Should You Consider Chapter 7 or Chapter 13 Bankruptcy?

April 21, 2012 by  Filed under: Bankruptcy 

There is much to consider when considering bankruptcy. In order to file for either Chapter 7 or Chapter 13 bankruptcy, you must first obtain credit counseling from an approved source.

When you file for Chapter 7, or liquidation bankruptcy, property that is valued higher than the allowable exemption for that property type usually is sold by the court-appointed trustee. You get to keep some of what you own, such as clothing and other personal effects, some household goods and furnishings, and possibly your home. You might be allowed to keep a vehicle. The trustee likely will sell all collectibles and heirlooms.

Even though you are forced to part with prized possessions, some debts are not erased. You will continue to owe child support payments, whether current or in arrears; alimony payments; some back taxes and most student loans; and the bankruptcy trustee’s fees, filing fees and all attorney fees you incur while pursuing either Chapter 7 or Chapter 13 bankruptcy. There are 19 types of debt that cannot be erased or discharged through a Chapter 7 bankruptcy. There are a few types of debts that continue after completion of a Chapter 7 bankruptcy that can be discharged if you instead file under Chapter 13.

Generally, any money you owe that you do not pay becomes, by law, income to you. For example, John Jones owes $25,000 of credit card debt. He files for Chapter 7 bankruptcy. The trustee must pay secured debts first before applying money to unsecured debt. In this example, there are only enough funds gained through sale of non-exempt property to pay $5,000 of the credit card debt. The credit card company, once payment to it is finalized, reports the remaining $20,000 as income to John Jones. This report is sent to the Internal Revenue Service, with a copy to Mr. Jones. John Jones is liable for paying income taxes, both state and federal, on the $20,000 for the year in which it is reported. Mortgage debt that is forgiven, under certain circumstances, may be exempt from this rule.

To qualify for Chapter 7 or Liquidation bankruptcy, you must pass a “means test.” If you have a regular source of income and own property, proceedings under Chapter 13, Adjustment of Debts of an individual with regular Income, might be better. Chapter 13 requires that you develop and file a budget that includes a schedule of payments you will make to reduce your debt. If you want to keep your house and other possessions, your budget shows how you will bring those payments up to date within the five-year time frame allowed. Once your plan is approved by the court, you will continue to own any property that you yourself do not sell. Your actual payments go to the bankruptcy trustee, and the trustee distributes the money. When you complete all payments mandated by the bankruptcy payment plan, the court discharges your debts.

Once the bankruptcy court discharges your debts, all debts covered by the bankruptcy filing are eliminated. Usually, more debts are eliminated under Chapter 13 bankruptcy than under Chapter 7 bankruptcy. Discharge of debts is much faster, however, for Chapter 7 bankruptcies, often in as little as three months. Discharge of debt in Chapter 13 bankruptcies may take as long as five years.

If you are considering bankruptcy, you will want to fully educate yourself as to the benefits and disadvantages of each available option. You then will be able to choose the course of action that is best for you.

Christopher Alliotts
60 W Alisal Street, Suite 10
Salinas, CA 93901

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