What Is Bankruptcy? Part 2

Whether you're up to your neck in loans, out of work or stretching one small paycheck to meet ever-growing obligations, nearly everyone occasionally flirts with the idea of ditching their debt.

Chapter 13

Also known as debt adjustment, Chapter 13 allows individuals, not corporations, to temporarily halt foreclosures and collection actions while they draft and execute a plan to repay some or all of the debts over a three- to five-year period.

One of the biggest benefits for Chapter 13 filers is that the amount you're going to have to pay on that debt will depend not on how much you owe but on how much you have -- your regular income, hence the nickname "wage earner's plan."

"In many cases, if you are behind on your mortgage or your car loan, and you don't think you can catch up quickly, you file a Chapter 13," says Sommer, author of "Consumer Bankruptcy: The Complete Guide to Chapter 7 and Chapter 13 Personal Bankruptcy." "That's probably the No. 1 reason people file Chapter 13."

This type of bankruptcy lets you reschedule and extend secured debts over the life of your Chapter 13 plan.

Types of debt

Chapter 13 differentiates between three types of debt:

• Priority debts, which often include some taxes and child support, have to be paid in full.
• Secured debts, which are debts secured with some form of collateral, must be paid up to at least the value of the collateral, and in some cases, up to the total amount of debt.
• Unsecured debts, like credit cards, typically receive just a percentage of the total due. "The plan need not pay unsecured claims in full as long it provides that the debtor will pay all projected 'disposable income' over an 'applicable commitment period,' and as long as unsecured creditors receive at least as much under the plan as they would receive if the debtor's assets were liquidated under Chapter 7," says the Administrative Office of United States Courts.

With a Chapter 13 bankruptcy, you must be under the allowed debt limits. As of April 2005, it's $307,675 of unsecured debts -- such as credit card debt and medical bills, not tied to an asset -- and and $922,975 of secured debt -- those tied to an asset that can be repossessed or foreclosed upon, such as a house or car. The limits change April 1 each year.

Debt owed to a single creditor totaling more than $500 for luxury items bought within 90 days of filing are non-dischargeable; cash advances of $750 within 70 days are also non-dischargeable.

New, tougher laws

Once again, however, new bankruptcy laws will toughen a debtor's ability to qualify.

For instance, if a debtor's income is greater than the state median income, they have to establish a five-year repayment plan where they have to pay a certain amount of money to creditors. This amount is based on a strict allowed expenses-to-income formula. The allowed expenses -- not actual expenses -- are set each year by the IRS collections department. On the anniversary date of a confirmed plan, they must file a new statement of income and expenses.

Before you file, you must also provide a copy of your latest tax return at least seven days before the meeting of creditors. Those filing under Chapter 13 have to be current on tax returns for the previous four years.

Chapter 13 documentation

Like debtors filing for Chapter 7, failure to provide the following documents within 45 days after the petition has been filed results in automatic dismissal of the case. However, debtors can apply for a 45-day extension.

Debtors must provide:

• A list of creditors
• Schedules of assets and liabilities
• Income and expenses
• Certificate of credit counseling
• Evidence of payment from employers, if any, received 60 days before filing
• Statement of monthly net income and any anticipated increase in income of expenses after filing
• Tax returns or transcripts for the most recent tax year
• Tax returns filed during the case including tax returns for prior years that had not been filed when the cases began, and;
• Photo I.D.

Assets harder to hold

To retain a home, filers have to keep making their monthly payments. But the amount that was past due at filing can be included in the bankruptcy debts, and paid over the life of the bankruptcy plan.

Under the new reforms, it will be harder for debtors filing Chapter 13 to keep a vehicle. Those who plan to keep their vehicle have to pay the full loan amount, rather than just its current value as previously allowed. This new rule applies to all car loans less than two and a half years old as of the filing date.

