Is It Better to File a Chapter 7 or 13 Bankruptcy?
The average person has little to no understanding of bankruptcy, which means there’s a steep learning curve if you need to consider bankruptcy as a solution to your financial situation.
But even if you’ve determined that bankruptcy is the best or only reasonable road to debt relief, there’s still the question of which type of bankruptcy filing will is the right choice for you or your business. The most common bankruptcy filings for individuals are either Chapter 7 or Chapter 13, and there are some big variations between those options.
If you can’t see any possible way to pay your debts, it’s time to enlist the help of a knowledgeable bankruptcy attorney. In the meantime, educating yourself on your options will give you a better idea of what to expect.
Chapter 7 vs. Chapter 13
The goal of bankruptcy is to discharge or eliminate debt that you are unable to pay under your current circumstances. However, not all debt will qualify.
No matter what type of bankruptcy you file, you cannot discharge debts like student loans, and domestic support obligations like alimony and child support. Bankruptcy will not release you from a tax lien, but you may be able to discharge tax debt under certain circumstances.
The biggest difference between types of bankruptcy is that Chapter 7 is a liquidation, where all assets are sold and the money used to pay creditors, and Chapter 13 is a reorganization, where the debt is reorganized to make it manageable for the debtor. Both will discharge eligible debts, but the mechanism for doing so is different for each.
|Chapter 7||Chapter 13|
|Must pass a means test||Must have debt below debtlimits|
|Repayment plan||None||3-5 years|
|Timeframe||4-6 months||3-5 years|
|Stays on credit report||Up to 10 years||Up to 7 years|
Chapter 7 Bankruptcy
This is the most common form of bankruptcy, making up over 70% of the filings in 2021. In order to qualify for Chapter 7, you must pass a means test to show that your income is lower than your state’s median income. If you have too much income, you can file for Chapter 13 bankruptcy.
Chapter 7 is the quickest bankruptcy process, reaching completion in 4-6 months on average. Your eligible debts are wiped out, including credit card debt, medical bills, and personal loans. This forgiveness comes at a price, however: all your assets with any value are sold off. In some cases you may be able to keep your car or house as long as you don’t have any past due mortgage payments, but this is not always the case.
Chapter 13 Bankruptcy
This form of bankruptcy is a reorganization of debts, with the goal of making debt manageable and possible to pay off in three to five years. If filing before April 1, 2022, debts must not exceed $1,257,850 in secured debt and $419,275 in unsecured debt. However, these limits are adjusted every three years based on the Consumer Price Index, and are slated to increase.
For debt higher than these limits, it may be possible to file for Chapter 11 bankruptcy.
This can be a good option for people who will not be able to discharge their debts by filing for Chapter 7. If you have federal student loans or there is a tax lien on your property, by reorganizing your debts so that you can meet your monthly payme, you may be able to use this option to repay those debts and get the lien released. However, those debts cannot be discharged at the end of the repayment plan. Only unsecured debts like credit card debt and medical debt are discharged at that time.
Unlike Chapter 7, you can use the Chapter 13 repayment plan to make up missed car payments and mortgage payments, allowing you to keep possession of these assets.
Tax Liens and Bankruptcy
Unpaid taxes can sometimes be discharged in a Chapter 7 bankruptcy, but if unpaid taxes keep growing then you may find yourself with a tax lien against your property. This can happen from federal taxes, where the lien is filed by the IRS, often for debts exceeding $10,000. This can also occur if you fall behind on state taxes; in Maryland the lien is filed by the Comptroller.
When a lien is filed against your property—and this can include any assets of value, like real estate or vehicles—you will be unable to sell that property unless you are using the funds to pay your tax debt. The lien will also be noted on your credit report, making it very difficult to get loans or new credit cards. It is best to prevent tax debt from turning into a tax lien, since the effects are far-reaching and can make life very difficult.
A tax lien cannot be discharged via bankruptcy. However, you can use a Chapter 13 filing to make a repayment plan that includes the payment of tax debts. Filing for bankruptcy also freezes the accrual of interest and penalties on tax debt. If the repayment is successfully completed, the tax lien is removed.
The Statute of Limitations on Tax Debt
It is possible to have your tax debt forgiven if you wait long enough. There are risks with trying to wait it out. For instance, interest and penalties will continue to accrue, letting your debt grow bigger and bigger. The IRS may also garnish your wages for unpaid taxes. If a tax lien is placed on your property, it will be difficult to sell that property without putting the proceeds toward your tax debt. It is in the best interest of the government to collect money from you, one way or another.
[H3]: Federal Tax Debt
The statute of limitations on federal tax debt is 10 years. This starts from the time the penalty was assessed, and ends at the Collection Statute Expiration Date (CSED). Since the IRS does not benefit from forgiving this debt, they will try to get collect what is owed, especially as the CSED approaches. They could negotiate the amount, or try to get you to agree to a payment plan. These could extend the statute of limitations on this debt, so it is best to seek out a tax professional before agreeing to anything.
RELATED POST: How Long Can the IRS Try to Collect a Debt?
Maryland Tax Debt
The statute of limitations on Maryland tax debt is 20 years. Like the IRS, the Comptroller of Maryland has some incentive to negotiate tax debt using an Offer-In-Compromise (OIC) rather than allow it to expire. Since 20 years is a long time for penalties to accrue, it is best to talk to a tax professional to see if there is a better solution to resolve your debts.
How a Bankruptcy Attorney Can Help You Resolve Tax Debt or Tax Liens
Waiting for the statute of limitations to run out is a risky move. It’s better to address the debt as soon as you can. However, if you are not a bankruptcy lawyer yourself, you may find the process complicated and you run the risk of not understanding your best course of action.
This is why it is critical to hire a tax attorney experienced in handling bankruptcy cases. They may be able to prove that your taxes were incorrectly calculated and get the lien reduced or withdrawn. They’ll also know how to negotiate your debt in order to find a solution that you can pay back.
A skilled tax attorney will know if it is in your best interest to try filing for bankruptcy, or try to find an OIC or payment plan to tackle your tax debt.
Try a Free Consultation With S.H. Block to Manage Your Tax Debt
Our tax experts are familiar with tax debt and its implications. Whether you have tax debt or a tax lien, our attorneys can find a solution to help you find relief from what you owe.
Our law firm has been helping individuals and business with their difficult tax and debt problems for more than 50 years. We understand your situation and want to help you protect your assets, which is why we offer a free consultation to talk about your debt.
United States Courts. (2021, September 30). Business and Nonbusiness Cases Filed, by Chapter of the Bankruptcy Code. City, ST: United States Courts. Retrieved from https://www.uscourts.gov/sites/default/files/data_tables/bf_f2_0930.2021.pdf
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