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What is Chapter 7 Bankruptcy?

Bankruptcy can provide a financial reset when other methods of debt relief have failed. While there are several different types of bankruptcy that are available to individuals, the two most common are Chapter 7 and Chapter 13. In this article, we will address common issues involving Chapter 7 bankruptcy:

  • Should you file for Chapter 7 bankruptcy?
  • Are you eligible for Chapter 7 bankruptcy?
  • The means test
  • Exempt vs non-exempt property
  • Chapter 7 bankruptcy discharge

In Chapter 7, sometimes referred to as a liquidation bankruptcy, the court will seize your non-exempt property and assets to pay off your creditors. However, bankruptcy is not designed to leave a person with nothing to survive on. If so, there would be no incentive for anyone to declare bankruptcy. That is why certain property is allowed to be exempt (or excluded) from the bankruptcy process.

Should You File for Chapter 7 Bankruptcy?

Deciding whether to file for bankruptcy can be a daunting and complicated task. Declaring bankruptcy should not be done casually. It's always best to explore all your options before asking the court for bankruptcy relief.

Before filing for bankruptcy, consider contacting your creditors to see if they'll be willing to work with you to create a repayment plan. Many creditors will agree to this when the only other alternative for the debtor is to declare bankruptcy. It is in the interest of creditors to work with debtors directly whenever possible since they'll have more control over repayment rather than having the court decide. Should you determine that filing for bankruptcy is in your best interest, you will need to decide which chapter of the Bankruptcy Code to file under.

Are you Eligible for Chapter 7 Bankruptcy?

You must meet certain eligibility criteria to qualify for chapter 7 bankruptcy. This type of bankruptcy is available to individuals, partnerships, corporations, and limited liability companies (LLCs) as long as the other requirements are met. However, only individuals may have their debts discharged under Chapter 7 bankruptcy. For corporations, partnerships, and LLCs, the purpose of a Chapter 7 is to close the business and liquidate assets in order to pay off its creditors. In general, a business will only be in Chapter 7 if their bankruptcy filing for Chapter 11 was dismissed or converted by creditor(s) request.

The individual consumer must also meet income requirements, pass a means test, and complete mandatory credit counseling prior to filing for Chapter 7 bankruptcy.

Chapter 7 Income Requirements

Since Chapter 7 bankruptcy gets rid of eligible debts, the person filing for Chapter 7 must meet certain income requirements. Debtors who earn less than the median income in their state will generally qualify to file a Chapter 7 bankruptcy. A list of median incomes based on family size in all states is maintained by the U.S. Department of Justice. Qualification is determined by taking the debtor's average income over the previous six months and comparing it to state income figures for families of the same size.

The Means Test

There are some instances in which a filer who has an income over the allowable amount might still qualify for Chapter 7. This is determined by completing and passing the means test. This test is meant to stop people from claiming protections under Chapter 7 when they have the ability to repay creditors. Debtors who make too much and fail the means test will likely need to file for bankruptcy under Chapter 13.

The means test takes certain monthly expenses and compares those expenses to the income of the filer. The test is designed to determine how much disposable income debtors have left after paying their expenses. Even those earning significant incomes may be able to pass it if they do not have enough money left over each month after covering their bills.

Most of the expenses used for performing the means test are based on national or local standards rather than the debtor's actual costs. This prevents the bankruptcy system from being abused by debtors who spend extravagant amounts.

Bankruptcy courts may allow other expenses to be considered in special circumstances. Also, disabled veterans who incurred the debts included in their Chapter 7 petitions while on active duty or performing homeland security assignments are exempt from the means test.

Chapter 7 Filing Process

The paperwork involved in filing a Chapter 7 bankruptcy case includes the official bankruptcy petition asking the court for debt relief. Other required forms must document your income, assets, debts, and expenses. Below, we've included a step-by-step guide to filing for Chapter 7 bankruptcy.

Step 1: Gather information necessary to fill out the bankruptcy filing forms and schedules, including:

  • A list of all creditors, total amounts you owe, and the nature of the creditor's claims
  • The source of your income, the amount, and the frequency of payment
  • A list of all your property
  • A list of your monthly living expenses, including the amount of money spent on food, shelter, clothing, utilities, medicine and transportation

Step 2: Individuals file the official petition in the federal bankruptcy court serving the area where they live. Business debtors file the petition in the federal bankruptcy court serving the area where their principal place of business is located. All official petition forms can be found on the United States Courts website. At the same time, the debtors must file these documents with the court:

Step 3: You must pay the filing fees with the court clerk.

Step 4: You must provide the bankruptcy trustee with:

  • Copy of tax returns or transcripts from the most recent tax year and of any tax return filed during the proceedings.
  • Individual debtors also include evidence of credit counseling within the previous 180 days and a copy of any debt repayment plan drafted during counseling.
  • Statement of monthly net income, proof of payment from the debtor's employer within 60 days before the filing of the petition and a statement of any anticipated rise in income or expenses after the bankruptcy filing.

Exempt vs Non-Exempt Property

Despite its fearsome moniker as a “liquidation bankruptcy," Chapter 7 allows the debtor to keep any property that is exempt from bankruptcy proceedings. Only non-exempt property can be sold by the trustee and used to repay creditors. What property is and is not exempt from the bankruptcy estate is dependent on both federal and state bankruptcy law. Although bankruptcy is governed by federal law, states may craft their own property exemption laws. Some states allow the debtor to choose whether to follow state law or federal law. Determining specifically which of the debtor's possessions may be considered exempt property is conducted on a case-by-case basis.

In general, items considered necessary for modern life are typically exempt. This protects the property you'll need to survive. Exempt property may include:

  • Cars, trucks, and other vehicles
  • Clothing
  • Furnishings and other goods from the home
  • Jewelry
  • Appliances
  • Pensions
  • Equity in the home itself
  • Items considered to be necessary for work
  • Benefits, including Social Security

Many of these categories come with limits and are subject to oversight from the court and the trustee. For instance, necessary clothing can be kept, but frivolous clothing may have to be sold off. Vehicles, homes, and wages may be kept only in portion, or up to a specific value. For example, someone who is declaring bankruptcy may not be allowed to keep a foreign sports car worth $500,000, but may be able to keep a sedan.

Chapter 7 Bankruptcy Discharge

The last step is the bankruptcy discharge. A discharge absolves the debtor of most of their debts and prevents creditors from taking further action against the debtor for those debts. Excluding cases which were dismissed or converted, individual consumers who filed for Chapter 7 were granted a discharge in more than 99% of cases. The discharge is only available to individual debtor seeking Chapter 7 bankruptcy relief. Any Chapter 7 filed by a partnership, corporation, or LLC will result in the business closing and its assets sold off to repay creditors.

Keep in mind that a Chapter 7 bankruptcy discharge may not completely wipe the slate clean. There are some debts which are not dischargeable via bankruptcy. These debts include, but are not limited to:

  • Alimony and child support
  • Student loans
  • Debts for certain criminal restitution orders
  • Certain taxes
  • Debts for personal injury or death resulting from debtor's DUI/DWI

Learn more about Chapter 7 Bankruptcy

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