Frequently Asked Questions for Individuals

What is bankruptcy?

Bankruptcy is the legal process where persons declare that they are unable to pay their debts and request relief from the court. There are two basic purposes of bankruptcy: to give the debtor a fresh start and to repay creditors to the extent that the debtor has non-exempt assets.

Bankruptcy comes in two forms, liquidation and reorganization. The four types of bankruptcies available to private individuals fall under one of these two forms.

1. Liquidation Chapter 7, also known as “liquidation,” is usually the simplest and quickest form of bankruptcy. In a Chapter 7 bankruptcy, the bankruptcy court appoints a trustee who gathers and sells any non-exempt property that you might have, and uses the proceeds to pay your creditors. Chapter 7 is available to individuals, married persons, corporations and partnerships.
2. Reorganization Chapter 11, a reorganization, is primarily used by business debtors but sometimes by individuals who have substantial assets and debts. Under Chapter 11, a business is allowed to continue operating while the court supervises the reorganization of the company’s debts and determines whether to grant partial or complete relief.
3. Chapter 12 is a special type of bankruptcy set aside only for family farmers
4. Chapter 13 is the reorganization of an individual’s debts where the individual pays off the debt, or some portion of the debt, usually over a 3 to 5 year period, under a plan approved and supervised by the court.

Is bankruptcy right for me?

Whether bankruptcy is an option for you depends very much on your particular financial circumstances and what you hope to accomplish. You should consider first whether bankruptcy will “discharge” (i.e. release you from liability) enough of your debts. Debts that are “non-dischargeable” will have to be paid even after bankruptcy. The primary debts that are non-dischargeable are as follows:

• Income tax debt, unless:
    • the debt is more than 3 years old, and
    • a correct & timely tax return was filed.
• Student Loans, unless repayment would cause undue hardship to the debtor;
• Domestic Support Obligations (i.e. Child Support & Alimony);
• Debts resulting from injury by willful or malicious acts or through fraud; and
• Court judgments for injuries or death resulting from driving while intoxicated.

Assuming you do have sufficient debts to make bankruptcy worthwhile, you should also determine what property will be taken and sold to pay your creditors and what property you will be allowed to keep. See Exempt and Nonexempt property.

Can anyone file for bankruptcy?

Yes, but some restrictions do apply.

In 2005, the Bankruptcy Code was amended to impose additional requirements on anyone wishing to file a bankruptcy case. The new law now requires that debtors perform a “means test” to determine whether or not they are capable of paying back a portion of their debts. If a debtor qualifies under the means test, he, she or they may file under Chapter 7. However, if the debtor does not meet the means test’s standards, the debtor likely will have to file their case under Chapter 13 and pay back some portion of their debt. Note however, that the means test requirement will not apply to debtors whose debts are incurred primarily in the course of business.

Despite the new means test requirement, most individuals and couples will qualify to file bankruptcy under Chapter 7. See means test for a more in depth look at the new standards.

Can I file for bankruptcy as often as I want?

No. There are restrictions on the length of time you must wait before filing for bankruptcy again.
If you meet the time restrictions, a court may nevertheless determine whether they feel you
are filing in “good faith.”

Filing for Chapter 7

If you previously filed a Chapter 7 Bankruptcy case, you will have to wait 8 years before qualifying to receive a discharge under Chapter 7 unless your earlier case was dismissed.

If you previously filed for Chapter 13, you will have to wait 6 years to file for Chapter 7 unless your Chapter 13 plan meets certain requirements.

Filing for Chapter 13

You can be discharged under Chapter 13 if you filed for Chapter 7 more than 4 years ago.
If you previously filed for Chapter 13, you can file for Chapter 13 again after only 2 years.

Under which bankruptcy chapter (7 or 13) should I file?

As was just discussed, the first question is whether a debtor is eligible to file for Chapter 7 based on the results of the means test. Assuming that the means test’s restrictions don’t apply, debtors are free to choose between filing Chapter 7 or Chapter 13. The decision will likely be based on whether there is certain property, like a home or car, the debtor wants to keep.

