experience in this area of law... PLEASE correct me. This is just how I understand it would work based on the tax laws and what our atty told us before we dissolved the business.

The other thing you mentioned has to do with a manufacturer you are doing business with on credit terms as well as a business credit card. BK law REQUIRES that you include ALL of your creditors regardless of whether you are current or behind. If this is credit in the name of the corp only, it's not relevant. However, if you personally guaranteed the credit... you are personally liable and must disclose it. So, if your situation where reversed and it was the s-corp filing BK instead of you personally, would you be liable for the debts of the business? If the answer is yes, then it's personal debt and must be disclosed. Hope that helps. I'm certain there are people here with more knowledge to add that will be helpful. If you haven't already done so, be sure to speak with several attorneys and write down your questions as they come up. Don't hold back any information... be completely honest and see what they say.
Best of luck to you!
The Bajan

[MikeW]

Thanks Bajan! That makes sense. Since I'm filing ch7 on a personal level, the business is seen as a personal asset. This is great news because my shareholder basis as of year-end 2012 was a measly $16. I'll have to look at the numbers, but I'm thinking my current basis is somewhere in the same ballpark. Can somebody verify that shareholder basis in the s-corp is the number that would be used when looking at my exemption amounts?

I'm still going to exceed the personal exemptions, but only by a small margin. I'm going to look into the procedure for buying back property.

As far as the business supplier is concerned, no personal credit app or personal credit check were performed. But I did sign a personal guarantee. I'm thinking I can play dumb on this one though. How thorough are they about requesting copies of credit apps to suppliers for businesses you own? That would be pretty hard to verify.

[frogger]

Thanks Bajan! That makes sense. Since I'm filing ch7 on a personal level, the business is seen as a personal asset.

? No, your shares in the s-corporation are a non exempt asset.

This is great news because my shareholder basis as of year-end 2012 was a measly $16.

Give the trustee more credit than that. Your "personal shareholder basis" is a figure that is easily manipulated.

I'll have to look at the numbers, but I'm thinking my current basis is somewhere in the same ballpark. Can somebody verify that shareholder basis in the s-corp is the number that would be used when looking at my exemption amounts?

Your s-corp has no exemptions. Period.

Your "books" are of no relevance. Period.

Your corporate and personal tax returns, including depreciation schedules, are very relevant.

All that matters are the assets/liabilities of the corporation, which determines the value of your shares.

I'm still going to exceed the personal exemptions, but only by a small margin. I'm going to look into the procedure for buying back property.

You're rushing things. If the trustee is interested in your property, you will receive the paperwork compelling you turn items over to the trustee. Then, you worry about purchasing them back.

As far as the business supplier is concerned, no personal credit app or personal credit check were performed. But I did sign a personal guarantee. I'm thinking I can play dumb on this one though. How thorough are they about requesting copies of credit apps to suppliers for businesses you own? That would be pretty hard to verify.

You signed a personal guarantee, therefore, they are a creditor and MUST be listed on your petition.

And on a side note... "playing dumb" is going to cause you a world of hurt.

Do this right, and do it right the first time. Don't attempt to play games.

[TheBajan]

Thanks Bajan! That makes sense. Since I'm filing ch7 on a personal level, the business is seen as a personal asset. This is great news because my shareholder basis as of year-end 2012 was a measly $16. I'll have to look at the numbers, but I'm thinking my current basis is somewhere in the same ballpark. Can somebody verify that shareholder basis in the s-corp is the number that would be used when looking at my exemption amounts?

I'm still going to exceed the personal exemptions, but only by a small margin. I'm going to look into the procedure for buying back property.

As far as the business supplier is concerned, no personal credit app or personal credit check were performed. But I did sign a personal guarantee. I'm thinking I can play dumb on this one though. How thorough are they about requesting copies of credit apps to suppliers for businesses you own? That would be pretty hard to verify.

Mike,
The shareholder basis is not determined on a dollar figure but rather on the percent of the company that you own. In other words, regardless of how much much you personally invested in the corp, if you are the only shareholder, then you own 100% of the corporation and value of that asset is equal to the current value of the corp. Does that make sense? It's like buying a stock at $40 ten years ago and now that stock is worth $10. Your asset value is $10 rather than the $40 you spent on it. It doesn't matter if you spent $16 to start this corp or if you spent $16,000. Your shares in the company are valued at the current value of the company [corporation]. I agree with Frogger regarding the issue of non-disclosure. Don't try to play games like that. Be honest from the start and don't try to hold back anything. You can really end up in a world of hurt!
Best of luck to you.

