How to qualify for a Chapter 7 Bankruptcy

Most people just need to restructure their debt quickly and get back to work.  A chapter 7 is quicker and cheaper than filing a Chapter 13.   Something horrible like a lost job, death in a family, or divorce often is the cause of a Bankruptcy.  But not everyone qualifies for a Chapter 7.  You can only file one Chapter 7 every 8 years timed from the date the first case was filed until the next Chapter 7 case. If you know the rules, you will be able to make sure you qualify for Chapter 7, and you don’t have to spend five years repaying all your disposable income in Chapter 13

About 95% of Americans qualify for Chapter 7.  But attorneys are paid 3 to 4 times more if the case is filed as a Chapter 13.   If you time your bankruptcy, increase the reasonable expenses and decrease the prior 6 months of income it is normally easy to qualify.  To avoid filing as Chapter 13 you need to know why some people are forced to file a Chapter 13 and when you need to.

No money down Chapter 7 cases are now possible

Prior to 2019 attorneys were required to collect attorney fees upfront for a Chapter 7.   Some people are so poor they can’t afford the attorney fees of Chapter 7 upfront.  After 2019 you can now finance your attorney fees and start your cases with no money down.  Financing it over time does cost more than paying cash upfront.   At the moment you file you cannot be billed for work which was done prior to filing and debts you owed prior to filing.

To do a no money down Chapter 7 you file a skeleton petition and have your attorney prepare the remaining schedules after filing.  Since the work is done post-petition you can then pay him post-petition over time.    So why are most clients told they have to file as a Chapter 13?

Avoiding Chapter 13

Attorneys get paid more for a Chapter 13 (3750) than they do for a Chapter 7 (1400-1600 nationwide in 2020).  Because of this, some offices may make certain most of their clients are stuck in Chapter 13. When you do the means test, you automatically qualify for a Chapter 7 generally if your income is less than the average income for your size of family.  This page has the normal amounts for your budget in 2020 but we always review expenses in our office.

But there is a second part of the means test.  Looking at your net income and deducting for necessary and reasonable expenses such as your daycare, mortgage, and car payments, is there any money left over so creditors can be repaid something.  If a lawyer leaves out expenses, you may be forced into Chapter 13 although you can’t afford it.  Here are the US Trustee median income guides for each family size in 2020 and later.  A single person can make 44,000 and automatically pass.

Include future expenses in your budget and document it

It may be months or years before some expenses like a replacement vehicle happen.  But a furnace replacement and other items need to be in the budget if they are definite and foreseeable.  Some people replace that auto before filing so less is paid to creditors in Chapter 13 or nothing is paid back in Chapter 7.  A furnace, car, or tax repayment can be in your budget.

A quality attorney understands these needs and plans for them in the budget so you can qualify for a Chapter 7.  High medical expenses like 800 per month in diabetic medications are just one example of a high reasonable or necessary expense.  Daycare and medications have to be included in the budget.  The judges and trustees generally trust clients but they will ask for verification of the expenses if you take high expenses.

Timing your Chapter 7 bankruptcy every eight years

You can only file one Chapter 7 bankruptcy every eight years.  This is calculated from the date the first case is filed until the second filing date.  You can file a Chapter 13 immediately after Chapter 7 to catch up a foreclosure or for other valid reasons.  But you can only get a discharge by waiting before filing a new case.  The type of chapter you file and how much a Chapter 13 pays back can dramatically change how long you may have to wait.  Filing one Chapter 7 after the other is the longest period you will have to wait.

In some cases, you may not need the discharge of Chapter 13.  Chapter 13 cases that only need to catch up with a mortgage or manage student loans or tax debts may not need a permanent discharge.  In some cases, you only need to manage the debt and make it affordable.  In those cases, you file a Chapter 13 to manage the debt.

Reasons for Chapter 13

There are valid reasons for a Chapter 13.   Only a Chapter 13 allows you the time you may need to catch up on a mortgage.   Only Chapter 13 allows you to avoid repaying student loans for up to 5 years.   Chapter 13 also protects you from IRS debts and you can take up to 5 years to repay the priority or secured portion of an income tax debts and repay the unsecured portion of the debt at 10% or less.

