Personal Bankruptcy in Colorado: Is Chapter 7 or 13 Better for Me?

June 30, 2014

By: David M. Serafin

As a consumer bankruptcy and tax lawyer practicing primarily in Denver and Aurora, Colorado, I can’t count how many times I receive a call from a prospective client with debt problems who will only consider chapter 7 bankruptcy. Chapter 7 is the quickest, easiest and most straightforward type of bankruptcy, and does not involve a repayment plan to creditors. But chapter 7 isn’t always the best option for those seeking debt relief and who struggle to pay back creditors.

Your household income usually needs to be low enough to be considered below the family median income. For Chapter 7 cases filed on or after May 1, 2014, the inflation adjusted median income for a $50,978 for a family of 1, $66,663 for a family of 2, $72,180 for a family of 3, $84,551 for a family of 4, and so forth. Gross income, not net income, is what is counted. (See Line 22 of a Federal income tax return.) For W-2 employees, gross income will include not only wages but also overtime, bonuses, vacation and sick pay. For self employed bankruptcy debtor, I measure gross income as gross receipts minus ordinary and necessary business expenses on a pre-tax basis.

If your household income is above these government set standards, the debtor in bankruptcy is required to complete the full Means Test (Form 22A), which factors in basic expenses (such as housing, vehicles, out of pocket medical costs) to determine whether the debtor has enough monthly disposable income to pay back to unsecured creditors over a 3 to 5 year period. Most debtors who file for chapter 13 are in this category because they simply are required to do so because their income is too high and/or expenses are too low in relation to household size.

So, why not push for chapter 7 relief for every client with overwhelming debt who is financially eligible and skip the reorganization of chapter 13?

First, you can only file for chapter 7 every 8 years – this time period runs from the date of original filing (not the later discharge) to the date of the later filing. But, the restriction is only 4 years to be eligible for chapter 13. (Chances are the repeat debtor would normally qualify income wise for another chapter 7 but for the 8 year rule thereby allowing them to pay back a small part of debt over only a 3 year plan.)

Second, chapter 7 does little to protect valuable assets such as a house with equity or a small business. Those with over $60,000 of equity (the homestead exemption for most in Colorado) take a big risk with an aggressive chapter 7 trustee (representing the creditors) who could force a sale of the house if the homeowner cannot pay back the extra equity within a short time frame. Payment arrangements with the trustee can be worked out over 6-12 months if there’s a small amount of non-exempt equity but, should this amount clearly be too high to pay over a year or less, the 3- 5 years allowed by chapter 13 is preferable. There is no exemption for small business assets which makes it paramount to protect corporate bank balances and hard assets (used for the normal operation of a business) from creditors.

Related to the asset protection benefits of chapter 13 is the fact that you can always (absent fraudulent conduct) “get out” and voluntarily dismiss the chapter 13 if you don’t like the way the case is going (almost always because the chapter 13 trustee is demanding a higher plan payment). There is no automatic right to walk away from a chapter 7 case if the trustee seizes assets to pay creditors.

Third, chapter 13 can save your home or car by best protecting against a pending foreclosure or car repossession with the opportunity to make up past due mortgage or car payments – interest and creditor harassment free – over 3-5 years. Due to job loss, medical bills or any other hardship, a homeowner may fall behind on mortgage payments and may simply need time to get caught up.

Fourth, non-discharged tax debt – usually newer income taxes or taxes stemming from an unfiled return – can be paid back without any further interest or penalties imposed by the IRS or State of Colorado over the 3-5 years. A chapter 7 debtor might opt for the quick discharge and then enter into an IRS Installment Agreement but would face continuing interest and penalties even when in full compliance with the Agreement. The chapter 13 stops this snowballing of IRS fees and the automatic stay rules prevent collection of back taxes paid through the repayment plan.

Last, although more difficult with rising real estate prices in Denver and most of Colorado in 2014, only chapter 13 allows a second mortgage lien to be partially or entirely eliminated (“stripped off”) if your home’s value is less than the first mortgage balance alone. Similarly, an older car loan can be “crammed down” to the car’s value, with a drastic interest rate reduction, in chapter 13 only.

Note that many below AND above median income chapter 13 filers simultaneously pay back tax debt, mortgage arrears and the value of anything not protected by Colorado exemptions, yet STILL get rid of most or all unsecured credit card, medical or collection debt.

If you’re not sure about which chapter of bankruptcy you’re eligible for and which is more advantageous and want to find debt freedom, please contact the Law Office of David M. Serafin at 303-862-9124. Our Law Office is a qualified debt relief agency under Colorado law.