The Bajan

[MikeW]

Thanks Frogger. I appreciate your black and white way of putting this in perspective.

Give the trustee more credit than that. Your "personal shareholder basis" is a figure that is easily manipulated.

This does make sense because my next question was going to be "Who does the legwork to verify that my basis number is accurate?"

I saw the sticky post from anonymuse in the Exemptions sub-forum, concerning exemptions for tools of the trade. (I'm still too new here to post the link.) Would it be a pipe dream to expect an exemption for my business property? Every bit of it is necessary for me to earn a living. It would only bring in about $1,000 at garage sale though. But my vehicle, maybe $3,000. In anonymuse's sticky post, he mentions that if your vehicle is an integral part of your job, then you may be eligible for a vehicle exemption. Since I deliver pizza at night, if such an exemption is available in Florida, I can't see why I wouldn't be a candidate. At what stage in the process are exemptions determined? Is that something I would be able to get a handle on before I file for ch7? I'll be researching this in the meantime, because it raises alot of questions.

One more question about the business supplier. If they are listed as a creditor, is it automatic that they will be notified of the ch7? Or only if they are owed money?

Thanks again.
MikeW

[MikeW]

Mike,
The shareholder basis is not determined on a dollar figure but rather on the percent of the company that you own. In other words, regardless of how much much you personally invested in the corp, if you are the only shareholder, then you own 100% of the corporation and value of that asset is equal to the current value of the corp. Does that make sense? It's like buying a stock at $40 ten years ago and now that stock is worth $10. Your asset value is $10 rather than the $40 you spent on it. It doesn't matter if you spent $16 to start this corp or if you spent $16,000. Your shares in the company are valued at the current value of the company [corporation]. I agree with Frogger regarding the issue of non-disclosure. Don't try to play games like that. Be honest from the start and don't try to hold back anything. You can really end up in a world of hurt!
Best of luck to you.

The Bajan

Thanks Bajan. I was just under the impression that your were talking about shareholder basis when you mentioned the value of the corporation. Normally, I think of the value of a corp being its Retained Earnings balance, which in my case, matches my adjusted shareholder basis of $16. Now I understand that the trustee will be more interested in what real value my assets have.

[DeadManCrawling]

I will tell my story, as best I can, and try to relate it to yours. If you have questions, I will be happy to answer,

We filed CH 7 with a Sub S Corp that was our main source of income. The Corp provided about 15k per month in income, after expenses. The income, large as it may seem, was based entirely on my skill in a field that cannot be done by anyone else. Imagine an actor or artist. This is important because the equipment involved, while highly specialized, would have been of almost no value to an average auction buyer. To someone in the same business it might have been worth tens of thousands. However, trustees are not generally interested in taking a year or two to liquidate such things.

As a result, our attorney had us value the equipment at typical garage sale prices for general electronics like computers and answering machines. Worthless, in other words.

The value of the Corp was entirely based on myself and our connections to clients and suppliers. In anyone else's hands, that value evaporates.

The basis we had in the Corp was high. In excess of 200k. Basis is something that is not easily transferred and cannot be sold. There are reams of tax laws about this, all federal. I learned about this originally the hard way, through a divorce. My ex owned 49% of the company and accounted for about 100k in basis. On divorce, her basis had to be accounted for, but could not transfer to me, though I owned the Corp after the divorce. The end result was the basis disappeared and I had to pay the IRS 50 k in taxes and penalties. I won't pretend to know the laws behind this, but bring it up to explain that basis, no matter how large, is not something a trustee can seize or use against you, even to try to get a buyback. It simply cannot happen.

Our cases seem to differ on one important point. You have a large supplier and need a credit card or line of credit to keep operating.

If I were you, with an attorneys advice or a lot of research, here is what I would suggest.

