Filing Chapter 13 Bankruptcy May Provide You Relief
Who should file for Chapter 13 bankruptcy?
For people who have a regular income, filing Chapter 13 bankruptcy may allow the debtor to keep property including a house and car by reorganizing debts. By filing a Chapter 13 bankruptcy, a debtor can avoid a liquidation of non-exempt property in exchange for paying creditors part or all of the debtor’s outstanding debt balances at the time of filing Chapter 13 bankruptcy. By filing Chapter 13 bankruptcy, a debtor may be able to eliminate certain debts, make debt repayments more manageable and provide family stability, or prevent loss of property compared to filing a liquidation Chapter 7 bankruptcy.
A Chapter 13 bankruptcy is commonly referred to as a Wage Earner’s Bankruptcy because Chapter 13 requires a plan to repay creditors over a 3 or 5 year period. To complete the repayment plan, which starts upon confirmation of the plan, the debtor must have monthly income sufficient to satisfy the payment plan. If the debtor cannot complete the confirmed plan or modify the plan after confirmation, then the debts spring back to life and the creditors may enforce their rights.
Chapter 13 Bankruptcy Filing Process
Chapter 13 is only available for debtors who are consumers. Businesses may not file Chapter 13 bankruptcy. This includes a sole proprietorship, a limited liability company that is considered directly owned by the debtor for income tax purposes. Businesses have other options including filing Chapter 7 to liquidate or Chapter 11 to reorganize. Chapter 11 is for businesses what Chapter 13 is for individual filers.
Filing Chapter 13 bankruptcy has some of the same requirements as filing Chapter 7. For example, a debtor filing Chapter 13 must complete credit counseling prior to filing. In addition, a debtor must disclose a list of creditors and a list of assets and property owned at the time of filing. A debtor must also pay a filing fee to file a Chapter 13 petition and complete all necessary forms.
Are there any limitations on filing Chapter 13 bankruptcy?
A consumer debtor considering filing Chapter 13 must first evaluate the types and amounts of debts owed to creditors. An individual must have no more than $394,725 in unsecured debt, which typically includes credit card and medical debts. For secured debts, a debtor filing Chapter 13 bankruptcy cannot have more than $1,184,200 in secured debts, which includes mortgages and car loans. These amounts increase as the consumer price index increases. If a debtor has debts in excess of these amounts, the debtor cannot file a Chapter 13 bankruptcy. Instead, a debtor must attempt to utilize either a Chapter 11 reorganization or Chapter 7 liquidation. A Chapter 11 is commonly used by businesses looking to reorganize debts, but may also be used by individuals if Chapter 13 is unavailable. Chapter 11 has different rules from Chapter 13, so a different outcome may result.
Filing Chapter 13 requires filing income tax returns. Whether a taxpayer has not paid income taxes or not filed returns, filing tax returns is required to file a petition and the bankruptcy court will not hear a case until adequate proof of filing income tax returns has been provided. Income tax returns for both state and federal returns must be filed for the prior four years. Failure to file tax returns and disclose them to the court results in the case being dismissed.
The other main qualification is having the regular income necessary to make monthly payments towards the repayment plan. Income may be from wages earned as an employee, pension income, unemployment compensation, Social Security payments, royalties and rent and proceeds from a property sale. Debtors must submit their sources of income and submit the information to the court within 14 days of filing a petition.
Common Chapter 13 Plan Considerations
Assuming a debtor qualifies to file for Chapter 13 bankruptcy, the debtor then proposes a repayment plan. Importantly, only a debtor may propose a repayment plan in Chapter 13. There is no involuntary Chapter 13 bankruptcy comparable to a Chapter 7 bankruptcy where creditors may force a debtor to liquidate if certain conditions are met. A plan may last from three years to five years, but not longer than five years. The CARES Act passed in March of 2020 may modify certain plan repayment timelines because of coronavirus, but other plans are subject to the longstanding three and five year rules.
