In 2022, the United States recorded 370,685 personal bankruptcy filings. With one in every ten households having filed for bankruptcy at some point, the impact of job losses, reduced income, and the recession caused by the coronavirus in 2020 may contribute to an increase in these numbers if the economic recovery does not become swift and widespread.

Types of Personal Bankruptcy: Chapter 7 and Chapter 13

Chapter 7 Bankruptcy

The most common form of personal bankruptcy is Chapter 7, which involves the liquidation of the filer’s assets in order to discharge all or a portion of the outstanding debt. Individuals often opt for this path as they find themselves significantly overwhelmed and lack the necessary income to settle their debts within a reasonable period.

  • Means Test: To qualify for Chapter 7 bankruptcy, the debtor’s income must pass the means test. If their income is below the state median, they typically qualify for Chapter 7. Otherwise, they may need to explore other options.
  • Property Liquidation: In this liquidation bankruptcy, nonexempt assets are sold to repay creditors. The debtor may lose some property, but it provides a fresh start.
  • Foreclosure Protection: While Chapter 7 doesn’t directly prevent foreclosure, it can delay the process temporarily. However, the debtor must catch up on mortgage payments.
  • Debt Discharge: Most debts are discharged after liquidation, except for certain exceptions like student loans and recent taxes.
  • Duration on Credit Report: Remains on the credit report for 10 years.
  • Eligibility: Available to individuals, partnerships, and corporations with combined secured and unsecured debts below $2,750,000.
  • Third-Party Protection: No specific provision for protecting co-signers or third parties.

Chapter 13 Bankruptcy

Chapter 13 gives some quick relief and helps the person filing make a plan to pay back part of the debt based on what they can afford each month. This amount is figured out by their income and what they can realistically pay.

As the person follows this plan and pays off the debt, their credit score will slowly get better. In certain situations, they might be able to get an FHA, VA, or USDA home loan a year after filing for bankruptcy, or wait two to four years for a regular mortgage.

  • Means Test: There is no strict means test for Chapter 13. However, the debtor’s regular income plays a role in determining the repayment plan.
  • Property Liquidation: Debtors retain their property and create a repayment plan. The plan spans three to five years, allowing gradual debt repayment.
  • Foreclosure Protection: A significant advantage is its ability to halt foreclosure proceedings. Debtors can cure delinquent mortgage payments over time.
  • Debt Discharge: After successfully completing the repayment plan, remaining debts are discharged.
  • Duration on Credit Report: Chapter 13 bankruptcy is a bit less punitive than Chapter 7 bankruptcy because it stays on record for only seven years.
  • Eligibility: Open to individuals with regular income, allowing them to restructure debts over time.
  • Third-Party Protection: Offers protection for third parties liable on “consumer debts.”

The Essential Role of Tax CPAs in Debt Management and Bankruptcy

Integrating the expertise of a tax CPA in the process of managing debt, considering debt relief alternatives, and especially when filing for bankruptcy, can significantly influence the outcomes and ensure that all financial decisions are made with a comprehensive understanding of their tax implications.

Immediate Effects and Long-term Consequences of Bankruptcy

Filing for bankruptcy can quickly stop creditors from calling and threatening actions like eviction, foreclosure, repossession, utility shutoff, or wage garnishment, giving you a break during tough financial times. But, be ready for some tough moments, like the court taking some of your belongings to sell and pay off debts, or your credit cards being canceled.

It’s important to understand that this process may also limit your ability to obtain new lines of credit, making it challenging to rebuild your financial standing quickly. The emotional toll of filing for bankruptcy, including feelings of embarrassment or failure, should not be underestimated, but it’s also a step towards regaining financial stability.

When facing the immediate relief and long-term impacts of bankruptcy, a tax CPA can offer invaluable advice on how the decision might affect your current and future tax situations. Bankruptcy can have complex tax consequences, including the potential taxation of forgiven debts or the implications for tax returns in the years following the filing. A tax CPA can guide you through these nuances, ensuring you don’t encounter unexpected tax liabilities or miss out on possible tax benefits.

Exploring Debt Relief Options

You might notice TV ads offering help to reduce debt without going through bankruptcy. Keep in mind that even though these services can negotiate lower payments you can manage, they won’t prevent damage to your credit score. Whenever someone arranges to lower your debt, it appears as a negative mark on your credit report and can stay there for a long time.

Additionally, it’s vital to thoroughly research any debt relief program to avoid scams that prey on those desperate for a way out of debt. These programs often come with hidden fees that can potentially worsening your financial situation.

