What Is Dischargeable Debt?
Most unsecured debts, like credit cards, medical bills, and payday loans, are walk-away dischargeable debt in bankruptcy Chapter 7. You can wipe away the underlying debt, as well as any adverse action tied to that debt. After the bankruptcy is over, it is typically illegal for any moneylender to make any attempt to collect debts that have been discharged (forgiven) in bankruptcy.
Domestic support obligations, or DSOs, are on the opposite end of the spectrum. Alimony, child support, and other DSOs are almost never dischargeable debt in bankruptcy. That being said, the automatic stay does apply to DSOs. So, creditors must suspend any wage garnishment or other adverse action while the bankruptcy is active.
All other types of debts are somewhere in the middle. What options do bankruptcy Chapter 7 debtors have in these situations?
Secured Debts Are Non-Dischargeable
Secured debt (debt in which some collateral has been posted) is not discharged in bankruptcy Chapter 7, unless you surrender the collateral. If you surrender the collateral, the deficiency balance (the amount that is owed after the creditor sells the collateral) would become unsecured and discharged in your bankruptcy. A discharge of a deficiency balance only occurs if you have not signed a reaffirmation agreement (an agreement to repay the debt).
The following debts cannot be discharged in bankruptcy Chapter 7:
- Debts that were incurred by fraud
- Any debt that resulting from operating a motor vehicle, boat or aircraft under the influence (alcohol or drugs)
- Most taxes cannot be discharged, but some personal income tax may be dischargeable in bankruptcy.
- Property settlement agreements as a result of a divorce or legal separation.
- Student loans are not dischargeable in bankruptcy, except in cases where it would create an extreme hardship on the debtor to pay back the student loan.
- Child and spousal support obligations
- Any debt that is a fine or penalty payable to a government unit
- Any payment of an order of restitution
- Home owner association dues
When it comes to secured debts, the automatic stay applies to collection efforts, a category which includes repossession, lawsuits, and foreclosure. However, if you stop making payments per the security agreement and/or express an intent to surrender the collateral in the Statement of Intent, most judges routinely grant motions for relief from automatic stay and allow moneylenders to claim the collateral.
When Is Redemption an Option in Bankruptcy Chapter 7?
While most people want to keep their houses, cars, and other secured property, the payments may simply not be sustainable. Moreover, because these assets depreciate, debtors may owe considerably more than the fair market value. Redemption may be an option in these cases. Some debtors can pay the moneylender the actual fair market value of the asset. The moneylender then has a legal obligation to tear up the note.
Assume Dudley Debtor has a 2014 sedan. Even though it has only a $5,000 fair market value, Dudley still owes $10,000 on the loan. In some cases, Dudley can redeem the sedan by paying the moneylender $5,000. If he does that, the moneylender must forgive the $5,000 remaining on the note. Dudley therefore owns the sedan free and clear.
Redemption is not easy. If you lack the cash to redeem the collateral, the trustee may allow you to borrow the money from a third party. Although you can technically redeem any secured collateral, redemption nearly always involves motor vehicles. This is because these assets depreciate quickly and the redemption amount due is at least somewhat manageable.
What About Student Loan Debts?
Until just a few years ago, student loans were essentially non-dischargeable in bankruptcy Chapter 7. This is thanks to the so-called Brunner Rule. Prior to 1978, the Bankruptcy Code stated that debtors can discharge student loans along with all other unsecured debts.
This provision became quite controversial as Congress debated proposed amendments. This is because some people felt that some students were not making much of an effort to repay their education loans. So, when Congress amended the Bankruptcy Code in 1978, it included a provision that student loans could only be discharged based on “undue hardship.” However, the law did not define this phrase.
The Second Circuit Court of Appeals in New York defined the phrase in Brunner v. New York State Higher Education Services Corporation (1987). The court ruled that student loans could only be discharged in bankruptcy if there was evidence of:
- a good-faith effort to repay the loans,
- an inability to maintain a minimal standard of living if the debtor repaid the loans (“minimal standard of living” is basically the poverty line), and
- a permanent or long-term hardship.
Under the so-called Brunner Rule, it was almost impossible for anyone to discharge loans unless the debtor had a physical or other disability that prevented repayment.
Trying to discharge student loans is tricky. You thus need an experienced bankruptcy Chapter 7 lawyer to advise you regarding whether or not this is an option.
Income Taxes Are Dischargeable Debt
Although bankruptcy law is somewhat in flux regarding student loans, it is well-settled regarding taxes.
If people fall on financial hard times, they often fall behind on income tax payments. There is a significant conflict here. Because while the government has an interest in collecting all tax money that is due, it also has an obligation to give debtors a fresh start under the Bankruptcy Code. Although these two objectives seem mutually exclusive, the government has reached a compromise of sorts.
Only income taxes are dischargeable, which means no property, payroll, or other taxes are dischargeable. The Bankruptcy Code does not define “income tax.” Therefore, it is ultimately up to the taxing authority to fight or not fight discharge. Dischargeable debts must meet the 3/2/240 rule:
- The income tax must have been due at least 3 years ago,
- The returns must have been on file for at least 2 years, and
- The debt must not have been assessed within the last 240 days. (Basically, this means that the taxpayer has not received a collection notice in the last nine months.)
The income tax is dischargeable debt in these circumstances. However, if the taxing authority filed a lien, that lien remains in effect, because the bankruptcy court does not have the authority to extinguish liens.
Contact a Bankruptcy Attorney
Some debts are clearly dischargeable, others are clearly non-dischargeable, and many more are somewhere in between. To learn more, call the Law Office of Diane Anderson today and speak with an experienced bankruptcy Chapter 7 attorney who can help.