November 29, 2014

Why Chapter 13′s Rarely Make Sense

In many states, Chapter 13 Bankruptcy is more common than Chapter 7 Bankruptcy. However, in my bankruptcy practice in Texas, I rarely recommend Chapter 13. In this blog post, I will attempt to explain why. (Below, I discuss other states.)

In any state, it is almost always preferable to file a Chapter 7, if you qualify (see my other post on Qualifying for a Chapter 7), because in a Chapter 7 your debts are discharged within a few months. By contrast, in a Chapter 13 bankruptcy, you must make monthly payments for five years to the Chapter 13 trustee (and the trustee distributes those payments pro-rata to your creditors) and only after 5 years do you get a discharge on whatever amount of debt is still owing at that time.

In Texas, there is no wage garnishment (i.e. no deductions from your paycheck by creditors) and the list of exemptions (i.e. the list of stuff that is exempt from levy by creditors- and thus may be kept by you) is very generous. So, the third option (in addition to 7 and 13) of not filing any form of bankruptcy and doing nothing to respond to creditors attempts to collect from you is not such a bad option. This “do nothing option” is sometimes referred to as “informal bankruptcy.”

There are only two situations in which I commonly recommend that a debtor file a Chapter 13 bankruptcy in Texas (or probably any other state that does not allow wage garnishment):

1. Where the debtor is behind on his house and wants to force the mortgage lender to allow him to catch up on his late payments over time.  However, I rarely think this is a good idea because usually if someone has fallen behind on their mortgage payments, they are going to have a tough time getting caught up and staying caught up.

2. The situation in which the debtor makes too much money to qualify for a Chapter 7 but is not comfortable with the informal bankruptcy option, usually because he or she is a person of delicate temperament and is very bothered by the telephone calls from creditors. (NOTE: see my other post on How Creditors Can Attempt To Collect.)

Note: If you live in a state that allows wage garnishment and you don’t qualify for Chapter 7 (usually because you make too much money), then a Chapter 13 might make sense. A Chapter 13 is going to result in a deduction from your paycheck each month for 5 years (i.e. 60 months). The amount of the deduction is roughly the amount of your income in excess of the means test limit (which is more or less equal to the median income amount in your region). So, you have to do some math. Option A is you just allow the garnishment to occur until the debt is paid off. Let’s say your state allows 25% of your paycheck to be garnished, and let’s say you make $4,000 per month. In that case, the creditor is going to be paid $1,000 per month, if you don’t file a Chapter 13, until they are paid in full. Option B is you file Chapter 13 and the deduction from your paycheck will be the amount of income you earn in excess of the means test amount, but it will only last for 60 months and then the rest of the debt will be discharged.

In order to determine whether Option A or Option B is better, you just have to run the numbers. Try to find a bankruptcy attorney who will give you a free or low cost consultation and walk through the numbers with you.

I owe money to the IRS, can I discharge that when I file bankruptcy?

There answer to that question is that it depends.  There are two tests that have to be met.

1.  Has the return been on file long enough?

Were all of the related returns (i.e. all your tax returns for the tax years for which these taxes are owed) filed on a timely basis, and has it been 3 years since the last date such returns were due including all extensions? [Note: This means that for tax year 2006, the return with extension would be due Oct. 15th, 2007, and you'd have to wait three years from that date.  But if Oct 15th fell on a weekend, then the return would actually be due Oct 16th or 17th, and you'd have to wait three years from that date.  It's very tricky. ]

2.  Has the amount owed to the IRS been settled/assessed for at least two years?

If your return was ever challenged or if the amount you owed to the IRS was ever unclear for any reason, then you must also wait at least two years from the time the amount owed to the IRS was finally assessed.

 

If the answer to both questions above is yes, then you can file bankruptcy and discharge the IRS debt. If the answer is no, you can either (a) wait until it has been a long enough period of time and then file bankruptcy, or (b) try an “Offer in Compromise” now and see what happens.

You can find info on Offers in Compromise on www.irs.gov. Or you can hire a tax dispute attorney, to help you try to negotiate a settlement with the IRS. If you decide to go this route, be sure you hire a reputable attorney or CPA and not one of the Fly-By-Night organizations that claim to be able to handle tax problems.

Something to keep in mind – If some of this tax debt is for monies withheld from employees’ paychecks that you failed to forward to the IRS, then the debt may not be dischargeable, and such debt may pierce through a corporation or LLC entity and attach personally to the business owner.

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