CHAPTER 7 is called the fresh start because it wipes out all dischargeable debt while allowing the debtor to keep most, if not all, of his assets.
Meanwhile, Chapter 13 is the reorganization of debtor’s financial affairs because he or she is allowed to restructure debts with partial or no payments.
In Chapter 7, the debtor pays nothing to creditors and gets a fresh start in life with no debt but keeping all exempt assets. In Chapter 13, the debtor pays something to creditors depending on whether creditors are secured or unsecured.
Which is better, Chapter 7 or Chapter 13? The answer is it depends on what you are trying to achieve.
Let’s give some actual examples. The client is 64 and owes $50,000 of credit card debt. His gross income is $5,000 a month. He is married and his daughter and two grandchildren live with him. His wife receives social security of $1,000 a month. He owns a house worth $500,000 on which he owes a mortgage of $325,000. He has a brand new Tesla Model X on which he pays $700 a month. These are the basic facts for this client. So, should he file for Chapter 7 or Chapter 13?
In this case, all of the debtor’s assets are exempt. He can keep all his assets. The bankruptcy trustee cannot take any of his assets to sell and liquidate for creditors. Paying for $50,000 of credit cards is taking a big chunk out of his income. He needs to set aside $1,500 a month to keep his credit card masters happy every month with minimum payments. So, if he can wipe out all of the $50K credit cards, he can save how much? He can save $1,500 a month, or $18,000 a year. In two years, he will save $36,000.
Whereas if he just kept on going without Chapter 7, he would pay $36,000 to his credit card masters, but would still owe how much of credit cards? After paying $36,000 in two years, he would still owe his credit card masters exactly the same $50,000 that he owed two years ago.
It would thus give the client a great benefit if he could just wipe out the $50,000 of credit cards now at the age of 64. Why? Because in two more years, he will be getting full social security benefits even if he continues working his job which gives him $5,000 a month. If he has to continue paying $1,500 a month for $50,000 of credit cards, the amount is significant enough to cause him a lot of financial and emotional pressure. It just doesn’t make any sense to not get rid of the $50,000 of credit cards now. It’s like having a bunch of monkeys on his back that he has to keep on feeding every day. Nobody in his right mind wants to be in this situation.
But does the client qualify for Chapter 7? Well, we have to check if the client will qualify for Chapter 7 using the means test. We get his gross household income and family size and compare that with the state median income to determine if it’s below or over the median. If he is below the median, then we don’t have to proceed to the next step. He would appear to be eligible for Chapter 7. If he is over the median, we will have to determine if he has at least some disposable income that will allow him to pay at least 25% of the $50,000 in Chapter 13. We use the IRS deductions to arrive at his net disposable income. If his disposable income is such that he can pay at least 25% of the $50,000 over 60 months, then he would not be eligible for Chapter 7. If his case is filed as Chapter 7, there would be what’s called a “presumption of abuse” and he would have to be able to overcome that presumption of abuse by proving by a preponderance of the evidence that he is not abusing bankruptcy law. Motions to dismiss due to presumption of abuse are brought by the U.S. Trustee and debtor would have to respond to that motion before a federal bankruptcy judge. If the judge believes the debtor, then he still gets a discharge despite the presumption of abuse arising. Let’s just say that it’s not an easy task to overcome the presumption of abuse.
Let’s say the client passed the means test and there is no presumption of abuse. Then, I would file client’s case as Chapter 7 so he can get a fresh start without the burden of the $50,000 credit cards, which would be totally wiped out, while he keeps all his assets. If the client fails the means test, then I would file his case as Chapter 13 where he would have to pay at least $200 a month for 60 months, more or less. This means he pays $12,000 over 60 months, just the principal; no interest. After paying $12,000, the court will discharge $38,000 of the $50,000 and he will owe nothing.
Now, if the client in this example had a house that is worth $510,000, not $500,000, and owed $325,000 on it, I will file this case as Chapter 13 where the client would pay about $180 a month over 60 months. After that, $40,000 will be discharged.
If we add another fact, say client owes $10,000 to the IRS for last year’s income tax, then I would also file this as Chapter 13 where he would pay $150,000 a month to the IRS over 60 months with nothing paid to the $50K credit cards. After that, the entire $50,000 would be wiped out.
In other words, only the IRS gets paid the $10,000, the credit cards do not get anything. If we filed this as Chapter 7 under the first set of circumstances, the $50,000 would be wiped out, but the $10,000 IRS debt would not be discharged because the income tax is not yet three years old. If the tax were owed for the year 2016 and all other conditions to discharge income tax were present, then Chapter 7 would wipe out the $50,000 credit cards, and the $10,000 income tax.
As you can see, many factors can affect which case should be filed, Chapter 7 or Chapter 13. And the fact is that there are many other factors that can affect the issue of which case should be filed for the debtor, Chapter 7 or Chapter 13.
Suffice it to say that bankruptcy law is actually pretty complicated.
If you need debt relief, set an appointment to see me. I will analyze your case personally.
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Lawrence Bautista Yang specializes in Bankruptcy, Business, Real Estate and Civil Litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 20274 Carrey Road, Walnut, CA 91789 or 1000 S. Fremont Ave., Mailstop 58, Building A-10 South-Lower Level Suite 10042, Alhambra, CA 91803.