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Chapter 13 Conquers Both Older and Newer Income Taxes

If you owe a number of years of income tax debt, Chapter 13 allows you to favor those taxes that have to be favored, while dumping the taxes that can be dumped.

In my last blog I gave an example showing how Chapter 13 can be an extremely good way to handle income tax debts particularly when you owe multiple years of taxes. In that hypothetical case, without a bankruptcy a couple would have had to pay about $30,000 to the IRS for back taxes, plus about another $45,000 in medical bills and credit cards, a total of $75,000. And paying this huge sum of money on their income would have taken them many, many years of pressure and uncertainty. In huge contrast, in a Chapter 13 case this same couple would only need to pay about $17,500, less than 1/4th the amount. And they would be allowed to do so through pre-arranged affordable monthly payments, for three years, all the while not having to worry about aggressive actions by any of their creditors, including the IRS.

How does Chapter 13 pull this off?

1) Tax debts that are old enough are lumped in with the lowest priority “general unsecured” creditors—like medical bills and credit cards—and so in many cases do not need to be paid anything unless there is enough “disposable income” to do so. This means that often those taxes are paid either nothing—as in the example—or  only a few pennies on the dollar.

2) The more recent “priority” taxes DO have to be paid in full in a Chapter 13 case, along with interest accrued until the filing of the case, but a) penalties—which can be a large part of the debt—are treated like “general unsecured” debts rather than “priority” ones, and 2) usually interest or penalties stop when the Chapter 13 is filed. These can significantly reduce the amount of tax that has to be paid.

3) “Priority” taxes are paid in a Chapter 13 case before and instead of “general unsecured” debts. This often means that having these taxes to pay simply reduces the amount of money which would otherwise have gone to those “general unsecured” creditors. So sometimes, amazingly, having tax debt does not increase the amount paid in a Chapter 13 case. In our example, the couple paid about $500 per month for three years, which is the same amount they would have paid even if they did not owe a dime to the IRS! They met their obligations under Chapter 13 by paying the IRS instead of their other creditors.

4) The bankruptcy law that stops creditors from trying to collect their debts while a bankruptcy case is active—the “automatic stay”—is just as binding on the IRS as on any other creditor. The IRS can continue to do some very limited and sensible things like demand the filing of a tax return or conduct an audit, but it can’t use the aggressive collection tools that the law otherwise grants to it. Gaining relief from collection pressure from the IRS AND all the rest of the creditors is one of the biggest benefits of Chapter 13.

I confess that I put this example together in a way that would showcase the advantages of Chapter 13 in dealing with income tax debts. If the facts were different, the advantages could easily be less. If, for instance, more of the taxes were “priority” debts that had to be paid, the debtors would have to pay more, either through larger monthly payments or for a longer period of time. There are definitely situations where it is a close call choosing between Chapter 7 or Chapter 13, or possibly even not filing bankruptcy at all but doing an offer in compromise with the IRS. To decide what is best for you, you need the independent advice of an experienced bankruptcy attorney, who is ethically and legally bound to look out for your best interests. Regardless whether your tax debts and other circumstances point strongly in one direction or it’s a closer call, you need a professional qualified both to help you make an informed decision and then to execute on it.  

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Chapter 13 Tames Your Income Tax Monster

A “straight” Chapter 7 can write off some income taxes. But if you owe recent taxes, or multiple years of taxes, Chapter 13 is usually a much better way to go. It often provides tremendous advantages over both Chapter 7 and dealing with the IRS on your own.

I’ll illustrate this with an example, and then explain it in my next blog.

