Chapter 13 Bankruptcy

Last Updated :

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Blog Author :

Aswathi Jayachandran

Edited by :

Rashmi Kulkarni

Reviewed by :

Dheeraj Vaidya, CFA, FRM

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Chapter 13 Bankruptcy Definition

Chapter 13 Bankruptcy defines the code of the US used to deal with debt adjustment for individuals with regular income who are struggling to pay off their debts. The provisions in this chapter offer several advantages to debtors and creditors. It reflects legislative intent to help individual debtors use repayment plans to achieve debt relief and supports creditors by facilitating debt recovery. It is also called a Wage Earner's Plan.

Chapter 13 Bankruptcy

People have several advantages under Chapter 13 compared to liquidation under Chapter 7 bankruptcy. One of the most significant advantages is that it helps individuals avoid debt foreclosure on their homes. Filing under this chapter allows individuals to halt foreclosure proceedings and work towards resolving delinquent mortgage payments through a payment plan that is spread over a specific period.

Table of contents
  • Chapter 13 Bankruptcy Code of the US allows debt adjustment for individuals who have a regular income but are unable to pay off their debt. 
  • The repayment plan under Chapter 13 extends typically to a period of five years, and the provisions do not allow for more time if the debtor's monthly income is higher than the state-provided median.
  • Chapter 13 provides legal protection to debtors from creditors’ collection efforts. It means creditors must stop phone calls, letter deliveries, visits, lawsuits, wage garnishments, and other debt collection methods.
  • The discharge of certain types of debts, including mortgages, student loans, child support, certain taxes, alimony, and debts related to criminal activity, is disallowed per the provisions of this chapter.

Chapter 13 Bankruptcy Explained

Chapter 13 Bankruptcy Code guides individuals with regular income by giving them repayment options. The plan can involve full or partial repayment of debt. The code enables debtors to offer creditors a repayment plan that calls for regular payments over three to five years. If the debtor's monthly income is below the state median, the plan's duration is typically set at three years; however, the court may grant a longer payback time for them.

The repayment plan under Chapter 13 is normally set at five years, and it cannot go beyond this time frame if the debtor's monthly income is higher than the state-provided median. Even if the debtor suggests a longer repayment time, it cannot exceed five years, according to the provisions of the plan. In addition to these, the law also forbids creditors from starting or continuing collection actions against the debtor during this time.

Chapter 13 provides legal protection to debtors from creditor collection efforts. This protection includes pausing phone calls, letters, visits, lawsuits, wage garnishments, and other debt collection methods. It is called the automatic stay. Creditors must legally halt all collection attempts once the repayment plan is approved. This protection allows debtors to reorganize their finances and repay their debts without undue harassment from creditors.

Any outstanding debt in a Chapter 13 bankruptcy is normally discharged after the repayment plan is finished. This implies that even if the creditor did not collect the entire amount due, the debtor is no longer bound to pay the loan. It is crucial to remember that not all obligations are dischargeable under Chapter 13. For instance, Chapter 13 bankruptcy does not allow for the discharge of some debts, including mortgages, student loans, child support, certain taxes, alimony, and debts related to criminal activity.

Requirements

Some of the requirements for Chapter 13 bankruptcy filing under the code are given below:

  • Self-employed individuals or those who operate an unincorporated business may qualify for Chapter 13. As long as their combined total of secured and unsecured debts do not exceed $2,750,000 when filing for bankruptcy relief. This means that Chapter 13 may be viable for individuals with significant debts.
  • Chapter 13 bankruptcy requires individuals to have a regular income, file all necessary tax returns for the four years preceding the bankruptcy filing, and meet other eligibility criteria outlined in the US bankruptcy code.
  • To fully benefit from the bankruptcy laws and start anew, it is crucial to avoid accumulating new debt. If federal tax debts factor in the decision to file bankruptcy, increasing withholding or estimated tax payments may be necessary to address overdue taxes.
  • An individual is ineligible to file for bankruptcy under Chapter 13 or any other chapter if they have had a bankruptcy petition dismissed within the previous 180 days. This may be due to their failure to appear in court, disobeying court orders, or after creditors sought relief to reclaim property on which they have liens. It also covers another crucial aspect, which is a debtor’s willful and repeated abuse of the bankruptcy system and its provisions. It means such debtors have a history of filing for bankruptcy to avoid repaying legitimate debts.
  • A person must have received credit counseling from an accredited organization within 180 days before filing to be eligible as a debtor under Chapter 13. This can be done either individually or in a group setting.

