Bankruptcy can’t write off certain kinds of debts. Chapter 7 may give you enough help to avoid liens on your home from those debts
In our July 1 blog post we gave a list of 10 ways that a Chapter 13 “adjustment of debts” can help you keep your home. Today we get into the 6th of those 10 ways, starting with how Chapter 7 “straight bankruptcy” helps and doesn’t help. Here’s how we introduced this earlier, focusing first today on the Chapter 7 side of this.
7. Debts Which Cannot Be Discharged Such as Income Taxes & Back Child/Spousal Support
Some special debts cannot be discharged (written off) in bankruptcy. So those creditors can start chasing you on those as soon as you finish a Chapter 7 case. And that’s usually only about three or four months after you start a case. Sometimes sooner. Those creditors generally include the IRS, the state taxing authority, your ex-spouse, and the state or local support enforcement agencies.
These particular creditors often have extraordinary collection powers, including against your home. They can put a tax lien or support lien on the home. Under some circumstances can even seize and sell your home to pay those liens.
The key question is whether Chapter 7 discharges enough debts for you so that you can afford to pay off the debt(s) that isn’t (aren’t) discharged. If so, Chapter 7 would likely be the better option.
Here’s how this works in practice.
Assume that you own a home with some equity. Say it’s a $200,000 home with an $180,000 mortgage, so on paper you have about $20,000 equity.
Also assume that you are entitled to homestead exemption of $25,000. This means that you can have that much in home equity and protect that equity from your creditors. As a result all of the $20,000 in home equity is protected by this homestead exemption.
You’re in a financial hurt, owing $38,000 in medical bills and $42,000 in credit cards, a total of $80,000. You’ve fallen behind on your $1,000 per month child support payments by 4 months, or $4,000. And you owe $13,000 in income taxes to the IRS for last year and the year before.
You want very much to keep your home. You’ve managed to stay current on the mortgage and the property taxes because it’s been your highest priority. There are no liens against your home’s title other than the mortgage debt itself.
You’ve heard that your ex-spouse is referring the child support debt to the local support enforcement agency. It can and likely will soon put a lien on your home as part of its collections efforts. Same with the IRS.
Those two liens—in the amounts of $4,000, or whatever you owe in child support at the time, and $13,000—would eat up much of your home equity. These liens might even result in the foreclosure or forced sale of your home.
Chapter 7’s Limited Help
Here’s what a Chapter 7 “straight bankruptcy” would likely accomplish, and not accomplish, in this scenario:
- The “general unsecured” medical bills and credit card debts of $80,000 would very likely be discharged. You would never have to pay them.
- Older income taxes can be discharged if they meet certain conditions. But taxes from last year and the year before would not be old enough to qualify. So you would continue owing the entire $13,000 tax debt, plus interest and penalties. Those continue to accrue regardless of the Chapter 7 filing.
- IRS collection efforts, including the recording of a tax lien, would be “stayed,” or temporarily stopped. This “automatic stay” would be effective as of the moment the Chapter 7 case is filed. But it only lasts as long as the case is active. That’s a period of only about 3 or 4 months from the time the case is filed.
- That means that nothing would stop the IRS from recording a tax lien in the amount of $13,000 as soon as the Chapter 7 case was closed.
- There’s even less protection as to the child support debt. In fact there’s none. The “automatic stay” does not apply to support obligations under Chapter 7. So your ex-spouse or the support enforcement agency could garnish your paychecks and bank accounts, and very likely take various other aggressive actions against you and your assets and income, at any time, regardless of your Chapter 7 filing. That generally includes recording a lien against your home.
- Child support debts are not discharged in bankruptcy, under virtually any conditions.
When Chapter 7 Helps Enough
All this means that Chapter 7 would help only if the discharge of the $80,000 in medical and credit card debts would free up enough cash flow to:
- Enter into a reasonable installment payment plan with the IRS to pay the $13,000, plus ongoing interest and penalties.
- Negotiate with the ex-spouse or support enforcement agency for a payment plan to catch up on the $4,000 in support arrearage.
- Do these preferably without the creditor recording a lien against your home.
How likely this is depends on all circumstances.
The IRS is usually quite willing to enter into a monthly installment plan. Its policies have gotten more and more flexible during the last decade or so. Currently the interest rate is relatively low—3% for at least the last several years. Entering into an installment agreement reduces the failure-to-pay penalty of 0.5% per month to 0.25% (or 0.0025) per month.
How cooperative ex-spouses and support enforcement agencies will be of course varies greatly. But as to the latter anyway, they generally prefer voluntary payments to forced ones. And you’d likely save fees and a tremendous amount of frustration if you can avoid the nasty surprises these agencies can spring on you.
But your bankruptcy lawyer may look over your situation and determine that you wouldn’t have the means to keep your post-Chapter 7 creditor(s) happy. If not, Chapter 13 can often be a much better alternative. It is much better at preventing these kinds of creditors from recording liens on your home. We’ll show you how in our next blog post in a couple days