Let’s say a husband and wife owe $35,000 in a combination of medical bills and credit cards, requiring monthly payments of $800. After the husband lost his long-time job back in 2006, he followed his dream of starting a business, which was starting to make progress when it got hammered in the Great Recession. He closed it in 2010 and found a reliable job a number of months later, although one where he earns 30% less than he did at the one lost years earlier. His business had generated some income, but barely enough for the couple to meet their bare essentials. So there was no money to pay the quarterly estimated taxes, and they had no money to pay the amount due when they filed their joint tax returns for 2006, 2007, 2008, 2009 and 2010. They expect to come out even for the 2011 tax year because of tax withholdings from their wages. To try to simplify the facts, assume they owe the IRS $4,000 in taxes, $750 in penalties, and $250 in interest for each of those five years. So their total IRS debt for those years is $25,000—including $20,000 in the original taxes, $3,750 in penalties, and $1,250 in interest. The wife has had consistent employment throughout this time, with pay raises only enough to keep up with inflation. They filed each of the tax returns in mid-April when they were due, and have been making modest payments when they have been able to, but those have not even been keeping up with the penalties and interest. Assume they have no secured debts—no mortgage or vehicle loans. They can realistically afford to pay about $500 a month to all of their creditors, not enough to pay their regular creditors much less the IRS.

Outside of bankruptcy, the IRS would likely require payment in full of the entire tax obligation, with interest and sometimes penalties continuing to accrue until everything was paid in full. Their payments would be imposed without regard to the other debts they owe. And if the couple failed to make their payments, the IRS would likely try to collect through garnishments and tax liens. Depending how long repayment would take, the couple could easily end up paying $30,000 or more with additional interest and penalties. This would be in addition to their $35,000 medical and credit card debts, which could easily increase to $45,000 or more, especially if these other debts went to collections or lawsuits. That’s likely because the couple would be paying all available money to the IRS. So likely the couple would eventually end up paying at least $75,000 to their creditors.  

In a Chapter 13 case, the 2006 and 2007 taxes, interest and penalties would very likely be paid nothing and discharged at the end of the case. So would the penalties for 2008, 2009, and 2010. That takes care of $11,500 of the $25,000 present tax debt. The remaining $13,500 of taxes and interest for 2008, 2009, and 2010 would have to be paid as a “priority” debt, although without any additional interest or penalties once the Chapter 13 case is filed. Adding in some “administrative expenses” (the Chapter 13 trustee and our attorney fees), and assuming that their income qualified them for a three-year Chapter 13 plan, this couple would likely be allowed to pay about $500 per month to ALL of their creditors—credit cards and medical, AND the IRS. Then after three years, they’d be done. The “priority” portion of the IRS debt would have been paid in full, but the older IRS debt and all the penalties would be discharged likely without any payment. So would the credit card and medical debts. After the three years, the couple would have paid a total of around $17,500 (including the “administrative expenses”), instead of about $75,000 without the Chapter 13. They’d be done instead of barely starting to pay their mountain of debt. And they would have not spent the last three years worrying about IRS garnishments and tax liens, lawsuits and harassing phone calls, and the constant lack of money for necessities.

As I said, in my next blog I’ll explain how all this works.

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Writing Off Income Taxes with a “Straight Bankruptcy”

You don’t always need to file a Chapter 13 case—with its 3-to-5-year payment plan–to deal with income tax debts. Thinking that you do is a myth, alongside the broader myth that “you can’t write off taxes in a bankruptcy.” Both have a kernel of truth, which is why they persist. It’s true: some taxes cannot be discharged (legally written off) in bankruptcy. But some can. And it’s true: Chapter 13 is often an excellent way to solve tax problems. But that does not necessarily mean it is the best for you. Instead Chapter 7 might be.

Chapter 13 tends to be the better tool if you owe a string of income tax debts including relatively recent ones. Why? Because in this situation Chapter 13 gives you the best of both worlds. First, if you owe recent income taxes which cannot be discharged, you get lots of advantages under Chapter 13, including paying less by avoiding most penalties and interest. That can be a huge savings, especially if you can afford only relatively small payments. Second, if you have older back taxes, these are also wrapped into the Chapter 13 plan, often without you paying any more into your plan, then they are discharged at the end of your case.

But you DON’T NEED the best of both worlds if all or most of your income tax debts are dischargeable. Then Chapter 7, the straightforward “straight” bankruptcy is enough.

So, WHAT ARE the conditions for a specific income tax debt to be discharged in Chapter 7? How are you going to know if Chapter 7 will discharge all or most of your taxes so that it is the right option for you?

Some of the conditions for discharge of taxes are quite straightforward. Some are more complicated. And as you’ll see, some are even purposely vague. So unfortunately it’s not as simple as plugging a particular tax debt into a clear formula to see if it is dischargeable. Determining whether a particular tax debt will be discharged requires the careful judgment of an experienced attorney.