Your supplier makes money from you selling their product. It is in their interest, as well as yours, for you to continue in business. If you know them well enough, or even just enough that you are a promising future prospect, discuss this with them. In our case, we had a very large accounts receivable number. Over 70k. We asked all of our vendors, without explaining the BK, to get paid up, and gave them a deadline. Our excuse was that we were changing accounting software, and would apply a penalty after that date. They all paid. Every one. Then we spent that money on items that were covered under exemptions. Dental care, insurance, groceries, new equipment, medical needs, eyeglasses. In essence, we caught up on everything we had been neglecting to keep up with bills.

We filed our BK at the point when we had received and SPENT all the money. But BEFORE any new billing was due to us. We carved a donut hole into our year and used it, legally, and correctly.

Once you file, any money that comes in is yours.

Another possible difference between our cases is inventory. I would suggest you run inventory down to zero so there simply is nothing to worry about. If this is possible, I would ask your suppliers and vendors if they would mind direct shipping. We considered taking a month-long "vacation" during the BK filing period for the same reason. By doing so, you would not actually hold any inventory and business would go on as usual, with the vendors and suppliers doing the shipping. This also would allow them to remain oblivious to the BK filing. And it is legal.

Your office equipment is essentially worthless. The value in any business is the people and relationships with customers and vendors. Without you, there is very little chance that anyone but an expert in the same field can run your business, even in the short-term.

Finally, since you are going to be losing the house, go ahead and do so straight up. Put it in your filings. The reason is that your exemption level, in Florida, increases from the 1k personal property limit up to 5k, I believe. It might be higher. It doubles if you are married. But you can only take advantage of it if you are not claiming the homestead exemption.

Our case sailed through, with no problem. All of the above business information, including equipment, basis, previous accounts receivable, future accounts, and so on, were included in our schedules. We also had to include 5 years of tax returns, personal and corporate, to verify everything.

Even with what were, I think, quite large numbers, no questions were raised. It was all beautifully within the law. That is one thing I would strongly recommend AGAINST. If you are even slightly unsure about what is legal, ask an attorney, or err on the side of the trustee.

One example. We were right against the limits on the exemptions, after including our business gear. I had a lovely BMW Z-3 that I adored. We MIGHT have exempted it (married, double exemptions), but given everything we were already exempting, I noted it on the schedules as being NOT exempt. The trustee mentioned it at the 341. She asked, "The BMW? You don't want to try to exempt it or buy it back? I can probably sell you the difference at a decent price?" I said "No, I have claimed everything I really need, and it's only fair that the creditors get SOMETHING out of this. Also, I just don't want to try to squeeze it into the exemptions." We signed the title over to the court and they auctioned it.

In terms of the credit card you need for business, i cannot offer much advice. I would suggest talking to your main supplier(s) and seeing if they can extend a line of credit, to begin AFTER you file the BK. If that is not possible, I do not have any ideas. There is, generally, no credit card that survives BK. Rarely they do, but you cannot plan your business future on that chance.

If I can offer any other suggestions, or relate details on my own experience, please let me know, either here, or via PM if it is too personal.

I know from experience that your business CAN survive BK. It is all a matter of understanding the law, using it to your advantage, and most importantly planning, planning, planning. We took 3 years from the moment we decided to file BK until we actually did so. Most of that time was spent researching the law and how it related to our specific case.

One last thing, I almost forgot. We got through with such large income because we also had giant expenses. Our home, which we surrendered, cost about 8k per month just to operate. That was mortgage, HOA, lawn, insurance, maintenance, utilities, and so on. Yes, it was obnoxiously big, really a bit arrogant. But those expenses ended when we filed BK. Due to the strange case law in Florida middle, we were able to count the expenses of the home on the means test. However, the income did not factor into our schedules, and did not force us into a 13. It is all about knowing the law and using it.

Again, let me know if I can help in any way, and good luck to you.

Best,

DMC

[LadyInTheRed]

At what stage in the process are exemptions determined? Is that something I would be able to get a handle on before I file for ch7? I'll be researching this in the meantime, because it raises alot of questions.

You list all of your assets on one schedule of your BK petition. On another schedule, you apply exemptions to whatever assets you can. Your attorney will help you apply exemptions and can tell you what will qualify as a tool of trade if your state has a tools of trade exemption. The trustee can object to your exemptions if he/she doesn't agree with the value of the property or believes you applied the exemptions incorrectly.

