When people are behind on their mortgage payments and fear losing their house, they often turn to federal bankruptcy laws to stop the foreclosure and get protection.
Federal bankruptcy laws offer two different bankruptcy types to individuals, Chapter 7 and Chapter 13.
In Chapter 7, the bankruptcy trustee sells the debtor’s non-exempt assets, pays the creditors with the funds, and discharges most non-secured debt. Some debts are not dischargeable in bankruptcy, like taxes and student loans.
A Chapter 7 bankruptcy is often called a liquidation or straight bankruptcy, which is similar to wiping the debtor’s financial slate clean so they can indeed start over. In essence, the debtor exchanges his non-exempt assets for a discharge of debts.
But a Chapter 13 bankruptcy is for someone who wants to keep their house, car, and other assets and just needs time and a workable plan with the creditors.
Reasons for a Chapter 13 Bankruptcy
A Chapter 13 bankruptcy is about keeping assets and coming up with a three-to-five-year payment plan acceptable to the debtor, the creditor, and the trustee.
People who want to keep their assets often use Chapter 13 to halt creditors from collection, repossession, or foreclosure proceedings. Once under the protection of the Bankruptcy Court, creditors must stop their collection activities and abide by the bankruptcy laws and the decisions of the bankruptcy trustee.
Some of the main reasons people file a Chapter 13 bankruptcy are:
Foreclosures: The number one reason people use a Chapter 13 bankruptcy is to save their homes from foreclosure. Banks foreclose when a homeowner is behind on mortgage payments, and each state has different foreclosure laws. But without the protection of the bankruptcy laws, the homeowner may have no defenses to stop the bank. A bankruptcy filing halts a foreclosure, and the bank then has to abide by bankruptcy laws. This gives the homeowner time to catch up on the payments and cure the defaulted mortgage.
Repossessions: Similarly, a Chapter 13 filing can often avoid the repossession of a car or equipment when the debtor is behind on payments.
Taxes: A Chapter 13 bankruptcy can help a debtor who has years of unpaid back taxes. The tax debt is not discharged, but the trustee will determine which tax years are priority or non-priority years. Priority years are paid in full and non-priority years will be added to other unsecured debts, and a portion of it will be paid
Garnishments, Utilities, and more: A Chapter 13 filing is often used to stop specific impending financial disasters from happening like wage garnishments, bank freezes, electric and utility disconnections.
Student Loans: Student loans are not dischargeable under bankruptcy law. But under a Chapter 13 plan, they become part of the non-priority unsecured debts. The debtor can pay a reduced amount during the plan and resume regular payments when the plan is complete.
Credit Card: Most Chapter 13 bankruptcy plans include credit card debt. The debtor pays a portion of the credit card debt from discretionary income during the plan. When the plan is completed, any unpaid credit card debt is discharged.
The Chapter 13 Bankruptcy Plan – Income not Assets
The Chapter 13 Bankruptcy plan is not created by the trustee but by the debtor and must be approved by the trustee.
In a Chapter 7 bankruptcy, the trustee is concerned about assets they can sell to satisfy creditors.
But in a Chapter 13 bankruptcy plan, the trustee is concerned with the debtor’s income over the term of the plan and how it can pay the debtor’s obligations to the creditors.
Suppose the debtor’s monthly income is less than the applicable state median. In that case, the plan will be for three years unless the trustee allows it to be longer. If the debtor’s monthly income is higher than the state median, the plan will generally be five years.
Income Taxes and Chapter 13
With a Chapter 13 plan, there are two times to consider the tax refund. Similar to Chapter 7 bankruptcy, there is a portion of the tax refund that is owed to the debtor at the time of the bankruptcy filing. And then, there are the income tax refunds the debtor receives during the plan.
The Chapter 13 trustee uses the debtor’s income to pay the creditors. And income tax refunds qualify as income under the plan. However, technically it is the IRS giving you back your own money because you had them withhold too much.
Income Tax Refund Owed At Time of Bankruptcy Filing
When you file your Chapter 13 in Minnesota, you choose to use federal exemptions or Minnesota exemptions. The income tax refund that is due is an asset to your bankruptcy estate and not exempt.
The federal exemptions allow a wildcard exemption you can apply to your income refund due or owed at the time of the bankruptcy filing. Minnesota exemptions has no wildcard exemption. If you take no federal wildcard exemption, the income tax refund that is owed to you when you file your bankruptcy becomes part of the bankruptcy estate.
Tax Refunds During the Chapter 13 Bankruptcy Plan
Tax refunds paid to the debtor during the plan are income and part of the bankruptcy estate. Depending on the approved plan, all or some portion of the refunds may be applied toward creditor payments. The trustee also has the option of allowing you to keep the refund to pay for certain expenses.
You can use strategies to lessen the amount of refund to the estate. For example, you can reduce your withholding amount from your employer. The smaller your refund, the less the trustee can take.
Your Next Best Steps
If you are trying to save your home or other assets by filing a Chapter 13 bankruptcy, timing is critical. The sooner you are under the protection of federal bankruptcy laws, the sooner your creditors must stop collection practices and abide by those same laws.
Chapter 13 bankruptcy is a federally protected way to save your assets and create a workable plan to catch up and start over.
At Kain + Henehan, we approach the subject of bankruptcy with a compassionate guiding hand. We are qualified Minnesota bankruptcy attorneys. Helping people save their homes and other assets is something we do every day.
We know how difficult it can be to ask for help. If you are overwhelmed by debts and worried about losing your assets, let us help you.
We help families like yours get a fresh start in their new financial lives. Let us help you, too.