Can I File a Personal Chapter 7 If I Am a Partner in an LLC?

By Timothy Mucciante

You can file a Chapter 7 bankruptcy, the same as any other person, even if you are a partner (known as a "member") in a limited liability company (LLC). However, filing for personal bankruptcy will affect your LLC ownership. State laws typically require that the bankrupt member be disassociated from the LLC. Each state regulates LLCs differently, but some have adopted the Revised Uniform Limited Liability Company Act, passed in 2006 by the National Conference of Commissioners on Uniform State Laws and recommended for adoption by all states.

LLC Management

An operating agreement signed by all LLC members details their rights and responsibilities. The LLC is a hybrid business form, combining advantages of a corporate structure and a general partnership. A corporation insulates its shareholders from personal liability, just as the LLC protects its members from personal liability. However, a corporate shareholder may be subject to double taxation: the corporation is taxed and the shareholder is also taxed on dividends received. As in a general partnership, LLC members pay tax on income they receive. No income tax is assessed against the company itself.

Legal Requirements for an Individual Bankruptcy

Any person may file a Chapter 7 bankruptcy, seeking protection from creditors. The Chapter 7 bankruptcy trustee is appointed to administer the bankruptcy by collecting and liquidating the assets of the debtor. Among the assets that could be seized by the Chapter 7 trustee is any LLC ownership interest of the debtor. If the bankruptcy trustee takes over the disassociated member's interest, he then stands in the shoes of the expelled member, assuming the former member's LLC rights and responsibilities specified in the operating agreement.

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Member Disassociation

State laws, following the model uniform LLC law, require that a LLC member be automatically disassociated from the LLC when he files bankruptcy. By automatic disassociation, the bankruptcy trustee will not be able to include the member's LLC ownership in the assets to be liquidated. A result of this disassociation, depending on the exact language of the operating agreement, is that other LLC members have the automatic right to purchase the interest of the bankrupt LLC member.

Preset Mandatory Buyout Provisions

The operating agreement may fix the process to be followed by the other members when purchasing the disassociated member's interest, such as finding its value by independent appraisal. An appraisal may not be necessary if the operating agreement includes a mandatory price at which the interest must be purchased. Depending on the success of the LLC, the mandatory price may cause a significant loss for the member declaring bankruptcy. No matter the price at which the member's interest is purchased, the disassociated member is still responsible for any debts owed to the LLC.

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What Happens to My LLC If I Declare Personal Bankruptcy?
 

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Tax Differences of LLCs & PCs

A limited liability company is a company, typically with a small number of owners, known as members, that enjoys the same limited liability benefits as a corporation. All states now allow one-member LLCs; some states allow professionals to form professional limited liability companies, or PLLCs. A professional corporation, or PC is a special type of corporation designed for professionals such as lawyers and accountants. LLCs and PCs are taxed quite differently.

Do I Have to Dissolve My LLC if My Partner Is Insolvent?

Limited liability companies have certain advantages, such as allowing owners to enjoy liability protection similar to a corporation while being taxed like a partnership, thus avoiding double taxation. But an LLC also has disadvantages, such as when one member, or owner, becomes insolvent and has to declare bankruptcy. Even if there are only two members in an LLC, one member becoming insolvent doesn't necessarily mean that the LLC has to dissolve, but it can cause problems. Because an LLC is an independent legal entity formed under state laws, those laws dictate what follows.

What Is a Pro Rata Share for an LLC?

LLC is the abbreviation for limited liability company, which is an unincorporated business structure created under and governed by state law. If formed correctly in accordance with state law, the LLC is a legally recognized entity that allows the owners, who are called members, to enjoy limited liability and tax treatment similar to that of a partnership. This means that members incorporate business revenue into their personal income taxes. This is called flow-through taxation because the revenues and deductions flow from the business entity to the individual members. Given membership structure and tax treatment, to determine how to allocate profits, deductions, expenses and losses, many LLCs provide for distribution based on a member’s pro-rata share.

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