Chapter 7 personal bankruptcy allows debtors to wipe out most kinds of existing debt, but there are strict and relatively low income thresholds to qualify. This blog overviews the basics of Chapter 7 personal bankruptcy process.

Chapter 7 Transfers All Assets & Debts to Bankruptcy Trustee

The details of bankruptcy are specific and can get complicated, but in general, in a chapter 7 personal bankruptcy, everything you own and owe is legally transferred to a Bankruptcy Trustee, who can then use your assets to pay your debts. If you have more debts than assets, then those debts are (usually) “discharged” or wiped out (there are exceptions for some debts, which is part of why bankruptcy law is specific and complicated). The Bankruptcy Trustee is appointed by the Justice Department, is usually an attorney or an accountant, and is paid from bankruptcy filing fees and sometimes from commissions on the sales of assets sold.

What You Can Keep Through Bankruptcy

In a chapter 7 bankruptcy the debtor may keep either the (1) “wildcard” exemption, worth $29,275 in assets and cash that they select (such as cars and checking accounts), or (2) the “homestead exemption” which allows the debtor to keep $300,000 – $600,000 of the equity in a primary residence (in California), depending on the median sales price of a home in their county. And, debtors always keep all money in 401k and 403b retirement accounts, and up to $1.3 million in IRAs.

What Debts Does Bankruptcy Discharge?

Legal ownership of a debtor’s assets is transferred from the Trustee back to the debtor when the bankruptcy is completed. A chapter 7 bankruptcy, when approved and completed, almost always wipes out all credit card and other unsecured debts, such as medical bills and lease obligations. It often also erases tax debts, provided the tax debt is at least 3 years or older, returns were filed for the years in question, and the taxes aren’t payroll taxes (there are other conditions you can read about here). In rare and very specific circumstances, student loans used solely for living (rather than educational) expenses can be eliminated through bankruptcy. And bankruptcy can negate outstanding legal judgments, provided fraud wasn’t one of the elements of the judgment. Some kinds of debts, however, are impossible or tricky to eliminate with bankruptcy, such as student loans and certain kinds of tax debts. For this reason, it’s important to hire an experienced and knowledgeable bankruptcy attorney.

Income Thresholds for Chapter 7 Bankruptcy

There are income thresholds to qualify for a chapter 7. If you, or you and your spouse have mostly consumer debt (credit cards, medical bills) and make more money than the income threshold established by the law for your size and location, then you won’t qualify for a chapter 7. The income threshold to qualify for a chapter 7 bankruptcy is called the Means Test. This test looks at your income over the six months before you file for bankruptcy. If your annualized income is below the median income for a family of four (in California – this figure differs from state to state), which is $101,315 per year/$50,658 for six months (or below $60,360 per year for a single person), then you pass the means test and are eligible to file a chapter 7. If most of your debt is related to a business or to tax, then you don’t need to meet the Means Test. Yes, it’s complicated. You can get details at the U.S. Bankruptcy Court’s Website.

If your income is higher than the above numbers, you may still qualify for a chapter 7 because we can deduct your regular “allowable” expenses such as mortgage or rent payments, utilities, car payments, food, and health care. If your expenses bring your income down below the median rate, then you likely qualify for a chapter 7. If your income minus allowable expenses puts you above the median income in California, then you may benefit from a chapter 13 bankruptcy, intended for people with somewhat higher incomes and more assets to protect. Learn more about chapter 13 here.

Educating Yourself & Getting Guidance Are Key

The financial triggers that lead people to consider bankruptcy are stressful, emotional and often highly traumatic. As a result, many people avoid thinking about bankruptcy. But if you’re reading this, there’s probably a reason for it. Please do yourself a favor and call a bankruptcy specialist now. It doesn’t have to be me but call someone. You don’t need to do anything other than get accurate information on the alternatives for dealing with the financial circumstances that have caused you to be reading this. You don’t need to make a hasty decision. You don’t even need to make a decision. Just educate yourself.

November 11, 2022