I’ll just list these conditions for discharging income taxes here, and then explain them in my next blog. Don’t be surprised if they sound confusing in this list. It’s true: anything having to do with taxes tends to be complicated!

To discharge an income tax debt in a Chapter 7 bankruptcy case, it must meet these conditions:

1) Three years since tax return due: The applicable tax return must have been due more than three years before you file your Chapter 7 case. And if you requested any extensions for filing the applicable tax returns, you have to add that extra time to this three-year period.

2) Two years since tax return actually filed: Regardless when the tax return was due, you must have filed at least two years before your bankruptcy is filed in court.

3) 240 days since assessment: The taxing authority must have assessed the tax more than 240 days before the bankruptcy filing.

4) Fraudulent tax returns and tax evasion: You cannot have filed a “fraudulent return” or “willfully attempted in any manner to evade or defeat such tax.”

You can see that these are begging for some clarification. For that please come back to read my next blog. Or else call to set up a consultation with me. If you have substantial tax debts, you should definitely get some thorough personal advice. Know your options so you can make an informed choice, about bankruptcy and otherwise.

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Preserve Your Ability to File Bankruptcy at the Time You Want

Sometimes the timing of your bankruptcy filing hardly matters, but other times it’s huge.  The three examples in this blog should convince you that you want to avoid being rushed to file your case because a creditor sued you earlier and is now garnishing your wages. Instead you want to preserve the ability to file bankruptcy at a time that is tactically the best for you.

1. Choosing between Chapter 7 and 13:  Being able to file a Chapter 7 generally requires you to pass the “means test.” This test largely turns on a very special definition of “income.” For many people, their “income” under that definition can change every month, sometime by quite a lot. This means that you may not qualify to file a Chapter 7 case one month but then do so the next month. Being able to delay filing your case means being able to file when you will pass the “means test,” or at least more likely would do so, and therefore not be forced to file a Chapter 13 case. This means usually finishing your case in three or four months instead of three to five years, and almost always saving many thousands of dollars.

2. Discharging—writing off—debts:  Getting certain debts discharged is harder if those debts were incurred within a certain amount of time before the filing of your bankruptcy case. So being able to delay the filing of your bankruptcy case makes it less likely the creditor on one of these debts would challenge your ability to discharge that debt. Or if such a creditor would still raise such a challenge, defeating it would be easier.  The amount at stake is the amount of that debt, plus often the creditor’s costs and attorney fees, and your own attorney’s fees.  Avoid or reduce the risk of continuing to owe that after your bankruptcy is over by avoiding getting creditor judgments against you.

3. Choosing property exemptions:  The possessions you are allowed to keep in a bankruptcy depend on which state’s exemption laws apply to your case. If you moved to your present state of residence within two years before your bankruptcy is filed, you will not be able to use that state’s exemptions but rather your former state’s. Especially if you are getting close to the two-year mark, having flexibility about when to file would allow you to pick whichever state’s exemptions were better for you. Otherwise, you may either lose an asset in a Chapter 7 case, have to pay the trustee to be able to keep it, or else even be compelled to file a Chapter 13 case to keep it.

You may sensibly ask: if you do get sued, what are you supposed to do to avoid getting a judgment against you, so that you’re not later rushed into filling bankruptcy at an unfavorable time?  The answer: see a bankruptcy attorney as soon as you get sued to figure out how to deal with that law suit and with your entire financial circumstances. The earlier you get advice, the more options you will have.

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Stopping the Foreclosure of Your Home Temporarily and Permanently through Bankruptcy

Both Chapter 7 and Chapter 13 can help you save your home. Which one is better for YOU?

You have almost for sure heard that the filing of a bankruptcy stops a foreclosure. You may have also heard that Chapter 13—the repayment version of bankruptcy—can be a good tool for saving your home in the long run. Both of these are true, but are only the beginning of the story. This blog today tells you more about stopping a foreclosure. My next blog will get into longer term solutions.

