Chapter 13 Debt Limits

In order to be eligible to file for Chapter 13 bankruptcy, certain debt limitations apply. As of April 1, 2019, a debtor can have no more than $419,275 in unsecured debt (such as credit cards or personal loans) and no more than $1,257,850 in secured debts (such as mortgages and car loans). The limit amounts change every three years. Bankruptcy Law does not allow joint debtors to double the Chapter 13 debt limits. As a result, married couples are subject to the same Chapter 13 debt limits as a single filer.

Debtors who exceed the Chapter 13 debt limits need to file under a different chapter of bankruptcy. Debtors can file for Chapter 7 (liquidation) bankruptcy if they satisfy the means test. Chapter 7 has no debt limit. Debtors can also file for Chapter 11 (reorganization) bankruptcy, which also has no debt limit. Chapter 11 is the most complex and expensive form of bankruptcy, so it is used mostly by businesses and high income individuals. Debtors may also do a “Chapter 20” strategy, which is actually a Chapter 7 bankruptcy to discharge much of the unsecured debts followed by a Chapter 13 bankruptcy to restructure the remaining debts.

Nondischargeable Debts

Not all debts can be erased in a Chapter 7 bankruptcy. Certain debts are nondischargeable. A nondischargeable debt is one that the debtor remains responsible for paying after the bankruptcy proceeding. Such debts include:

● student loans. ● most federal, state, and local taxes. ● domestic support obligations (child support and alimony). ● debts arising from the debtor’s fraud, embezzlement, larceny, or breach of fiduciary duty. ● debts to government agencies for fines and penalties. ● court ordered fines and penalties. ● debt arising from intentionally injuring someone or someone’s property (including punitive damage awards). ● debts for personal injury caused by the debtor’s operation of a motor vehicle while intoxicated. ● luxury goods purchased within 90 days of filing bankruptcy. ● cash advances of more than $1000 within 70 days of filing bankruptcy. ● debts owed to certain tax-advantaged retirement plans. ● debts or creditors that the debtor fails to list on the bankruptcy petition.

Forgiven Debt is Income

If you settle a debt for less than the amount owed or the debt is forgiven entirely, the IRS considers that forgiven debt to be income. The rationale is that the borrower is now in a better position than if the loan had been fully repaid.

Creditors canceling debt of $600 or more are required to send Form 1099-C to the borrower and to the IRS by January 31 of the year after the debt was forgiven. The borrower is then required to pay tax on this “income.” However, there are some situations in which forgiven debt can be excluded from income. The most common exclusions are:

● Bankruptcy: Debts discharged in bankruptcy are not included in income. (But if the debts were canceled before filing for bankruptcy, they do not qualify for this exclusion.)

● Insolvency: The forgiven debt is excluded to the extent that liabilities are greater than assets. (For example, a person with $30,000 of assets and $40,000 of liabilities can exclude up to $10,000 of canceled debt.)

Borrowers who qualify for an exclusion must file Form 982 (Reduction of Tax Attributes Due to Discharge of Indebtedness). There are also some “exemptions” in which the forgiven debt is not income and the borrower does not need to file Form 982. Common exemptions include:

● Student loans: If there is a loan forgiveness provision based on service in a certain field of work, the canceled debt is not income.

● Family and friends: if the debt was between family members or friends, the cancellation of the debt may be considered a gift. (But the creditor may have to file a gift tax return and pay gift tax.)

● Forgiven interest that would have been deductible (such as interest on business debt) is not taxable.

If you already paid taxes on forgiven debt despite qualifying for an exclusion or exemption, you could go back and amend the prior year’s tax returns (for up to three years) and you could get a tax refund.