The most common reason for filing Chapter 13 is to protect a home from foreclosure. In the typical case, the home has some equity but a homeowner may be behind in mortgage payments and the bank is in the process of foreclosure. A homeowner may file a Chapter 13 to stop the foreclosure process and keep the home, but must make up missed payments as part of the repayment plan and may not modify the mortgage or eliminate part of the mortgage balance. Importantly, the homeowner that seeks Chapter 13 protection must timely make future mortgage payments during the life of the Chapter 13 repayment plan.
A debtor may not use a Chapter 13 plan to eliminate all debt. A critical factor for debtors is to determine the categories or classifications of debt under the bankruptcy rules and whether those debts are secured, unsecured or priority. A secured debt is typically a mortgage or auto loan, where the creditor can seek recourse against a debtor by foreclosing its interest or repossessing the property through self-help.
An unsecured debt requires a creditor to seek a judgment against a debtor for the unpaid debt, then collect through garnishment or seizing assets using the judicial process. The IRS has its own set of rules using liens and levies.
Priority debt is a concept under the bankruptcy laws that provide for orderly distribution of assets to creditors depending on the type of debt or who the creditor is. For example, the highest priority debt is for domestic support obligations (aka, child support) that is paid in full before any other unsecured creditor is paid at all. Next is administrative expenses of the bankruptcy (e.g., lawyer fees, accountant fees, taxes owed by the estate, etc.). There are additional priority categories that must be considered.
For purposes of Chapter 13, these unsecured debts must be paid in full as part of the bankruptcy repayment plan for the court to confirm the plan. A debtor has flexibility in how to structure the payments, but these debts must be paid in full for plan to be confirmed unless there is a hardship that arises later during the plan and the debtor cannot complete the plan.
Another critical consideration is that unsecured creditors must receive at least as much repayment of debts in a Chapter 13 filing as they would in a Chapter 7 bankruptcy filing. This policy requiring a minimum payment to unsecured, non-priority creditors ensures that creditors are not treated unfairly at the choice of a debtor. It is also important for debtors to consider that in a Chapter 7 bankruptcy, priority debts are not required to be repaid in full, just repaid in the order of priority to the extent a debtor’s estate has assets that may be used to pay creditors. A debtor in Chapter 7 often has only exempt assets, so unsecured priority and non-priority creditors do not receive any distribution payment.
Dismissal of Chapter 13 Bankruptcy Case
If a debtor does not successfully complete the repayment plan, and cannot or does not modify the plan during the repayment period to complete the plan, then the Chapter 13 filing will be dismissed. A dismissal has important consequences that must be considered prior to filing Chapter 13 bankruptcy to ensure that the debtor will achieve a successful outcome.
First, the property is no longer protected from the bankruptcy filing. All liens, judgments and transfers voided or nullified because of the bankruptcy filing are reinstated. Creditors that lost rights as a result of the bankruptcy will regain those rights and pursue them once permitted by the court and the dismissal of the case.
The property is also technically vested back in the debtor instead of the estate, and creditors may pursue collections against the debtor the same as they could prior to the bankruptcy filing and protection from the bankruptcy’s automatic stay. For example, the IRS could pursue collection actions through its lien or levy property to collect unpaid taxes that may have been part of the repayment plan.
A Chapter 13 petition that is dismissed does not generally prevent a debtor from filing another Chapter 13, but if the debtor filed a Chapter 7 bankruptcy within a certain time period or a case was dismissed for failing to appear in court within 180 days prior to the Chapter 13 filing, the debtor may lose rights to a discharge of debt.
Contact Michigan Bankruptcy Attorney Andrew Steiger for More Information
If you are considering filing bankruptcy, understanding how Chapter 13 works and compares to a Chapter 7 liquidation is important to manage your finances and repay or eliminate your debts. Contact Detroit bankruptcy attorney Andrew Steiger at Steiger Tax Law for a free consultation to discuss your options and what debt relief you can expect by filing bankruptcy. Contact him at (248) 259-6367 or by email at Andrew.Steiger@SteigerTaxLaw.com.