The “automatic stay” is the part of the federal bankruptcy law which immediately blocks a foreclosure from happening. The very act of filing your bankruptcy case “operates as a stay,” as a court order stopping “any act to… enforce [any lien] against any property of the debtor…  .”

But what if your bankruptcy case is filed and the mortgage lender or its agent can’t be reached in time so that the foreclosure sale still occurs? Or if there’s some miscommunication between the lender and its agent or attorney, with the same result? Or if the lender just goes ahead and forecloses anyway?

As long as your bankruptcy is in fact filed at the bankruptcy court BEFORE the foreclosure event, then that foreclosure is not legally valid, whether it occurred by mistake or intentionally. (This filing “at the bankruptcy court” is usually actually done electronically from my office, with a date and time-stamped record proving when the court filing took place.)

IF a foreclosure happens by mistake after the filing of your bankruptcy, lenders are usually very cooperative in legally undoing the foreclosure and its documentation. If your lender would fail to undo such a foreclosure after becoming aware of your bankruptcy filing, it would be in ongoing violation of the automatic stay, exposing itself to significant financial penalties. That would be rare.

Does it matter whether your bankruptcy case is a Chapter 7 or Chapter 13 one for purposes of the automatic stay?

No, the automatic stay is the same under both Chapters, and would have the same immediate effect.

On the other hand, how long the protection of the automatic stay lasts can definitely depend on which Chapter you file. That’s because even though you get the same automatic stay, the other tools each Chapter gives you for protecting your home are very different. So your mortgage lender may very well react quite differently depending on the Chapter you file, as well as on what you propose to do about your home and your mortgage within that Chapter. I’ll write about those options  in my next blog.

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Creditor Collections NOT Stopped by a Bankruptcy Filing

You can’t count that filing a bankruptcy will instantaneously stop every act against you by every one of your creditors. Or can you?

Isn’t one of the most important benefits of filing bankruptcy the fact that it puts a screeching halt to all collection efforts of your creditors against you and your property? Yes, and in fact in many cases it does exactly that. This benefit of filing bankruptcy is called the “automatic stay,” because at the moment of the filing of your case a legal injunction automatically goes into effect “staying,” or stopping, most actions by creditors against you. But exactly because the automatic stay is something we count on so much, we better know its exceptions.

Today I’m just going to list some of the most important exceptions. Then in the next couple blogs I will explain in practical terms these and other important aspects of the automatic stay.

So creditors CAN do the following in spite of your bankruptcy filing:

1) A district attorney or other governmental authority can begin or continue a criminal case against you, such as an indictment, a criminal trial, or a sentencing hearing. This includes not just felonies and misdemeanors, but also lesser matters like traffic infractions that you might not think of as “criminal.”

2) Your ex-spouse, or about-to-be ex-spouse, or somebody on his or her behalf, can start or continue a variety of divorce and family court proceedings. These include legal procedures to establish paternity of a child, determine or change the amount of child or spousal support to be paid, settle child custody or visitation issues, address domestic violence disputes, and even dissolve the marriage. (Although a marriage dissolution usually cannot include a determination about how assets or debts would be divided between the spouses.)

3) Specifically about child or spousal support, the person owed ongoing support can continue collecting it. If there is back support owed, then in spite of a Chapter 7 filing, the person who is owed the support can in most cases start or continue collecting it. This includes not only collection through wage withholdings and garnishment of bank accounts, but also through seizure of a tax refund and suspension of a driver’s license, an occupational or professional license, or even a hunting or other recreational license. In contrast, a Chapter 13 filing can stop these aggressive methods of collecting back support.

4) Taxing authorities can start or finish a tax audit, can send you a notice that you owe taxes, can demand you to file your tax returns, can assess your taxes and demand you to pay them, and in some situations can even file tax liens against you and your property.

Notice that each of these exceptions involves a special kind of creditor. As I said, the automatic stay stops actions against you by most creditors. But if you are involved in a court proceeding or collection efforts by the criminal or taxing authorities, or by an ex-spouse, be especially aware of these exceptions.

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Another Five Ways to Save Your Home through Chapter 13

In my last blog I gave you the first five of ten big ways that Chapter 13 allows you to keep your home.  Here are the other five.

