What happens to contractors when employer goes bankrupt?

Question

The U.S. company at which I was a contractor has closed its doors and laid off all employees. I read in the news that all its assets were bought by another company.

All regular employees were paid up to the last day, but as a contractor, I was not. I'm still owed two paychecks. I was told that I would be getting a letter from the bankruptcy lawyers.

I read that after a Chapter 7 bankruptcy (which this sounds like), the creditors who have highest priority for being paid are "secured" creditors (whatever that means), and the second-highest are employees owed wages, commissions, and salaries.

1. Am I in the category of employees with second-highest priority? I submitted weekly invoices and was paid bi-weekly.

2. It's been just over two weeks since the job ended, and I haven't heard from the lawyers. Is there any way to know how long this process could take?

EDIT: I was an independent contractor; I didn't work through an agency. (Does anyone know if I'll have to pay taxes on money owed to me?)

Answer 1

1: no. You are among the rabble. Because you are a contractor, i.e. another business. This is part of the deal of being a contractor - you control your busienss and are responsible for your risk. And yes, your risk includes your counterparty risk. Everything not in protected groups gets pooled and gets paid pro rata from the money left over after all people with priority.

2: Well, being a business, ask your lawyer. Which likely is not worth it ;) Write off the money, you get at some point some cents for the dollar, most likely. Can take a long time.

Adding to the edit:

(Does anyone know if I'll have to pay taxes on money owed to me?)

Your accountant will know. It depends how you account (debt vs. paid). And whether you can expect to BE paid or write off the debt. Generally you can avoid paying taxes if you write it off. But really thisis a case you acutally pay your accountant for.

Answer 2

Exactly the same thing happened to me.

Short answer: Don't hold your breath waiting for the money.

Under US bankruptcy law, there is a long list of priorities for who gets paid first. Yes, "secured creditors" are at the top. That means somebody who has a lien. A mortgage usually includes a lien on the house and a car loan includes a lien on the car, etc. Employees also come near the top. I think the government comes above employees: if the company owes back taxes, those are paid before almost anything. Contractors are way, way down the list.

In my case, I got letters from the bankruptcy court for years keeping me informed of progress on the case. But I never got any money. Not one dime.

RE taxes: Short answer: No, you don't have to pay taxes on the money you were never paid.

Longer answer: You can pay taxes based on either "cash" or "accrual" method. Most businesses use the cash method, and this is the default. You have to specifically opt to use the accrual method. The cash method means that income and expenses are counted when you get or pay the money. The accrual method means that income and expenses are counted when you make the sale or commit to the payment.

If you're using the cash method, than you don't declare the income until you actually receive the money. If you never receive the money, then you never declare the income.

If you're using the accrual method, then you declare the income when you sign the contract, and pay taxes at that time. When it becomes clear that you will never receive the income, you report a "bad debt" which subtracts from your income, and thus reduces your taxes in the year that you report the bad debt. So you pay the tax and then you get the money back.