[tobee43]

i filed TWO separate petitions, one personal and one for the S-corp...even though i had some personal guarantees we had to fight the creditors and we won...ALL of them. as these guarantees were signed personally as a s-corp, and held under the s-corp protection... and it was discharged and closed.

did it cost us. absolutely. but in the end we were in a much better position. again two separate petitions, one for us, and one for the company.

[MikeW]

Thanks for the help guys!

I will tell my story, as best I can, and try to relate it to yours. If you have questions, I will be happy to answer,

Thanks for the thorough response Deadman! I really appreciate your input on this. (It looks like you found me from my other post. I wasn't able to post the link because I am new on the board.) Our cases are very similar, except my dollar amounts are much lower and I'm single. That's amazing that in 3 years, you were able to continue earning that kind of money, yet simultaneously spend it within the legal framework in amounts and in places that kept you around the exemption limits. That gives me something to strive for!

These are the exemptions for Florida, taken from the attorney's handout:
- $1,000 equity in a single vehicle in your name
- $1,000 per person for personal property
- 100% for homestead - unless you have lived in your home for less than 1215 days, then the bankruptcy code limits the exemption to $137,500 of equity
- $4,000 wild card exemption per person if you aren't claiming homestead exemption
- Compensation claims (unemployment and workers)
- Most life insurance, 401K's, retirements, annuities, and IRA's
- Wages, but not commissions (if head of household)
- Florida Prepaid College - 529B / Social Security / Disability

If I can exempt some business property, I should be well below the $5,000 total. I'm guessing that inventory is taken at cost, not garage sale value. If it was taken at garage sale value, then it would be too easy to simply buy up a ton of inventory before filing and use that to your advantage.

With the business, I can't ask the manufacturer to drop-ship for me. But I was thinking about offering to prepay them. It's not much money. We're talking 3 or 4K. I just don't know where that prepayment would put me legally. That's why I need to read up on exemptions, payments to creditors, and the ch7 timeline itself. I don't work tonight, so I should have some study time.

You list all of your assets on one schedule of your BK petition. On another schedule, you apply exemptions to whatever assets you can. Your attorney will help you apply exemptions and can tell you what will qualify as a tool of trade if your state has a tools of trade exemption. The trustee can object to your exemptions if he/she doesn't agree with the value of the property or believes you applied the exemptions incorrectly.

Thanks Lady. A good portion of what I have should fall under 'tools of the trade', if available to me that is.

[DeadManCrawling]

Prepayment may be an option, but you want to be very careful here. Any account you have that is "yours" or the company's still qualifies as an asset. One possible way to avoid this would be to make the prepayment agreement a nonrefundable "deposit" or some such term. This is beyond my knowledge, but I suspect there is a way to get this done legally.

The idea is that the prepayment, if it is even called that in legal terms, is not something that can be returned to you. Think of escrow money on a house that you decide not to purchase. It is refundable, but not in all circumstances.

The downside of this, of course, if that you will be absolutely tied to that particular supplier. The upside is that you will have a guaranteed method of continuing to operate. You will want to research this thoroughly. I imagine there is quite a bit of case law on the subject.

As far as inventory, no idea there. I doubt it would always be valued at cost, because, at the least, if you returned it there would be shipping and restocking fees in most cases. Good questions for an attorney, especially one with business knowledge.

Good luck in your efforts!

Edit: Where a prepayment puts your supplier, legally, is a good question, too. They are not a creditor, since you would not owe them any money, with a prepayment. It would be the reverse. That is why I suggest making any prepayment plainly irrevocable in a contract or agreement, so that it cannot be counted as an asset, either.

[DeadManCrawling]

One other note:

As far as I know Florida does NOT have a tools of the trade exemption. Unless the law has recently changed. That was one of my initial hopes when we were preparing to file, as well. But it may not matter.

Most people seriously overvalue their property, by mistake and out of ignorance of what the true value of used goods really is. Even a newer computer, once plugged in and used, plummets in value immediately. Unless you have easily sold antiques, jewelry (most people overvalue this, too), or highly sought baseball cards, you can probably fit nearly everything you need into the 5k exemption. The key is what you NEED, not WANT. That is another common mistake, the idea that people must "save" as much as they can. The relief of BK is worth losing a few "things". Things can be replaced later with better, newer things.

