Debts in bankruptcy: What the fate has in store for them

When filing for bankruptcy, be it Chapter 7 or Chapter 13, it is important for you to know the fate of your debts and how to deal with them accordingly.

What do you understand by the term ‘priority debts’?

Almost all of your debts can be included in your bankruptcy case. But, as per the Bankruptcy Code not all that you include in your petition for discharge will be entertained or for that matter will be obliged by the competent court of law. Debts that will not get discharged and for which you’ll remain liable to pay back are known as priority debts. The reason is that they enjoy greater priority over other lines of credit.

In the case of a Chapter 7 bankruptcy, your priority lenders will be in the forefront when the proceeds from the asset liquidation occurs and hence, will get their share of the pie ahead of all the other creditors. Interestingly, these are such a kind of debt that they don’t even get discharged, even in cases where you may have no asset to liquidate with which to pay them off. This is why in Chapter 13 bankruptcy cases, it is mandatory to provide a detailed debt repayment plan to the court through which you are planning to pay off your priority debts.

Examples of priority debts

Here are some priority debts of which you’re probably aware of:

• Penalties, fines, and other outstanding fees owed – Some of the instances of these financial liabilities are fines slapped on charges of overdue speeding tickets, tax penalties, vehicle registration fees and so on will not be discharged by the bankruptcy court.
• Home loans, car loans and other secured loans – Loans (mortgage, car loan, etc) that originate in exchange of an asset pledged as collateral to buy a home or a car are called secured loans. These secured loans can have your home or your favorite car repossessed in case of repeated payment default. If you file for Chapter 13 bankruptcy protection, then secured loans will be restructured such that all the outstanding payments, fines, and penalties are included in the modified repayment plan.

However, if you’ve opted for Chapter 7 bankruptcy, then you may be allowed to keep your asset, provided you have the necessary financial resources to catch up with the missed payments. And not only that, you’ll have to be consistent in making the monthly repayments to hold onto your asset long after your bankruptcy case is complete.

• Debts incurred due to malicious or harmful behavior – It may happen that you’ve incurred debts because you willfully inflicted injury on other people or to their properties. In that case, if a court has directed you to pay up for the damages caused by you due to the intentional injury you brought upon your victims or to their assets, then those obligations will not go away. This includes damages caused to public or private properties due to rash/negligent driving or worse, driving under the influence of intoxicants.

No matter what type of bankruptcy protection you ask for, these debts simply won’t be discharged, rather they’ll be restructured with other priority as well as secured debts and can be included into your Chapter 13 bankruptcy repayment plan, provided you’ve opted for one in the first place.

Tax debt – The proper timing for a discharge

The Internal Revenue Service (IRS) will forgive its due and you can obtain a complete discharge from your tax debts, only if you can fulfill the following conditions:

• Your debt must have originated from income taxes and this doesn’t include in any way other financial obligations like payroll or sales tax.
• You did not commit any kind of tax fraud such as tax evasion or filed fraudulent annual tax returns.
• Your income tax debt must be minimum three years old. In case you’ve gotten behind in making your tax payments in the recent past, then you have the option to work out a suitable repayment plan or apply with the IRS for an Offer-in-Compromise (OIC) where, if you qualify, you’ll be allowed to pay less than the actual debt amount owed to Uncle Sam.
• Your annual tax return paper that was generated as your income tax bill must have happened on time and should be 2 years old to say the least. It must be noted here that you are not allowed to postpone filing your annual tax returns for consecutively several years at a stretch and then put in your tax papers all in one year so as to claim bankruptcy protection from paying the outstanding taxes to the IRS and avoid a big financial hiccup.
• Your tax debt must not have been assessed at least 240 days prior to submitting your bankruptcy petition in the court.

It’s best to come clean when dealing with the IRS, since they can put liens on your property for defaulting in tax payments – something that sticks on, even if you’ve been discharged of all your other debts in a bankruptcy. In Chapter 7, just because a debt is discharged does not mean that the lien is removed from your asset. There are some exceptions and strategies your attorney can do in order to remove in the lien or at least work with the creditor to compromise.

This post was contributed by Any Raybuck. He is a financial writer and personal finance consultant. He participates in quite a number of online communities and social media outlets to resolve people’s daily monetary queries and there he gives them crisp, straightforward answers that can easily be followed.