 

6. If you need to sell your home, Chapter 13 usually gives you much more time to do so than a Chapter 7 case. More time means more market exposure, which usually means selling at a better price. That’s especially true if you are otherwise forced to sell during a slower time of the year, or are trying to sell on a short sale (where the house is worth less than the debt against it). If you are behind on your mortgage payments and in danger of a foreclosure, a Chapter 7 case will usually only buy you an extra three months, and sometimes even less if the creditor is aggressive. Often the only way to stop the foreclosure is by paying the entire arrearage of payments, interest, late charges, foreclosure fees and attorney fees in a lump sum, often totaling tens of thousands of dollars. In contrast, in a Chapter 13 case you can usually maintain the status quo and stay in the house by resuming regular monthly mortgage payments and making meaningful progress towards paying the arrearage. If there is sufficient equity in the property, most or even all the arrearage can often be paid from the proceeds of the anticipated sale, reducing what needs to be paid monthly before then.

7. If you are behind on your child or spousal support obligations, Chapter 7 does nothing to stop collection efforts against you on those obligations, including against your home. Support obligations in most cases turn into liens against the real estate you own, including your home, often giving your ex-spouse the ability to force the sale of your home to pay the support arrearage. On the other hand, Chapter 13 does stop most collection efforts during your case as to any support arrearage which existed as of the time your bankruptcy is filed.  Your Plan must show how you are going to pay that arrearage before your case is completed, and you must stay current on those Plan obligations. But as long as you do, any support lien cannot be enforced against your home. At the end of your Chapter 13 case, you will have paid off the support arrearages, so the lien will be released, with no further risk to your home. (Important: Chapter 13 does NOT stop collection against any new support that you fail to pay after the filing date, so you must stay current on any such new obligations.)

8. In our last blog, I showed how Chapter 13 is usually the better option when dealing with an income tax lien against your home. There I used the situation in which the lien is on a tax debt that cannot be discharged—written off—in bankruptcy. But if the tax upon which the tax lien has been recorded can be discharged—because it is old enough and meets the other conditions for a dischargeable tax debt—dealing with the lien against your home in this situation is also better under Chapter 13. Depending on the amount of equity you have in your home and other possible factors, the IRS or other taxing authority may well not release the tax lien even after the underlying tax debt is discharged in a Chapter 7 case. In a Chapter 13 case, in contrast, there is an established mechanism for determining the value of that lien, and for paying it, so that at the completion of your case the tax debt is discharged and its lien is satisfied.

9. If you have fallen behind on property taxes, Chapter 13 is often the better way to deal with them. Usually, being current on property taxes is a condition of your mortgage, giving your mortgage lender an additional independent reason to foreclose if you are not. (This assumes you are not set up to pay the taxes through the “escrow” portion of your mortgage payment, but rather directly to the property tax authority.)  By showing in your Chapter 13 Plan how you are curing your property tax arrearage—even if it takes years to do so—your mortgage lender is no longer able to say you are in breach of your mortgage and justify foreclosing on that basis.

10. Saving the most obvious for last, people often file Chapter 13 to prevent a Chapter 7 trustee from taking assets that are worth more than the applicable exemptions. And that applies to your home as much as anything. If you have more equity in your home than the homestead exemption allows, you risk losing your home in a Chapter 7 case. That risk is aggravated these days because the highly irregular housing market makes property appraisals difficult to predict accurately. Chapter 7 trustees have a great deal of discretion, and predicting how aggressive yours will be is made even more difficult because in most places there is no way of knowing which trustee will be assigned to your case. In contrast, usually all Chapter 13s in a region are assigned to the single local “standing trustee.” So we are familiar with his or her inclinations. Even more important, Chapter 13 provides a much more predictable procedure for determining the value of a home, and a mechanism to protect the value of the home in excess of the homestead, if any.

In a nutshell, Chapter 13 provides quite a number of tools to help you keep your home. Simply said, it gives you more control over the situation. It is definitely not the automatic answer just because you have a home in distress, because Chapter 13 certainly has its limitations. But it is often a powerful option that you should discuss carefully with your attorney.  

