Self-Employment Income and Bankruptcy: What Counts and How to Report

If you’re self-employed, you need to understand how your income is classified in bankruptcy. Whether you’re an independent contractor, gig worker, sole proprietor, or business owner, you must disclose business income along with allowable expenses. The process depends on your business structure. Independent contractors, gig workers, and sole proprietors report business income in personal bankruptcy. Business owners with separate legal entities face additional considerations.

What’s Considered Business Income in Bankruptcy?

Even if you don’t consider yourself a business owner, some income could be classified as business income. Under bankruptcy law, there are three primary categories of income.

Employment Income

You earn this money by working as someone’s employee. It includes wages, commissions, tips, and bonuses. If you receive regular paychecks with taxes withheld, you’re an employee. You also receive a W-2 tax form.

Income From Operating a Business

If you work for profit, you’re either an employee or independent contractor. Gig workers and freelancers usually receive 1099 tax forms. Money you earn from independent contract work counts as business income for bankruptcy purposes.

Other Income

Income from all sources other than work falls into this category. Examples include:

• Social Security or public benefits
• Alimony or child support
• Rental income
• Interest, dividends, or royalties
• Pension or retirement income
• Unemployment or disability income
• Lawsuit settlements
• Lottery or gambling winnings

In your bankruptcy paperwork, you must disclose all income earned during the past two years.

Business Income and Expenses

You must also disclose ongoing business income, even as a secondary source. If you work retail 30 hours weekly and write freelance articles on weekends, include both income sources.

Don’t include occasional hobby income if you won’t regularly receive it going forward.

You may deduct necessary business expenses from your income. If you earn money as a freelance wedding photographer, deduct expenses like tripods, lenses, and editing software from gross business income.

Your expense deductions must be itemized, and you may need documentation. If you deduct something as a business expense, you can’t deduct it again as a living expense.

Types of Self-Employment

Self-employment takes many forms. Bankruptcy rules stay the same whether you make side money or run a full-time company. How you’re set up affects income reporting, which debts and assets are included, and whether your business could file bankruptcy.

Here are the main types:

• Independent contractor
• Gig worker
• Sole proprietor
• Business owner

Independent Contractor and Gig Worker

Independent contractors receive payment directly from clients instead of being on payroll. You handle your own taxes, insurance, and business expenses. Most receive a 1099 tax form from each client or company.

Gig workers are a specific type of independent contractor. You find work through a platform or app. You’re still responsible for expenses and taxes. The company sends you work and pays you directly instead of finding each client yourself.

Independent contractors don’t file separate business bankruptcy. Everything is handled through personal filing. On your forms, list both total business income and expenses paid to run your business. Assets or debts connected to your work are automatically part of your personal case.

Sole Proprietor

A sole proprietorship is the default structure if you haven’t registered as another entity type. You and your business are legally the same. There’s no separation between personal and business assets or debts.

Many sole proprietors also work as independent contractors or gig workers. You usually file business taxes on your personal return using your Social Security number. Some sole proprietors apply for an Employer Identification Number (EIN).

In bankruptcy, all business debts and assets are included in your personal case. Significant business property or inventory can complicate protecting them through exemptions.

Sole proprietors can’t file separate bankruptcy for the business. It’s always handled as part of your personal filing. Report your total business income and subtract allowable expenses to show net income.

Business Owner (Separate Legal Entity)

If you’ve formed a corporation, LLC, partnership, LLP, or professional corporation, your business is a separate legal entity. It can own property, take on debt, and file bankruptcy in its own name.

In your personal bankruptcy, include:

• Wages or draws the business pays you
• The value of personal expenses the business pays on your behalf (these count as income even if money never enters your bank account)

Identifying Your Business Structure and Name

When you file for bankruptcy, the court needs to know your business setup and name. Speak with a bankruptcy attorney for free to understand how this information determines which debts and assets are included in your case.

Business Structure

Your business structure describes the legal setup of your work. In bankruptcy, this affects how your assets, debts, and income are treated.

Registered entities include corporations, LLCs, LLPs, partnerships, and professional corporations. If you’ve officially registered your business with your state, it’s a separate legal entity. It can own property, have its own debts, and file bankruptcy independently.

Sole proprietorships are different. If you haven’t registered your business as a separate entity, you’re automatically a sole proprietor. This is the most common setup for freelancers, gig workers, and small-business owners. Legally, you and your business are the same. Your personal assets and debts connect to your business assets and debts.