But if you can get through this with your business and sanity intact, you will be way ahead, and able to get your life back together.

Good luck!

[MikeW]

Thanks Deadman. I've been doing a little research on preferential payments to suppliers. This is a scary thing for companies that offer credit terms to their customers. You can receive payment for merchandise, think you are free and clear, then a month later, a bankruptcy trustee rips the money right back from you. If the payment was deemed preferential, you have to pay it back.

There is an "Ordinary Course of Business Defense" available. To make sure your payments qualify, you need to keep things regular. If you always pay near 30 days, continue doing that. Where a creditor can get in trouble is when they know you are in trouble and offer you special payment terms. Since those terms differ from the normal agreement you had, and their normal agreement across the board with other customers, it can be found to not comply with ordinary course of business.

In my case, if I pay my supplier in advance, that would be considered preferential. As far as the day-to-day orders I place with supplier, as long as I pay them in a consistent manner, those payments should fall under ordinary course of business. The expensive part will be paying an attorney to verify the numbers and the business relationship to the court. According to the articles I've read, it's very expensive and time consuming. Of course, my case is many times smaller.

[MikeW]

Thanks Deadman. I've been doing a little research on preferential payments to suppliers. This is a scary thing for companies that offer credit terms to their customers. You can receive payment for merchandise, think you are free and clear, then a month later, a bankruptcy trustee rips the money right back from you. If the payment was deemed preferential, you have to pay it back.

There is an "Ordinary Course of Business Defense" available. To make sure your payments qualify, you need to keep things regular. If you always pay near 30 days, continue doing that. Where a creditor can get in trouble is when they know you are in trouble and offer you special payment terms. Since those terms differ from the normal agreement you had, and their normal agreement across the board with other customers, it can be found to not comply with ordinary course of business.

In my case, if I pay my supplier in advance, that would be considered preferential. As far as the day-to-day orders I place with supplier, as long as I pay them in a consistent manner, those payments should fall under ordinary course of business. The expensive part will be paying an attorney to verify the numbers and the business relationship to the court. According to the articles I've read, it's very expensive and time consuming. Of course, my case is many times smaller.

It looks like I spoke too soon. After doing more research on this, I found that there are actually three possible defenses available to defend against a claim that a payment to a supplier is preferential: the Contemporaneous Exchange Defense, the Ordinary Course of Business Defense, and the Subsequent New Value Defense. Payments that occur within a 90-day window (Preference Period) of filing bankruptcy are payments that can be challenged. A payment that is mailed 95 days out, but deposited by the supplier 89 days out, would fall into that window.

The Contemporaneous Exchange Defense involves a simultaneous swapping of money for goods or services. I don't think it really matters which comes first. This is basically COD terms. Say supplier realizes you are in trouble. You may owe an old past due invoice, but supplier would still like to do business. They can use COD terms for future orders. Those payments should not be considered preferential. But if the supplier tries to apply your next payment to the old past due invoice, then that is a preferential payment. Of course you want to have a written or email record of these agreements.

The Ordinary Course of Business Defense involves payments that occur in a pattern consistent with your relationship. They use a 1-year lookback period. If you've always paid around 60 days, if you continue to do so within the 90-day preference period, then the payments should not be considered preferential.

The Subsequent New Value Defense involves making prepayments for goods or services. If you pay $1,000 up front and are later shipped $600 of goods, then the $600 should not be considered preferential. The $400 leftover would be considered preferential though. It gets complicated if multiple payments and shipments are made.

There's a good writeup and video series on all of this stuff at a website I can't link to yet. One thing I noticed is that they are careful to say "Such payments MIGHT NOT be preferential" They are very careful not to be definitive. Judging by some of the other articles I've read, courts have been inconsistent about which way they rule on these issues. Though the trend appears to be moving in the favor of the defenses.

In my case, COD terms with the supplier would be a good alternative. But this would require a supplier that is already educated on these matters. I could try and convince them that COD would be the safest payment terms for them. But it might be a whole lot easier for them to just cut things off.

One thing that isn't clear to me is the 1-year lookback period when using the Ordinary Course of Business Defense. Since my relationship with the supplier is only a month old, I might have a hard time defending the payments I've made to them. I might be able to use the long history I had with the previous supplier as an example of how I normally pay. That is definitely a question for an experienced attorney.