Chapter 13 Explained
ADVANTAGES OF CHAPTER 13
Chapter 13 offers individuals a number of advantages over liquidation under chapter 7. Perhaps most significantly, chapter 13 offers individuals an opportunity to save their homes from foreclosure, cars from repossession, etc. By filing under this chapter, individuals can stop foreclosure or repossession proceedings and may cure delinquent payments over time. Another advantage of chapter 13 is that it allows individuals to reschedule secured debts (other than a mortgage for their primary residence) and extend them over the life of the chapter 13 plan. Finally, chapter 13 acts like a consolidation loan under which the individual makes the plan payments to a chapter 13 trustee who then distributes payments to creditors.
THE CHAPTER 13 PLAN
A plan must be submitted for court approval and must provide for payments to the trustee on a regular basis. The trustee then distributes the funds to creditors according to the terms of the plan, which may offer creditors less than full payment on their claims, usually after the plan has been confirmed.
There are three types of claims: priority, secured, and unsecured. Priority claims are those unsecured claims granted special status by the bankruptcy law, such as most taxes and the costs of bankruptcy proceeding. Secured claims are those for which the creditor has the right to take back certain property (i.e., the collateral) if the debtor does not pay the underlying debt. In contrast to secured claims, unsecured claims are generally those for which the creditor has no special rights to collect against particular property owned by the debtor. The plan must pay priority claims in full unless a particular priority creditor agrees to different treatment of the claim.
If the debtor wants to keep the collateral securing a particular claim, the plan must provide that the holder of the secured claim receive at least the value of the collateral. If the obligation underlying the secured claim was used to buy the collateral (e.g., a car loan), and the debt was incurred within certain time frames before the bankruptcy filing, the plan must provide for full payment of the debt, not just the value of the collateral (which may be less due to depreciation). Payments to certain secured creditors (i.e., the home mortgage lender), may be made over the original loan repayment schedule (which may be longer than the plan) so long as any arrearage is made up during the plan. The debtor should consult an attorney to determine the proper treatment of secured claims in the plan.
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. In chapter 13, “disposable income” is income (other than child support payments received by the debtor) less amounts reasonably necessary for the maintenance or support of the debtor or dependents and less charitable contributions up to 15% of the debtor’s gross income. If the debtor operates a business, the definition of disposable income excludes those amounts which are necessary for ordinary operating expenses. The “applicable commitment period” depends on the debtor’s current monthly income. The applicable commitment period must be three years if current monthly income is less than the state median for a family of the same size – and five years if the current monthly income is greater than a family of the same size. The plan may be less than the applicable commitment period (three or five years) only if unsecured debt is paid in full over a shorter period.
THE CHAPTER 13 DISCHARGE
A chapter 13 debtor is entitled to a discharge (forgiveness) upon completion of all payments under the chapter 13 plan so long as the debtor: (1) certifies that all domestic support obligations that came due prior to making such certification have been paid; (2) has not received a discharge in a prior case filed within a certain time frame (two years for prior chapter 13 cases and four years for prior chapter 7, 11 and 12 cases); and (3) has completed an approved course in financial management.
As a general rule, the discharge releases the debtor from all debts provided for by the plan or disallowed, with the exception of certain debts. Some examples of debts not discharged in chapter 13 include certain long term obligations (such as a home mortgage), debts for alimony or child support, certain taxes, debts for most government funded or guaranteed educational loans or benefit overpayments, debts arising from death or personal injury caused by driving while intoxicated or under the influence of drugs, and debts for restitution or a criminal fine included in a sentence on the debtor’s conviction of a crime. To the extent that they are not fully paid under the chapter 13 plan, the debtor will still be responsible for these debts after the bankruptcy case has concluded. Debts for money or property obtained by false pretenses, debts for fraud or defalcation while acting in a fiduciary capacity, and debts for restitution or damages awarded in a civil case for willful or malicious actions by the debtor that cause personal injury or death to a person will be discharged unless a creditor timely files and prevails in an action to have such debts declared nondischargeable.
Tax treatment
Generally, discharged debts are not considered taxable income. Please check with your tax advisor to see how the law may be applied in your situation.