You are allowed to keep a minor amount of equity in a home.  Each person on the deed is allowed to keep over 25,000 dollars in equity under the 2020 Federal exemptions.   This amount changes each year, and each state chooses whether to use the federal exemptions or its own state exemptions.  Kentucky uses the federal exemptions. Indiana has its state exemptions which is lower.  You can also keep 4,000 in an auto and about 17,000 in household goods in Kentucky.

People who own more than 25,000 in home equity per person on the deed do not have to lose their homes in Kentucky.   If they have 75,000 too much equity in their home, then their Chapter 13  needs to repay 75,000.   You are only at risk of losing property in a Chapter 7.  A Chapter 7 trustee may force you to remain in Chapter 7.  You are not required to remain in Chapter 13.  A Chapter 7 trustee is paid a percentage of what is repaid to creditors.  A Trustee has his own selfish reasons for keeping you in the case and selling your property.

The totality of the circumstances test in Chapter 7

Even if you pass the means test, you can still be forced into Chapter 13 if all the circumstances show you are able to repay a significant amount in a 13.   Imagine Jimmy a 21-year-old who has run up 40,000 in credit card debt  He makes 40,00 per year.  Jimmy lives at home with mom.  He walks next door to work.  Jim has no car expense, no apartment.  He makes less than the average household of one which is $44,000.  Why wouldn’t he automatically pass the means test.  Because he has zero expenses. Surely there is something he can repay and even a 200 per month payment would provide a significant repayment in Chapter 13.  He should have moved into an apartment and bought a car before filing.  The totality of the circumstances demands he file as a 13.

The same problem happens to someone who was laid off for the last six months and is now back to work at his 100,000 dollar job for a family of two.  The means test uses the average of his last six months of income.  Being laid off for a month or two may lower your prior 6 months of income enough to pass the means test.  But filing the bankruptcy just before you accept the 150,000 dollar promotion may be too late. The courts look into the future as well as the prior 6 months.

Because your income drops it may allow you to file as a Chapter 7.  But, if it is obvious this is just temporary, the court will look at all the factors to determine whether filing as a Chapter 7 would be an abuse.  So how can you know to a certainty whether you can file as a Chapter 7?

Planning your Chapter 7 bankruptcy

Although the bankruptcy system is designed to catch fraud there is nothing wrong in properly planning a bankruptcy.  You file a Chapter 7 when you are poor and have no assets.   You file a Chapter 13 when you have just enough income to make a minor payment to the court.   That Chapter 13 payment often catches up the mortgage.  Or it pays the car and any priority taxes which must be repaid.

You can plan a bankruptcy to take the maximum amount you can use in exemptions.  An experienced attorney will plan your exemptions to keep property.  He will look over your budget to make sure any Chapter 13 plan is affordable and every Chapter 7 has eliminated unwanted and unnecessary debts.  The purpose of bankruptcy is so you can have a fresh start on a budget you can afford.

An example of proper planning is when you have an asset and just change it into a different type of asset or spend down the asset before filing.  For instance, you may have 10,000 in your bank account and own a 1995 jeep worth only 4,000.   If you spend the 10,000 dollars on a new motor, transmission, tires, and winch on the jeep, the jeep is still only worth 4,000.  But you don’t have to turn over the 10,000 to the trustee.  Another example is maintenance and repairs on your home and medical procedures.  Selling an auto to pay for a house repair is not fraud.

Avoiding fraudulent and preferential transfers

Transfer to another person for less than the fair market value just before filing also includes giving a lien to an unsecured creditor. Creditor garnishments are an example of a preferential transfer.  Preferential transfers and fraudulent transfers are often confused.  However, if you wait long enough after a gift is completed to file bankruptcy, then the transfer at some point loses being fraudulent.  In bankruptcy court, this is 1-2 years and in Kentucky state court, it is five years at most.

It isn’t illegal or improper to plan your bankruptcy to keep property, but you do need to ensure you do not make any fraudulent transfers before filing.  Fraudulent transfers are when you sell a property for less than what it is worth.   These transfers may or may not be to friends and family.  If you sell your new Mercedes worth 50,000 to your mother for 1,000 dollars before filing bankruptcy, it is a fraudulent transfer.  If you have questions about how to file a Chapter 7 be sure to contact us.

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