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Ten Ways to Save Your Home through Chapter 13

In my experience the number one reason people choose to file Chapter 13 instead of Chapter 7 is to save their home. And it’s not just because it gives you a bigger hammer against your mortgage company. It gives you a hammer, but also a whole bunch of other tools. Some are more subtle but just as important in the right case. Each person’s situation probably doesn’t call for more than a few of those tools, but it’s great to have them all in the tool chest. So let’s look at the ten main ones, the first five in this blog and the other five in my next one.  


1.  The one tool most people know about is that in most circumstances you are given the length of your Chapter 13 Plan–as long as 5 years—to cure your mortgage arrears, the amount you are behind on your mortgages at the time your case is filed. Outside of Chapter 13, mortgage companies seldom let you have more than a few months to pay the arrears, an impossible task if you are not expecting to receive some windfall of money. During the entire repayment time that a Chapter 13 allows, you are protected from foreclosure and most other collection efforts, just so long as you play by the rules laid out in your Plan. If you do play by those rules, you will be completely current on your home when you finish your case.

 

2.  A benefit of Chapter 13 which has become tremendously helpful during these last few years of shrinking home values is the “stripping” of junior mortgages. If your home is worth no more than the amount of your first mortgage, then any second mortgage can be “stripped” of its lien against your home and treated in your Chapter 13 case like a “general unsecured creditor.” That means that the second mortgage balance is lumped in with the rest of those bottom-of-the-barrel creditors, and whatever portion of the balance is not paid during your case is written off at the end of it. This is not available in Chapter 7.

 

3. Both Chapter 7 and Chapter 13 prevent federal and other income tax liens from attaching to your home, but, assuming the lien would be on a tax that cannot be written off in bankruptcy, Chapter 7’s protection lasts only a few months. The tax lien can be imposed against your home just as soon as the Chapter 7 case is over, usually only about three months later. This gives the IRS or other taxing authority lots of additional leverage against you, requiring you to pay lots more interest and penalties, AND putting your house in jeopardy. In contrast, if you file a Chapter 13 case before a tax lien is recorded, there will never be a tax lien against your home. That’s because this tax will be paid off in your Chapter 13 case as a “priority creditor,” without any additional interest or penalties, with no tax enforcement—including a tax lien recording—permitted throughout the process.

 

4. Chapter 13 is also the better route if your home already has an unpaid income tax lien against it before you file bankruptcy. Again assuming that lien was imposed for a tax that cannot be written off in bankruptcy, Chapter 7 case neither provides you a way to pay this tax nor protects you from the full force of tax collection for any longer than a few short months. In contrast, Chapter 13 both provides you a mechanism to pay these inescapable debts on a reasonable timetable and protects you while you do so.

 

5. A key point of Chapter 13 is that it slashes your other debt obligations so that you can gain the needed monthly cash flow to better be able to afford your necessary home obligations. Amazingly, in many cases you can have more room in your budget to pay towards your home even than if you had filed a Chapter 7 case. That’s because if you owe certain kinds of debts that would not be written off in a Chapter 7 case—such as an ongoing vehicle loan, certain taxes, child or spousal support arrears, and most student loans—Chapter 13 could well allow you to pay less each month on those obligations, leaving more for the home.

 

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Qualifying for the Tremendous Tools of Chapter 13

You may want the fast fresh start of a Chapter 7 case, but sometimes your circumstances scream out for a Chapter 13 instead.  It’s true—for some people Chapter 13 provides tremendous tools not available under Chapter 7. Now all you have to do is qualify for it.

Qualifying for Chapter 13 is completely different than qualifying for Chapter 7. You 1) can’t have too much debt, and 2) must be “an individual with regular income.”

 

Too Much Debt

There is no limit how much debt you can have if you file a Chapter 7 case. But under Chapter 13 there IS a strict maximum debt amount. The idea is that Chapter 13 is a relatively straightforward and efficient procedure designed for relatively simple situations. If there’s a huge amount of debt, the theory is that you need a more complicated procedure, Chapter 11, which is arguably ten times more elaborate (and about that many times more expensive!).  

So Congress has come up, rather arbitrarily, with a strict debt maximum to qualify for Chapter 13. Actually, there are two separate maximums, one for unsecured debt and another for secured debt. You’re thrown out of Chapter 13 if you exceed either amount.

