Wednesday, August 10, 2011

Chapter 7 Bankruptcy, Taxes, and the IRS: The Basics

In my last blog post, we discussed the eligibility requirements for discharging taxes in a bankruptcy.  This is the first of three blog posts, in which we will discuss the basics of Ch. 7 bankruptcy, the pros and cons of filing, and the consequences of  options for you once you have decided to file.  Ch. 13 options related to taxes will be discussed in later posts.

What is Chapter 7 Bankruptcy?

A Chapter 7 bankruptcy is sometimes called a “straight” bankruptcy or a liquidation bankruptcy.  Under this type of filing, you will not be required to make any payments and the bankruptcy case is usually opened and closed within 4 to 6 months.  Debts that you owe are wiped away and if there is any equity in your assets (which is not protected by law; see below), you will lose that property. 

In most Chapter 7 cases, there are no assets to be sold and no payments are made to the creditors.  My research discloses that anywhere from 90 to 99% of all filed Chapter 7 cases nationwide are “no asset” cases.  That is good news for you. 

After the filing, you will no longer owe taxes which are eligible for discharge, as well as a variety of other debts (credit cards, medical bills, and judgments).  Some debts cannot be eliminated in a bankruptcy, including child support, student loans, and taxes which do not meet the requirements described previously

Process and Timelines

A Chapter 7 bankrupcty begins by the filing of paperwork called a “petition” with the bankruptcy court.  You will be required to take a pre-bankruptcy credit counseling class prior to filing.  In your petition, you will be required to list:

  • All of your assets;
  • All of your debts, including debts that you are still paying (e.g. – car  or house payments);
  • Monthly household income and expenses;
  • Disclosure of recent payments, lawsuits, transfers of property, and other financial information. 
Note that you do not have the discretion to list only some of your assets or debts; full disclosure (in other words, ALL of your assets) is required.  Also, in some jurisdictions, failure to disclose may prevent a debt from being discharged or could cause the failure of the entire case.  Preparing and filing the petition is the most time-consuming and complex process for most liquidation bankruptcies. 

Most of your assets will be protected by “exemption” laws (usually unique to your state) which prevent your creditors and the bankruptcy trustee from seizing and selling them.  The purpose of the exemption is to protect you from losing your most valued possessions (home, personal items, auto and other items necessary for your livelihood).  You should consult a bankruptcy attorney about how to best use these exemptions.
Once the petition has been filed, the you will then be required to take a “financial management course.”  (These classes are a result of the 2005 changes to the bankruptcy code that also added the so-called “means test” which we will discuss at a later time.  In my opinion, the classes are mostly useless).

About 5-6 weeks after filing the petition, you are required to participate in a “meeting of creditors” where you will be asked questions by the bankruptcy trustee concerning the disclosures in the petition.  Creditors are also given the opportunity to ask questions.  In most cases, the meeting is fairly routine and takes no more than 5 minutes. 

Approximately 60 days after this meeting, you will be issued a “discharge” by the bankruptcy court which legally eliminates all dischargeable debt.  A debtor can only obtain a discharge once every 8 years.  

Up Next: The Means Test, IRS Levies/Garnishments During Bankruptcy, and Tax Liens

Do you have questions about this topic? Email or call me for a free consultation and we can discuss your situation. (760) 990-1632.

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