Chapter 7 and Chapter 13 Bankruptcy Q & A

An interview with attorney Steven Neuner of Neuner & Ventura LLP

What is the difference between Chapter 7 and Chapter 13 bankruptcy?

In general, Chapter 7 allows you to wipe out most if not all of your unsecured debt while Chapter 13 requires you to repay what you owe your creditors based on what you can afford or the value of your property. In order to file for Chapter 7 and receive a discharge of debts under that chapter, your household income cannot exceed your basic living expenses by substantial amounts. If your gross income from all sources over the previous 6 months puts you in the top half of New Jersey households with the same number of members as you, a “Means Test” comes into play. Under this test, your ability to pay is measured by using the expense allowance structure the IRS uses in deciding how much you can afford in repaying back taxes. If the resulting figure is too high, you may not qualify for Chapter 7 (although there are certain exceptions).

If you don’t meet the eligibility requirements for Chapter 7, you can file Chapter 13, assuming your fixed unsecured debt and total secured debt does not exceed specified limits. Under Chapter 13, you create a repayment plan in order to consolidate your unsecured debt into one monthly payment to a bankruptcy trustee. After the term of your repayment plan is over, your remaining debt will be wiped clean as well. Most taxes and any Domestic Support obligations as well as certain other categories of debt do not get discharged.

Will I lose my house if I declare bankruptcy?

In many cases, declaring bankruptcy can actually help many people avoid foreclosure by freeing up income to keep mortgage payments current or giving them time to bring a mortgage current over 3 to 5 years. Once you file for Chapter 7 or Chapter 13 bankruptcy, an automatic stay is put in force preventing debt collectors and banks from pursuing or continuing debt collection or foreclosure actions. While the stay is temporary, it can provide you with enough time to get your finances in order. Here, once your bankruptcy is finalized and your debt is either discharged or consolidated into a single manageable monthly payment, you may have enough money to pay your monthly mortgage. As a result, many people who file for bankruptcy are actually able to save their home.

How long will a bankruptcy stay on my credit report?

A bankruptcy will appear on a credit report for ten years. Debts that are discharged in bankruptcy can be removed from the report 7 years after the bankruptcy filing or the first date they went to collections, whichever is first.

Will I ever qualify for a credit card again after filing for bankruptcy?

Most likely, yes. Keep in mind banks and credit card companies are interested in making money. If they refused to approve people who at one time filed for bankruptcy, they’d deny themselves an opportunity to make money. In fact, many people who file for bankruptcy receive credit card offers in the months following their bankruptcy filing. It’s important to keep in mind, however, that credit card and loan offers you receive will carry a higher interest rate and a lower amount of credit offered. Even so, if you manage your credit responsibility you can begin the process of rebuilding your credit in the years following your Chapter 7 or Chapter 13 filing.

Wouldn’t I be better off using my 401(k) or my IRA to pay my debts?

Unfortunately, due to the stigma that still surrounds bankruptcy, some people choose to deplete their 401(k) or IRA accounts in order to avoid bankruptcy. This, however, can be extremely expensive and is generally unwise. First, in New Jersey any money properly invested in an IRA, 401(k) or other type of tax qualified retirement plan is totally protected from claims of creditors. Secondly, any money prematurely withdrawn from these accounts will be taxed and you will pay a penalty, resulting in a total tax expense as much as 40 percent. Finally, when you withdraw or deplete these accounts, you lose the retirement and emergency cushion these accounts are meant to provide, as well as any money that would have accrued to the account had you not used it. Depending on the amount of money involved, the cost could be tens if not hundreds of thousands of dollars.

On the other hand, if you file for bankruptcy you can wipe out your debt and begin the process of rebuilding your credit. Your credit report will be affected and you may initially only qualify for higher interest rate loans and credit cards; however, in the long run, the amount of money you save will be substantial, and your chances of achieving long term financial security are greatly improved.

Can I include my back-owed mortgage payments in a bankruptcy?

In a Chapter 7, you discharge your personal obligations under the Mortgage Note (your “IOU”) but the mortgage lien and the lender’s right to foreclose on your real estate passes through the bankruptcy unimpaired. Thus if you are behind, a foreclosure, while temporarily stayed, will be in your future. However, if you file a Chapter 13 bankruptcy you have the option of bringing your mortgage payments current over 3 to 5 years. If you have a second mortgage, you may be able to “cure” the arrears over 3 to 5 years. If your home is worth less than the first mortgage balance, you have the opportunity in Chapter 13 to “lien strip” your second mortgage, turning it into unsecured debt that can be discharged with less than full payment and removed as a lien on your property.

Should I tell debt collectors that I’m filing for bankruptcy?

After you have hired a bankruptcy attorney, you should tell debt collectors what you are doing and instruct them to contact your attorney. In our experience, most debt collectors who have not already filed suit will put your debt on the “back burner” for a while. After you file for bankruptcy, debt collectors should not contact you anymore. If they do you can hold them financially liable for violating the law.

Can only one spouse file for bankruptcy or do both have to?

Yes, only one spouse can file for bankruptcy. Ideally, the non-filing spouse’s credit report won’t be affected. However, if the other spouse’s name is on loan or credit card accounts that you intend to discharge, he or she should seriously consider filing bankruptcy with you. Otherwise, debtors will hold your spouse responsible for any joint obligation debt to be discharged. However, merely because you are married does not by make your spouse legally responsible for all of your debt (with a few limited and rare exceptions). In an individual filing where you and your spouse are not separate, you will still need to disclose a limited amount of your spouse’s income and expenses in your Chapter 7 or Chapter 13 filing.

I’m facing divorce. Should I file before or after my divorce is finalized?

The answer to this is not simple and is very much dependent on your circumstances. Generally, filing a divorce during a pending bankruptcy or a bankruptcy during a pending divorce is not the best course of action. But in many cases, accumulated debt has to be dealt with in a divorce and bankruptcy, properly planned under the guidance of an experienced bankruptcy lawyer with knowledge of divorce laws should be seriously considered. At Neuner and Ventura LLP we have extensive experience in both areas. If you are planning on divorcing your spouse, you should to discuss your bankruptcy plans with your divorce and bankruptcy attorney first. This is an area where spouses facing divorce may both benefit from bankruptcy filings by removing debt problems and thus making the terms of a divorce settlement easier to negotiate.

I owe back taxes. Can I discharge tax debt through bankruptcy?

The short answer is “sometimes” but the issue is a bit complicated. Sales taxes and unpaid employee withholdings that you were supposed to pass on to the taxing authorities but did not, will not be dischargeable. In order to discharge back-owed income taxes, your tax debt must first meet multiple requirements. A tax return must have been filed for each of the years in question and it cannot be part of a tax fraud. The tax obligation must be older than certain specified periods (often 3 years from the last day the tax return was due if timely filed). If you have back-owed tax debt, we strongly recommend seeing a qualified tax adviser and filing any needed returns, and discussing your case with an experienced bankruptcy attorney.

IRS CIRCULAR 230 DISCLOSURE: Pursuant to Treasury Regulations, any tax advice contained in this communication (including any attachments) is not intended or written to be used, and cannot be used or relied upon by you or any other person, for the purpose of (i) avoiding penalties under the Internal Revenue Code, or (ii) promoting, marketing or recommending to another party any tax advice addressed herein.