People typically prefer to file a Chapter 7 Bankruptcy over a Chapter 13 Bankruptcy because a Chapter 7 Bankruptcy does not require debtors to pay back their creditors; however, some debtors simply just do not qualify for a Chapter 7 Bankruptcy. That said, a Chapter 13 Bankruptcy provides options that a Chapter 7 Bankruptcy just do not offer, making a Chapter 13 Bankruptcy the better option in some cases because it has provisions that will permit an individual with regular income to repay some of their creditors an amount that is less than the amount actually owed; however, not everyone is eligible for Chapter 13 Bankruptcy.

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Reasons Debtors Choose Chapter 13 Bankruptcy

There are reasons debtors choose a Chapter 13 Bankruptcy over a Chapter 7 Bankruptcy; but most of the reasons are based on whether the filer has equity, especially if the filer wants to retain that equity. Below are examples of reasons why some debtors choose a Chapter 13 Bankruptcy over a Chapter 7 Bankruptcy:

A debtor whose income exceeds the Chapter 7 "Means Test" maximum is not eligible to receive a Chapter 7 Bankruptcy discharge to clear qualifying debt.

A homeowner who is behind on a mortgage payment can pay the arrears over three-to-five years and keep the house. The same holds true for an overdue car payment.

A debtor can prevent a collection action, such as a wage garnishment, while still paying off a tax bill, overdue child or marital support and/or other non-dischargeable debt in a repayment plan.

A debtor can keep "non-exempt" property that would otherwise get liquidated or sold in a Chapter 7 Bankruptcy; however, the debtor will need to pay for the nonexempt portion in the three-to-five-year repayment plan as part of the Chapter 13 Bankruptcy process.

The advantages to a Chapter 13 Bankruptcy can be significant to a debtor who just fell behind; but who has property that he or she may want to retain, such as a house and/or a vehicle.

Qualifying for Filing Chapter 13 Bankruptcy

The benefit of a Chapter 13 Bankruptcy is that you repay some of your debts; but usually not all of them and usually not for the full amount of the debt, over the course of a three-to-five-year repayment plan. Before the Bankruptcy court "confirms" or "approves" your Chapter 13 Bankruptcy plan, you must complete the official bankruptcy paperwork and prove that you are:

  • You must be up-to-date on your federal and state tax filings;
  • You must be within certain debt amount limitations with sufficient disposable income;
  • You must be employed and have enough income to cover the required monthly payment, and
  • An individual, not a business (however, all financial aspects of a sole proprietor’s business get included in the bankruptcy).

These requirements are set forth more fully below.

You Must Be Current on Federal & State Tax Returns

In addition to the above-listed requirements, to file for a Chapter 13 Bankruptcy, you must submit proof that you filed both your federal and state income tax returns for the four (4) tax years prior to the date of your bankruptcy filing. If you need time to get current on your federal and/or state income tax filings, the court can, but will not always, permit you to postpone the proceedings. Ultimately, however, if you do not produce your returns or transcripts of the returns for those four (4) years, a Chapter 13 Bankruptcy will be dismissed for want of satisfying the statutory requirements to filing for a Chapter 13 Bankruptcy.

You Must Have Sufficient Disposable Income

To qualify for Chapter 13, you will have to show the bankruptcy court that you will have enough income, after subtracting certain allowed expenses and required payments on secured debts, such as a car loan or a mortgage, to meet your repayment obligations. Your plan must pay back certain debts in full, or the judge will not "confirm" or "approve" it and allow you to proceed.

You Must Have a Sufficient Income Source

Debtors filing for Chapter 13 Bankruptcy can use the following sources as income:

  • Regular wages or salary
  • Income from self-employment
  • Wages from seasonal work
  • Commissions from sales or other work
  • Pension payments
  • Social Security benefits
  • Disability or workers' compensation benefits
  • Unemployment benefits, strike benefits, and the like
  • Public benefits (welfare payments)
  • Child support or alimony you receive
  • Royalties and rents, and
  • Proceeds from selling property, especially if selling property is part of your primary business property.

If you are married, your income does not necessarily always have to be "yours." A nonworking spouse can file alone and use money from a working spouse as a source of your income. Additionally an unemployed spouse can file jointly with a working spouse.

Your Debts Cannot Be Too High

You will qualify for a Chapter 13 Bankruptcy if your secured and unsecured debt exceed certain amounts. These debt figures change every three years.

A debt is secured if you stand to lose specific property if you don't make your payments to the creditor, such as a mortgage or a car loan; however, a debt might also be secured if a creditor, such as the IRS, has filed a lien or notice of claim against your property.

An unsecured debt does not give the creditor a right to take a particular piece of property. Most debts are unsecured, including credit card debts, medical and legal bills, utility bills, and department store charges.