Chapter 7
Under a Chapter 7 bankruptcy, the trustee will seize all non-exempt property and sell it, using the proceeds to pay creditors of the bankruptcy estate. Typically all of a Chapter 7 debtor’s property will be exempt, so in reality, the “liquidation” rarely takes place. In this situation, the Chapter 7 debtor’s bankruptcy petition basically puts the trustee on notice that he or she has no assets to liquidate for the benefit of creditors. Following the completion of two, brief credit counseling courses and the required Creditors’ Meeting, the debtor will usually receive a discharge in as little as 3 to 4 months. If the following facts apply in your case, you may want to consider filing for Chapter 7 bankruptcy:

• Other than furniture and clothing, you have very little property;
  
• If you do own a home or a car, you have very little equity in either one (i.e. you owe almost as much or more than the property is worth); and
  
• After paying your basic living expenses each month, you have very little, if anything, left over to pay toward your debt.

See Chapter 7 for more details.

Chapter 13
If you do not qualify to file Chapter 7 under the means test, you are considered under the law to be able to pay off some portion of your debt. In this case, you then have the option to file for bankruptcy under Chapter 13 where you will be required to pay off at least some of your debt. You may also choose to file under Chapter 13 if you own a home or car that you wouldn’t otherwise be able to keep under Chapter 7. A Chapter 13 bankruptcy is basically a 3 – 5 year repayment plan that you and your attorney submit to the bankruptcy court for consideration by the bankruptcy trustee. Assuming the trustee and the court agree with your proposed plan, your creditors have no choice but to accept its terms. You may consider filing for bankruptcy under Chapter 13 if:

• You own your home and/or car and are in risk of losing them because you are behind
  on your payments;
  
• The equity in your assets is more than the amount of your available exemptions;
  
• The value of your home and/or car are significantly less than the loans that they secure;
  
• You have significant debts that are non-dischargeable under Chapter 7; or
  
• You haven’t filed your tax returns for several years.

See Chapter 13 for more details.

Will all of my property be taken away?

No.
The bankruptcy law is intended to give people a new beginning, but it doesn’t force people to start from scratch. That’s why the bankruptcy law contains exemptions, property that each person is allowed to keep. For example, clothes, books and family pictures of the debtor and his dependents are exempt from creditors’ claims. The debtor also gets to keep $4,000 worth (i.e. “garage sale value”) of furniture, appliances, and other personal property, and the entire amount of all money invested in retirement plans such as stock bonus, pension, profit sharing, annuity or simplified employee pension plans.

What about my house?

In many cases, debtors will be able to keep their house. The answer will depend on how much equity the debtor has in the property.

In Illinois, each person is entitled to a $15,000 homestead exemption. This means that if your home is worth $200,000 and you owe $185,000 or more, you will be entitled to keep the property assuming you stay current with your mortgage payments. If you are married, you and your spouse are each entitled to the $15,000 exemption, meaning you can protect up to $30,000 in equity. Assuming your home is worth $200,000, you would be able to keep it if you owe $170,000 or more.
If you have more equity in your home than the $15,000/$30,000 exemption amount, the trustee may sell the property to pay off your creditors. In that case, assuming you want to keep your home, you will want to consider Chapter 13.

Remember that even though your home may be exempt in either Chapter 7 or Chapter 13 Bankruptcy, a lender can always foreclose on the home if you do not stay current with your payments. That’s why it is a good idea to make sure that you will be able to afford to make your mortgage payments after bankruptcy.

Will I be allowed to keep my car?

Yes, but make sure it is in your best interest.
In Illinois, every person is entitled to an exemption of $2,400 for their car, $4,800 for married couples. Therefore, you would be allowed to keep your car in the following circumstances:

• Your car is worth $2,400 or less for an individual, $4,800 for a married couple;
• Your car is worth more than you owe for it, but the difference is less than or equal to $2,400
  (i.e. your car is worth $10,000, and you owe $7,600 or more)

If you have more than $2,400 of equity in your car, you also have the option to buy the excess equity from the trustee by simply writing him or her a check.
Just like with a home, you must continue to make your payments on time after the bankruptcy or the lender that gave you the loan to buy the car may repossess it.