Business Name

You’ll need to list your business name on bankruptcy forms. How you figure this out depends on your operations:

• Registered businesses: Use the name on your official registration documents.
• Sole proprietors with a DBA: Use your trade name (like Michael’s Lawn Service or Special Moments Photography).
• Sole proprietors without a DBA: Use your full personal name, even if you contract through Uber or DoorDash.
• No business name: Some self-employed people use their own name. List that name.

If you’re unsure what to put, match the name on your paychecks, invoices, or bank deposits.

How to Calculate and Report Your Self-Employment Income on Bankruptcy Forms

When you file for bankruptcy, tell the court how much you make from self-employment. You’ll use two main forms: the Chapter 7 means test and Schedule I.

The means test covers your past six months, while Schedule I focuses on future income. Both help the court decide if you qualify for Chapter 7 and understand your finances.

Self-employment income isn’t as straightforward as employee paychecks. You might not have pay stubs. Your income might change monthly. You’ll also need to account for business expenses.

Chapter 7 Means Test Form

The means test looks at your average monthly income from the last six full months. It’s based on actual numbers, not estimates.

To calculate your self-employment income for the bankruptcy means test:

• Step 1: Gather records for the past six full months (not including the filing month).
• Step 2: Add up all money received from self-employment, including client payments, gig platform payouts, business draws, and personal expenses the business paid.
• Step 3: Add up your allowable business expenses for the same period.
• Step 4: Subtract expenses from total income.
• Step 5: Divide by six to get your average monthly income.

Bank statements, payment processor reports (PayPal, Stripe, QuickBooks), and invoices are easiest for tracking.

Schedule I: Your Income

Schedule I asks for projected future income. What will you realistically earn going forward, after expenses?

Here’s how to calculate:

• Step 1: Review your last 12 months of income and expenses to find a stable average.
• Step 2: Adjust for expected changes (gaining or losing clients, seasonal work patterns, upcoming contracts).
• Step 3: Subtract average monthly business expenses to get net income.
• Step 4: List that net income as monthly self-employment income.

The court knows projections aren’t exact, but they need to be reasonable. If you list business income on Schedule I, you may need to provide a statement of business income and expenses, often from your most recent tax return.

FAQs: Self-Employment and Chapter 7 Bankruptcy

Many self-employed people successfully file Chapter 7 bankruptcy every year. Here are the most frequently asked questions.

Can I Still Qualify for Chapter 7 if My Income Changes Every Month?

Yes, you can qualify even with fluctuating income. The means test uses a six-month average, which naturally smooths out variations. Schedule I asks for your best estimate of typical monthly income going forward. Be honest about seasonal patterns and realistic about what you expect to earn. If your income spiked temporarily during the six-month lookback period, you can explain the circumstances to the trustee.

Which Business Expenses Can I Deduct in the Means Test?

You can deduct ordinary and necessary expenses required to operate your business. These typically include supplies, equipment, software, business mileage, advertising, professional services, and business insurance. You cannot deduct personal expenses, even if you sometimes use business funds to pay them. You also cannot deduct depreciation on the means test, though it appears on tax returns. Keep receipts and be ready to explain each deduction.

Will I Lose My Tools, Vehicle, or Equipment?

Most states have exemptions that protect tools of the trade up to a certain dollar amount. Many also have vehicle exemptions. If your work equipment and vehicle fall within your state’s exemption limits, you’ll keep them. If your equipment is worth more than the exemption amount, you may still keep it by paying the trustee the non-exempt value. Discuss your specific situation with a bankruptcy attorney.

What Proof Will the Trustee Want to See?

Expect to provide bank statements for all accounts, six months of payment records, recent tax returns (usually two years), and itemized expense documentation. The trustee may also request invoices, contracts, 1099 forms, and proof of business-related purchases. Gig workers should bring platform earnings statements. Having organized records makes the process smoother and faster.

Does Hobby Income Count?

Occasional hobby income doesn’t count if it’s not regular or ongoing. If you sold some crafts at a holiday fair once, that’s not business income. But if you regularly sell items online or take commissions, even as a side activity, you must report it. The key question is whether you’ll continue earning this income going forward.

What if I Owe Back Taxes From Self-Employment?

Chapter 7 can discharge some tax debts if they meet specific conditions. Income taxes older than three years may qualify for discharge. Payroll taxes and recent income taxes generally cannot be discharged. You’ll still owe these after bankruptcy. A bankruptcy attorney can review your tax situation and explain which debts can be eliminated.

What Happens if I Personally Guaranteed a Business Loan or Lease?

Personal guarantees make you personally liable even if your business is a separate entity. These debts can be discharged in your personal Chapter 7 bankruptcy. However, if your business is an LLC or corporation, the business itself will still owe the debt. The creditor just can’t come after you personally anymore. If you’re a sole proprietor, the business debt is already your personal debt.