Does filing business bankruptcy affect your personal credit?

On Behalf of | Feb 27, 2024 | Debt

Filing for bankruptcy when your business is drowning in debt may be the only way out of an otherwise untenable situation. However, you likely worry about how doing so might impact your personal credit.

Whether a business bankruptcy affects your personal finances mainly depends on the structure of the company and how you have operated your business.

The importance of your business structure

If you operate as a sole proprietor, you and your business are one legal entity. This means that any debts your business accrued become your personal debts, too. Therefore, filing for bankruptcy directly affects your personal credit score.

If you structure your business as a partnership, things get a bit more complex. Each partner in a general partnership is personally liable for the business debts. If the partnership files for bankruptcy, it will likely affect the personal credit of each owner. The same goes for limited partners who have a stake in the business.

However, if you registered your business as a corporation or a limited liability company, the situation changes. In these cases, you typically are not personally liable for the company’s debts because the enterprise is a separate entity. Thus, if the corporation or LLC files for bankruptcy, it should not directly impact your personal credit.

Ways business bankruptcy from a separate entity can still impact your personal credit

While LLCs and corporations should offer liability protections to your personal credit and assets, there can be exceptions. A problem could arise if you “pierced the corporate veil.”

This term means the court can remove the protection of personal assets for business owners and decide that they should be personally responsible for their company’s debts. This only occurs when an owner does not keep personal and business finance matters separate, highlighting the benefits of proper accounting practices.

Another significant factor is if you signed a personal guarantee for any business loans or debts. This essentially means you pledged your personal assets or credit to secure the business debt. If the business files for bankruptcy and fails to clear these debts, your personal credit will likely take a hit.

Similarly, certain types of business taxes that you withhold from your employees’ salaries can become your personal responsibility if you leave them unpaid. Bankruptcy does not usually discharge these tax obligations, which can adversely affect your credit if you do not address them.

Clearly, you can take steps to prevent a business bankruptcy from impacting your personal credit. However, this involves careful planning and good accounting in your operations.