The current maximums are $1,081,400 for secured debt and $360,475 in unsecured debts. Those same numbers apply whether you are filing by yourself or with a spouse.

These amounts may sound like way beyond what most consumers would owe, and in fact they do not cause most people a problem. But these limits are problematic more than you might think. Consider if you owed a normal amount of debt and then were hit with a catastrophic medical emergency and/or very serious ongoing condition that quickly exhausted your medical insurance. A few hundred thousand dollars of medical debts can add up faster than you can believe.  

Other potentially troublesome situations, particularly for the unsecured debt limit, include if you’ve owned a business, or are involved in serious litigation. Or if you own real estate, especially more than just your primary residence, the secured debt limit can also be reached quickly, especially in certain part of the country.

 

“Individual with Regular Income”

First, corporations and partnerships can file Chapter 7s, but not 13s—you must be an “individual.”

Second, the Bankruptcy Code defines—not very helpfully, mind you—“individual with regular income” as someone “whose income is sufficiently stable and regular to enable such individual to make payments under a plan under Chapter 13.”  That’s sounds like a circular definition—your income is regular enough to qualify to do a Chapter 13 case if your income is regular enough to do a Chapter 13 case!? Such an ambiguous definition gives bankruptcy judges a great deal of discretion about how they enforce this requirement. Some are pretty flexible, letting you at least try. Others look more closely at your recent income history and have to be pursuaded that your income is consistent enough to meet this hurdle. This is one of those areas where it pays to have a good attorney in your corner, one who has experience with your judge and the expertise to present your circumstances in the best light.

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Five Truths about Qualifying for Chapter 7 Bankruptcy

Not everyone who wants to file a Chapter 7 “straight bankruptcy” can do so. But most can. There is probably no topic that causes more confusion among people thinking about filing bankruptcy –do they qualify? Let me set the story straight.

1. Inaccurate publicity:  

People think it’s difficult to qualify for filing bankruptcy because of lingering public memory of a major amendment of the bankruptcy code six years ago.  This “reform” was intended to make filing bankruptcy, and especially Chapter 7, more difficult, and its proponents were happy to proclaim this intent. This has stayed in the public’s mind even though the law actually did not make it harder for most people to file whichever Chapter they wanted.

2. Confusion breeds fear:  

If you don’t think that it makes sense that a law which went into effect in the middle of the last decade continues to sow such misinformation, bear two things in mind. First, this set of amendments to the Bankruptcy Code was one of the most confusing, self-contradictory, and convoluted pieces of legislation ever to pass through Congress. (And that’s saying a lot!) Second, sorting out this sweeping set of statutory contradictions and ambiguities through the court system takes many years. Some of the important issues are just now making it to the U.S. Supreme Court. Others won’t be resolved for years. In an environment where the law is not reasonably clear, even common sense suggests “erring on the side of caution.” Add a dose of misinformation, and it’s easy to see why people assume the worst.

3. The new “Means Test” does not even apply to many bankruptcy filers:  

The “means test,” the main new hoop to jump through to qualify for Chapter 7, has complications, but a large percent of filers avoid it altogether. If your annualized income during the six full calendar months before filing the bankruptcy—counting income from virtually every source other than social security—is less than the published median family income in your state for your size of family, then you qualify for Chapter 7, without needing to apply the “means test.” A large percentage of people filing bankruptcy have relatively low income, at least for a time, and so they dodge the “means test.”

4. The “Means Test” is often easy:  

Even if your income IS higher than the applicable median, most of the time the expenses that you are allowed to subtract from your income enables you to pass the “means test” successfully. You end up showing you have no meaningful amount of “disposable income.”

5. Chapter 13 is often the preferred option anyway:  

The point of the “means test” is to require people who have enough “disposable income” to pay some (or, in rare cases, all) of their debts through a Chapter 13 case. In the relatively few times this happens, usually the amount that must be paid in the Chapter 13 case to the creditors is much less than the total debt. Plus, Chapter 13 provides advantages over Chapter 7 in many, many situations, so it may be the first choice anyway, regardless whether the person would pass or fail the “means test.”

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