Consulting a tax CPA is also advisable to navigate the tax implications of debt relief strategies. For instance, if a debt settlement is reached, the IRS may consider forgiven debt as taxable income, which could significantly impact your tax situation. They can offer strategies to minimize this tax burden and plan for any tax payments that might arise from debt settlement. The tax implications of consolidating loans or engaging in debt management plans can also be discussed with a CPA.

Bankruptcy’s Influence on Employment Opportunities

A newer problem that not everyone knows about is that some employers look at job applicants’ credit histories. This can make it harder to find a job and pay off debt if your past payments don’t look good. The best approach is to have a steady job before you consider getting help from a debt relief service or filing for bankruptcy.

Consider these things when navigating the complexities of financial stability and employment.

  1. Current Employment Security: Federal laws protect against discrimination for bankruptcy.
  2. Future Employment Prospects: Prospective employers in industries emphasizing financial responsibility may view bankruptcy filings unfavorably, making it harder to secure new employment.
  3. Professional Licenses and Contracts: Certain professions might have clauses that consider financial stability crucial. This could potentially affect your ability to maintain professional licenses or contracts after filing for bankruptcy.
  4. Security Clearance Jobs: While not a definitive barrier, bankruptcy can complicate the process of obtaining or retaining jobs that require security clearance.
  5. Credit and Trustworthiness Concerns: Employers managing financial resources may question the judgment of those with a bankruptcy on their record, impacting roles and advancement opportunities.

Seeking Professional Debt and Tax Advice

Before choosing a debt relief program, it’s smart to talk to a reputable, non-profit credit counseling agency for a free debt review. Pick a trusted agency that legally has to put your interests first. Watch out for unreliable debt advisors who might suggest options that benefit them more than you.

You should also consult a tax CPA to provide a clearer picture of your financial situation from a tax perspective. This professional advice is crucial because it can help you avoid making decisions that could adversely affect your tax status or miss opportunities for tax relief. With a CPAs understanding of your financial history and tax laws, they can serve as an advocate for your best interests, ensuring any financial strategy includes considerations for minimizing tax liabilities and optimizing tax benefits.

This step can provide valuable insights into various options and help you make an informed decision about managing your debt. A reputable counselor can also help you develop a budget that allows you to live within your means while addressing your debt, setting a foundation for financial health.

Understanding the Costs of Bankruptcy

If you choose to file for bankruptcy, know that court fees are around $300. Also, hiring a lawyer for a Chapter 7 bankruptcy can cost between $1,000 and $3,000, while for a Chapter 13 bankruptcy, it’s about $3,000 to $6,000.

These costs can add a significant burden, especially when you are already struggling financially. It’s important to factor in these expenses when considering bankruptcy as an option. Many attorneys offer a free initial consultation, which can be an opportunity to discuss your case and understand the potential costs and benefits of filing for bankruptcy. Planning for these expenses can help you manage the financial impact of bankruptcy more effectively.

The costs associated with filing for bankruptcy, including court and attorney fees, are not the only financial considerations. A tax CPA can explain how these costs might be treated in your tax filings, potentially identifying deductions or credits that could alleviate your overall financial burden. Moreover, they can provide foresight into the management of any tax refunds or liabilities that may arise post-bankruptcy, ensuring you’re prepared for your new financial start.

Utilizing a tax CPA in navigating the complex interplay between debt management or bankruptcy and tax implications is crucial. Their expertise ensures that decisions are made with a full understanding of how each step affects your financial health, not just from a debt perspective but also in terms of potential tax savings or liabilities. Engaging a tax CPA early in the process can lead to more informed decisions, potentially saving money and avoiding negative tax consequences.

For high-net-worth individuals navigating the complexities of financial transitions, including bankruptcy, LBMC Wealth Advisors offers a guiding hand. Our team, renowned for their expertise across a spectrum of critical services—accounting and tax services, estate and trust matters, executive compensation planning, philanthropy, as well as insurance and retirement planning—stands ready to deliver personalized, strategic advice.

Our wealth of experience ensures a comprehensive understanding of how each financial decision impacts the broader picture of your wealth and tax strategy. We encourage you to reach out and discuss how we can support your financial goals and navigate the challenges ahead. For a partner committed to your financial well-being, contact LBMC Wealth Advisors today.

LBMC tax tips are provided as an informational and educational service for clients and friends of the firm. The communication is high-level and should not be considered as legal or tax advice to take any specific action. Individuals should consult with their personal tax or legal advisors before making any tax or legal-related decisions. In addition, the information and data presented are based on sources believed to be reliable, but we do not guarantee their accuracy or completeness. The information is current as of the date indicated and is subject to change without notice.