If I am married, must my spouse file bankruptcy together with me?

No. Your spouse is not required to file bankruptcy with you, but it may be in his or her best interest.
Although Illinois is not a “community property” state, if you and your spouse have joint debts, joint property or community property (i.e. if you moved to Illinois from a community property state), the assets of the spouse who doesn’t file may still be subject to collection action.

What will happen to my retirement savings if I file bankruptcy?

Don’t worry. Although there are many negative myths about the new bankruptcy law, one positive that people can’t argue is that it increased the protections available for individuals’ retirement assets. Under the new bankruptcy law, if your retirement plan is considered property of the bankruptcy estate (i.e. most IRAs will be part of the bankruptcy estate), it will be exempt up to $1 million dollars.
For pension plans that are “qualified” plans under ERISA, the exemptions are not needed. The reason is that “qualified” plans are not considered part of a debtor’s bankruptcy estate, and therefore cannot be touched by creditors no matter how valuable.

Will my bankruptcy have tax implications?

Probably not. One benefit that bankruptcy has compared to other forms of debt relief is related to “cancellation of debt income.” Debtors in bankruptcy won’t get a big tax bill once their bankruptcy is over, but debt relief outside of bankruptcy results in “cancellation of debt income” which could mean an unexpected tax bill for some people.

When a debt is forgiven outside of bankruptcy, the person that receives the benefit normally has to recognize income equal to the amount of the debt. For example, assume that you hire a company to negotiate with your credit card company to reduce your debt of $10,000. Assume that the credit card company agrees to forgive 70% of your debt, or $7,000, and will only hold you liable for paying back $3,000. This sounds great except that you are generally required to treat that $7,000 as income. Basically this means that you will be paying tax on money you never received. And if you can’t afford to pay the tax on the forgiven debt? The IRS won’t be as forgiving as the credit card companies. The IRS will pursue you to try to collect the tax, and it has much broader and more intrusive collection powers than other creditors. For more on the tax consequences of non-bankruptcy debt relief, click here.

The good news is that debt discharged in bankruptcy does not fall within the definition of “cancellation of debt income.” Therefore, a person who files bankruptcy will not be required to recognize any income whatsoever. They can simply walk away with a fresh start.

NOTE that if one of your creditors issues you a 1099 for a debt that you discharged in bankruptcy, you should notify the IRS by submitting Form 982.

Will I be able to stop my wages from being garnished if I file bankruptcy?

Yes. Filing bankruptcy imposes an automatic stay only all creditor collection action. This includes wage garnishments. The only exception may be for child or family support that has been ordered by a court.
Once your bankruptcy case is complete, the creditor that was garnishing your wages won’t ever be able to garnish them with respect to your pre-bankruptcy debt again.

What will life after bankruptcy be like?

Don’t listen to anyone who tells you that it is impossible to recover after bankruptcy.
First of all, these people are ignoring the benefits that bankruptcy provides. Maybe you are in danger of losing your home and want to stop foreclosure or repossession. Maybe you are buried under a mountain of debt and experience constant anxiety worrying about how you’ll ever repay it. Bankruptcy is not for everyone, but for some people, it can lift the weight of the world off of their shoulders.

For people worried about the after effects of bankruptcy, the news isn’t all bad either. Most people are concerned that they will never qualify for credit again, but in reality, many people learn that their credit scores actually IMPROVE after filing bankruptcy. Although the cost of credit may initially be a little more (i.e. in the form of higher interest rates), there are companies that target debtors who have recently been discharged in bankruptcy. And why not? A person that has just been given a fresh start is no longer burdened by the medical bills, credit card payments, etc. that caused them to declare bankruptcy in the beginning, and should have more disposable income that would make them a better credit risk.

In addition to the availability of credit cards, you’ll likely find that within one to two years after filing for bankruptcy, you’ll be able to qualify for a mortgage at the same rates as people who never filed for bankruptcy. The real key, especially in today’s real estate market, is to show sufficient income and have a good down payment. Considering that bankruptcy will free up income that was going to pay other debt, you should be able to save money, and put yourself in a better situation when it comes to buying a new home.