Businesses Not Allowed to File for Chapter 13 Bankruptcy

A business cannot file for Chapter 13 Bankruptcy in the name of that business. Businesses are steered toward Chapter 11 Bankruptcy when they need help reorganizing debts. An exception exists, however, where a sole proprietor cannot file in the name of the business, both the business and personal debts are the responsibility of the individual, and therefore, are included in the bankruptcy filing. Thus, a Chapter 13 Bankruptcy can effectively help reorganize a sole proprietor’s business.

You can, however, file for Chapter 13 Bankruptcy as an individual even if you own a business. You will include business-related debts for which you are personally liable in your Chapter 13 Bankruptcy case. But, the business will remain liable for the debt. And yet again, the result is different if you are a sole proprietor, both the individual and business debt liability will be handled by the bankruptcy.

Important Note: Stockbrokers and/or commodity brokers cannot file a Chapter 13 Bankruptcy case even if they want to discharge only personal, or non-business, debts.

How to File for Chapter 13 Bankruptcy

You will disclose all aspects of your financial condition, including your income and expenses, assets, creditors, and previous transactions in the bankruptcy filing documents. The case will start once you file the forms and other necessary documents, such as a filing fee and proof that you completed a credit counseling class. You will thereafter have fourteen days to submit your Chapter 13 Repayment Plan unless you receive an extension from the court.

The Chapter 13 Repayment Plan

The main part of a Chapter 13 Bankruptcy is the "Repayment Plan", which is where you propose to your creditors and the Bankruptcy Court, the plan to repay your debts. You will either use the official plan form or your court’s local form, depending on where you file.

Your creditors and the Bankruptcy Trustee will have an opportunity to object to your plan. If you are able to make changes to everyone’s satisfaction, the Court will likely "confirm" or "approve" your Repayment Plan at the confirmation hearing. You will not wait until plan confirmation to start paying your monthly payment, however, because your payments on the Repayment Plan will begin the month after you file.

Examples of Debts Required to be Repaid Under a Chapter 13 Repayment Plan

Priority Debt - Your Chapter 13 Repayment Plan must pay certain debts, called "priority claims", in full. The priority claims include debts such as child support and alimony, as well as most tax liens and/or obligations.

Secured Debt - If you want to keep a car or house, you will have to continue to pay your regular payment on the car loan or mortgage. Whether you will have to pay these amounts as part of your plan will depend on your local court. If you are behind on payments, you have to repay the arrears in your plan.

Unsecured Debt - The plan must apply your disposable income, which is the amount remaining after the paying of secured and priority debt, as well as allowed living expenses, toward unsecured debts, such as credit card balances and medical bills. You do not have to fully repay these debts, or even pay them at all, in some cases. You just must show that you are putting any remaining income towards their repayment.

Value of Nonexempt Property - You are allowed to keep all of your property in a Chapter 13 bankruptcy if you can afford to do so.

Although the repayment length will depend on how much you earn, most will choose a five-year repayment plan because it is common for most filers to choose the more extended plan, primarily because it increases the likelihood that the Bankruptcy Court will approve or confirm the plan and is usually the repayment plan that most filers can handle financially.

The Confirmation Process

Before a Repayment Plan goes into effect, a Bankruptcy Court must "approve" or “confirm” the Repayment Plan at a confirmation hearing. Creditors will have an opportunity to object to the plan beforehand.

  • If there are no objections, the Judge will confirm the plan if it meets the following elements:
  • The plan is feasible, meaning the debtor has enough income to pay creditors as provided;
  • The debtor proposed the plan in good faith; and
  • The plan complies with bankruptcy law.

After Confirmation in a Chapter 13 Bankruptcy, the debtor must complete the three-to-five-year repayment plan before any debts get discharged. The confirmation therefore creates new contracts between the debtor and his or her creditors to ensure repayment of the debts over the three-to-five year repayment plan.

What Happens If You Cannot Continue Making Payments on a Repayment Plan?

A lot of financial changes can occur over the course of your plan; however, that does not mean you are out of the Repayment Plan automatically.

Suppose, for example, that your income decreases over the three-to-five year repayment plan period, in such a case, you may be able to modify the amount being paid to your unsecured creditors. If, however, you cannot pay a required debt, the court might let you discharge your debts due to a financial hardship.

If this is not feasible, you may be able to convert your Chapter 13 Bankruptcy to a Chapter 7 Bankruptcy, in which case all your debts will be discharged. Keep in mind, however, that there is a good chance that you may lose your nonexempt property. Another option is to dismiss your Chapter 13 Bankruptcy case; but the problem with this approach is that you will still owe your outstanding debt balance, plus any interest, to the creditors you did not pay during your Chapter 13 Repayment Plan.

How a Chapter 13 Case Ends

After completing your repayment plan, you must show the court that you are current on your child support and alimony obligations and that you have completed the credit counseling course. If the Bankruptcy Court determines that you met all the requirements, the remaining balance on qualifying dischargeable debt gets cleared. You should thereafter be debt less any non-dischargeable debts.

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