Do Chapter 13 Bankruptcy Plans Have to Last For Five Years

 Prior to the bankruptcy law overhaul in 2005 most individuals filing a Chapter 13 Bankruptcy  were only required to make plan payments for 36 months to receive the discharge. The 2005 law however added a requirement that debtors with above medium incomes had to enter a plan where the payments continue for 60 months, and only those debtors, who had below medium incomes can still file 36 month plans.  The medium income is based on the state the debtor resides in.  In Illinois the medium income for a family of four as of August 2013 is $6,731.00 a month or $80,776.00 a year (this is gross income not net income.)

Of course both before and after the law change debtors, who were eligible for the 36 month plan, often elected a longer plan period, because they could not afford to make large enough payments in 36 months to achieve their goals.  This could apply for example, if an individual was trying to stop a mortgage foreclosure through a chapter 13 plan, and the arrearage on the mortgage was too large to pay off in less than 60 months.

There is also an exception to the rule allowing debtors to shorten their plan term to whatever period it takes to pay off 100% of their debts; however, it is an unusual case for an individual, who is filing bankruptcy, to be able to pay off all of his or her debts in a shorter period than the law requires.

 Automatic Stay For Co-Debtors In Chapter 13 Bankruptcy

 The automatic stay in bankruptcy makes it illegal for any creditor to take action to collect a debt while an individual is in bankruptcy.  A bill collector cannot call the individual on the phone, take the debtor to court, or garnish wages while the bankruptcy is pending.

One advantage of a Chapter 13 Bankruptcy  is that the automatic stay can also cover a co-debtor who has not filed for bankruptcy.  Thus if a man cosigns for his daughter’s car loan, and the daughter goes bankrupt, the car lender would not be able to come after the father, if she filed under Chapter 13.  If it were a Chapter 7 bankruptcy the man would have no such protection.

There are several conditions for the automatic stay to apply to the co-debtor.  The co-debtor must be an individual, and the loan must be a consumer debt.  In addition the creditor could have the automatic stay lifted, if the co-debtor was the one receiving the consideration for the debt, or if the Chapter 13 plan did not provide for the full payment of the debt.  However, lifting the automatic stay requires the creditor to bring a motion to court and request this relief from the judge.

Taxation of Debt Forgiveness And Insolvency

The Internal Revenue Code provides that a cancellation of indebtedness is taxable income. Thus if you settle a $10,000.00 credit card debt for $5,000 you will have to pay income tax on the $5,000 forgiven.

Like most general rules this one has exceptions.   One exception is that a debt discharged in bankruptcy will not produce taxable income, and as a bankruptcy lawyer  I can say that without this rule very few debtors would actually receive the fresh start that bankruptcy is intended to confer.

Even if one does not go bankrupt though the forgiveness will not be taxable, if the debtor remains insolvent.  Thus if after the $10,000 is forgiven the debtor still has $30,000 of additional debt and has no property there will be no taxable income, because the debtor is still insolvent by $30,000.

One pitfall that is sometimes overlooked though is that the insolvency calculation requires the taxpayer to include  some items that he or she might not normally think of as property, such as assets in a 401k or a pension plan.  In trying to figure out if someone is insolvent with a pension one would of course have to figure out the present value of future pension benefits which very few people know how to do.  Unfortunately, some judges have even thrown out the insolvency exception just because the debtor had a pension that he was unable to calculate a value for.  The theory was that unless they could show the value of the pension the taxpayer would be unable to meet his burden of proof that he is indeed insolvent.












 

Paying Taxes Due After Filing Chapter 13

One reason people file a Chapter 13 bankruptcy  is that it provides a convenient mechanism for paying debts to the IRS that would not be discharged in a Chapter 7 bankruptcy, such as income taxes that are less than three years old.   The Chapter 13 debtor will be able to spread the payments over five years, and in most cases no additional interest will accrue after the filing date of the bankruptcy.

In some cases a taxpayer will even want to add income tax liabilities to the Chapter 13 bankruptcy plan, which fall due after the bankruptcy is filed.  For example if an individual files bankruptcy in November of 2012 and has a large balance due, when he files his 2012 tax return the following April, he may wish to amend his bankruptcy plan to also pay off his 2012 liability.

This is permissible under the law,  and it can  make sense to a debtor who is struggling already to keep up his plan payments and has little hope of coming up with the funds to pay the 2012 taxes with his return.  One thing to keep in mind in this case though is that because they fell due after the bankruptcy,  the 2012 taxes will continue to accrue interest on the unpaid balance during the bankruptcy.  Thus while the debtor will avoid harassment from the IRS and will probably reduce his total interest by doing it this way, he will often exit bankruptcy with unpaid interest still due to the IRS.