Process Steps

The steps involved in Chapter 13 bankruptcy filing can be summarized as follows:

  • Individuals must gather information about their creditors, income, expenses, assets, and debts before filing for Chapter 13 bankruptcy. They must also attend credit counseling at an approved agency. Upon successfully completing counseling, debtors receive a Certificate of Completion, which is a mandatory document required while filing for bankruptcy under this chapter. Bankruptcy filing fees are required but can be waived or paid in installments if income is insufficient.
  • After filing for bankruptcy, an automatic stay comes into effect, preventing most creditors from collecting debts. The court will notify creditors, and unsecured creditors must file a proof of claim to be part of the proceedings. A proof of claim is a formal document that outlines the amount of debt a debtor owes a creditor. The court will appoint a trustee to handle the case, and the debtor must make their first monthly payment to the trustee one month after filing.
  • Approximately one month after the trustee is appointed, a meeting of creditors will be held. The debtor must attend and answer questions under oath about their financial affairs and repayment plan. The trustee and creditors will also ask questions. A confirmation hearing will then be scheduled to ensure that the debts will be sufficiently paid off or paid down. 

Note: To fix Chapter 13 bankruptcy payments, the trustee will review the debtor's income and expenses to determine a fair and feasible payment amount.

Examples

Here are a few examples that explain the concept in more detail. 

Example #1

Patty is a salaried employee who lives paycheck to paycheck and encounters sudden expenses due to medical bills. She had taken out the amount as a loan from a creditor, and the interest has been accruing for years, resulting in a huge debt of almost $300,000. Unable to keep up with the due payments, she files for bankruptcy and approaches a Chapter 13 bankruptcy lawyer.

The lawyer creates a repayment plan with a comfortable amount of monthly 13 bankruptcy payments for 3–5 years, keeping her expenses in mind. This was sent to the court for approval, and Patty began making payments to a trustee who would distribute the fund to her creditor. With the help of her Chapter 13 bankruptcy lawyer, she could pay off her debts comfortably.

Example #2

A bankruptcy filing report reflects the state of bankruptcies in the US and highlights the state of affairs in the US economy. In the United States, bankruptcy filings decreased during the calendar year ending Dec 31, 2022. The situation reflects a continuing downward trend that started with the COVID-19 epidemic.

The annual number of bankruptcy filings in 2022 was 387,721, a decrease of 6.3% from the 413,616 cases filed in 2021. The data was made public by the Administrative Office of the US Courts. Although the number of bankruptcy filings declined during this time, individual Chapter 13 filings dramatically increased.

Many factors likely contributed to the drop in bankruptcy filings, including the strengthening of the economy, stronger bankruptcy laws, greater accessibility to credit, and the growing costs of filing. Even though bankruptcy filings decreased overall, the rise in Chapter 13 cases indicates that people still have financial difficulties.

Advantages And Disadvantages

Some advantages and disadvantages of filing for Chapter 13 bankruptcy are given below.

Advantages

  • Debt repayment: Chapter 13 bankruptcy payments enable borrowers to reorganize their difficult debts and create a three- to five-year repayment schedule. This could result in lower monthly payments that are easier to afford.
  • Asset preservation: Chapter 13 bankruptcy enables people to keep their assets while making debt payments, unlike Chapter 7 bankruptcy, which requires liquidating assets to pay off creditors.
  • Legal protection: Filing for bankruptcy under Chapter 13 gives protection from creditors' collection efforts for the repayment period. This includes phone calls, mailings, lawsuits, and other debt collection measures.
  • Discharge of outstanding debts: Following successful completion of the repayment plan, debtors may be granted a discharge of any outstanding, admissible debts, ending their liability to pay such debt back.

Disadvantages

  • Long process: Since Chapter 13 includes developing and adhering to a repayment plan that lasts several years, it often takes more time than Chapter 7.
  • Impact on credit: Bankruptcy can stay on a person's credit report for up to 7 years, which could make it more challenging to get credit in the future.
  • Chapter 13 bankruptcy cost: Filing for bankruptcy under Chapter 13 can be expensive since people must pay court costs, attorney fees, and other associated costs.  Chapter 13 bankruptcy costs can be more than anticipated, so individuals need to be careful.
  • Limited debt relief: Not all debts can be discharged under Chapter 13; people still have to pay back their higher-priority bills, like taxes and child support obligations.

Frequently Asked Questions (FAQs)

1. Does Chapter 13 bankruptcy stop garnishment?

Yes, wage garnishment typically stops after filing for Chapter 13 bankruptcy. This is due to the automatic stay provision of this chapter. It implies that a debtor's company will no longer be permitted to deduct funds from an individual's paycheck to pay their creditors. It is important to note that not all wage garnishments can be stopped by bankruptcy.

2. Does Chapter 13 bankruptcy affect tax returns?

Under chapters 7, 11, 12, and 13, bankruptcy filers must file all relevant tax returns due after the case begins. Not filing tax returns can cause a bankruptcy case's dismissal or conversion to another chapter. Similarly, federal tax debt being discharged depends on individual circumstances, where the type of tax debt, for how long it has been due, etc., are considered.

3. Is Chapter 13 bankruptcy public record?

Yes, Chapter 13 bankruptcy is a matter of public record. The case becomes accessible to interested parties, such as creditors, but not all information is revealed to the public.

4. Will Chapter 13 bankruptcy take my tax refund?

In a Chapter 13 bankruptcy case, the debtor's repayment strategy and the overall amount they will pay back to creditors, along with the size of the tax refund and any relevant exemption laws, decide whether they can keep their tax refund.