Who gets paid when

Re-payment priorities for people and companies (creditors) that are owed money have also changed. In other words, who's getting their money first is no longer the same: Under the new bankruptcy laws, people who are owed unpaid child support and alimony take priority over any other creditor.

Chapter 13 won't stop or even postpone some debt collections and lawsuits. New bankruptcy laws have dropped the following "automatic stays" of bankruptcy:

• Evictions
• Actions to withhold, suspend or restrict a driver's license
• Actions to withhold, suspend or restrict a professional or occupational license
• Lawsuits to establish paternity, child custody or child support
• Divorce proceedings, or
• Lawsuits related to domestic violence.

Debtors cannot confirm a bankruptcy plan or obtain a discharge of debts if their domestic support obligations are not paid according to its terms.

More debts not forgiven

Be advised. Debts from the following items will not be discharged under Chapter 13:

• Trust fund taxes
• Taxes owed for returns never filed or filed late (within two years of the petition date)
• Taxes owed from a fraudulent return or evaded taxes
• Fraud and false statements
• Domestic support payments
• Student loans
• Drunk driving injuries
• Criminal restitution
• Fines and civil restitutions
• Damages rewarded for willful or malicious personal actions causing personal injury or death

The repayment plan must be approved by the bankruptcy court and the trustee, and creditors are allowed to object. Sometimes individuals file for Chapter 13 only to find out they must convert it to a Chapter 7.

If the plan passes muster with the court, then all disposable income is given to the trustee, who keeps a percentage as a fee and parcels out the rest to the creditors in accordance with the plan. You're only prevented from re-filing for Chapter 13 for six months.

What's good about Chapter 13?

Chapter 13 allows debtors a chance to halt foreclosure proceedings on their homes. While they must still make mortgage payments on time, they can pay off delinquent mortgage payments and ultimately keep their homes, according to the Administrative Office of the United States Courts.

What's more, even though it lingers longer, Chapter 13 is kinder on the credit score than a total liquidation, says Ulzheimer. Creditors will see that the debtor is making an effort to pay off the debts. Unfortunately, it will be harder to obtain new credit because creditors will know you already have to pay off other creditors. With Chapter 7, they know you're not paying off those debts, he says.

One final note: At the end of any bankruptcy, you might receive a 1099 form from creditors listing your discharged debt as unreported income. If the IRS asks, supply the documentation that shows the 1099 form resulted from a bankruptcy.

"Chapter 20"

There is no Chapter 20 in the bankruptcy code. Instead the term refers to filing a Chapter 7 followed by a Chapter 13 (the sum of which is 20), says James R. Beaman, a Tucson-based attorney and co-author of "The Complete Idiot's Guide to Surviving Bankruptcy." The purpose of the second filing: to get rid of debts that are not dischargeable under Chapter 7.

This type of action is "pretty rare," says Sommer. More common is that individuals get into debt again within six years of a Chapter 7 and end up filing a Chapter 13. There are stricter limits to filing a case after a prior case under the new law.

For instance, a discharge will not be granted in Chapter 13 if the debtor obtained a discharge through Chapter 7, 11 or 12 within four years prior to the date of filing the new case, or if a debtor filed a Chapter 13 case within two years of the pending case.

Get a good attorney

In the event that you still want to file for bankruptcy, you need an experienced lawyer who specializes in bankruptcy to navigate the federal laws, state laws and tax consequences. Steer clear of petition preparers, typing services or paralegals, says Sommer. And if you are even considering filing on your own, remember the old adage: A man who represents himself has a fool for both an attorney and a client.

"It's a very bad idea," says Sommer. "Chances are, mistakes would be made that would cost you more than paying an attorney."

Under the new stipulations, lawyers must make a "reasonable inquiry to verify that the information contained" in petitions and schedules are correct. The signature of the lawyer on the petition will certify that the information in the schedules filed is correct. Lawyers face financial responsibility for court costs and creditor's attorneys' fees if the debtor's statements about property and finances prove to be false or incomplete.

Leslie Hunt contributed to this story.

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