How Personal Bankruptcy Affects your Taxes (Part I)

In recent years, bankruptcy filings have continued at a brisk pace. Many consumers are still feeling the effects of the housing market meltdown in the late 2000s and the financial crisis of 2008. The resulting foreclosures and job losses have prompted millions to seek some form of bankruptcy protection.

What is Bankruptcy?

Bankruptcy can come in a number of different forms. For consumers, there are two common types of bankruptcy protection, Chapter 13 and Chapter 7.

Chapter 13 Bankruptcy: Consumers that have fallen behind on some of their payments but are employed and believe they are able to repay their debts often choose to file a Chapter 13 bankruptcy. Chapter 13 is often likened to a court-administered debt consolidation. The debtor, with the assistance of his/her attorney, negotiates a repayment plan with the creditors with the court acting as the mediator. Interest reductions, payment reductions, and some level of debt cancellation are typical outcomes of a Chapter 13 negotiation. The end goal for the debtor is to develop a repayment plan that is workable and will not cause them to fall behind again.

Chapter 7 Bankruptcy: Chapter 7 bankruptcy is far less complicated than Chapter 13. In a Chapter 7 filing, the debtor petitions the court (usually through an attorney) to have his/her debts completely discharged. If the debtor meets the income and asset qualifications, the court will most likely grant the petition. A Chapter 7 bankruptcy is typically sought when the debtor has become unemployed, disabled, or fallen on some other financial hardship that has made it difficult or impossible to repay his/her debts.

Those filing Chapter 7 and Chapter 13 bankruptcies often have questions about the tax implications. We will take a closer look at those in Part II of this series.

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