This sudden economic downturn will cause a large number of individuals and corporate entity debtors to consider bankruptcy in order to get a better handle on their financial situation. While many associate declaring bankruptcy as an admission of failure or destitution, bankruptcy can actually offer debtors a path toward recovering from a devastating financial situation. When considering whether bankruptcy is the right option for your situation, it is essential to have a basic understanding of how bankruptcy works and the initial actions you should take should you need to proceed with bankruptcy.
Understand the Different Types of Bankruptcy
The different types of bankruptcy are referred to as “Chapters”, and likely only one form will apply to a specific situation.
- Chapter 7 Liquidation
- The simplest and most common bankruptcy, a “straight bankruptcy”.
- Individuals and most corporate entity debtors can qualify for Chapter 7.
- Debtors are not required to submit to a repayment plan, but it does require liquidation of all nonexempt assets to payback creditors.
- Chapter 11 Reorganization
- Form of bankruptcy for both individuals and corporate entity debtors.
- Rather than liquidation, the debtor submits a reorganization plan that explains how it will be able to repay creditors over a period of time.
- Chapter 13 Debt Adjustment
- Form of bankruptcy for individual debtors only.
- The individual debtor must have a certain level of income to qualify.
- Rather than liquidating all assets, it allows the debtor to protect certain property and have enough time to pay off your debts within a monthly payment plan.
There are other much less common chapters of bankruptcy, but 7, 11 and 13 are the most utilized.
To properly prepare for bankruptcy, there are also a number of steps we recommend.
Gather Financial Statements
Regardless of the form of bankruptcy applicable to the situation, the first step requires getting financial statements in order. Order copies of all banking and financial account statements, obtain past filed federal and state tax returns, and figure out your income level from pay stubs, Form W-2 and Form 1099 and more. Depending on the amount of disposable income available, a debtor may or may not qualify for different chapters of bankruptcy.
Prepare an Asset List
Bankruptcy also requires a list of all assets and property owned. This does not mean listing out every piece of furniture or article of clothing, but rather a list of every significant asset that has actual value. Real property, bank accounts, investment accounts, retirement accounts, vehicles, luxury items all need inclusion on an asset list.
Get Current with Taxes
Debtors not current with their federal and state taxes will often encounter great difficulties in qualifying for bankruptcy. Tax returns determine past and current earning and asset holdings, and inform the IRS whether a debtor owes any additional taxes beyond W-2 withholding or past payments made. Any tax owed on returns not yet filed is also not dischargeable in bankruptcy.
Prepare a List of Creditors
Bankruptcy requires a debtor’s complete disclosure of all debts not only to the court, but also to all creditors. Any creditor left out will not be included in the bankruptcy, which could cause massive complications for a debtor thinking it will get a clean slate. Ordering a credit report from one of the three major credit agencies is a good way to confirm that no creditor is left off the list. The creditor list needs to include all secured, unsecured, and priority unsecured creditors. If you owe back taxes, the IRS is also considered a creditor.
Avoid Fraudulent Transfers
In the period leading up to a bankruptcy, a debtor’s actions and transfers will receive heavy scrutiny from both the court and creditors. If one attempts to sell, transfer or hide assets before a bankruptcy, the court may block the discharge of any debts and the debtor may even be subjected to criminal penalties. Payments in the ordinary course of business are permitted, and transfers or sales made in furtherance of paying debts and expenses are also allowed, but may require additional explanation and verification from the court and creditors. Also avoid preferential transfers to family member debts as those will also be potentially considered fraudulent transfers.
Retain Qualified Counsel
Navigating the complex bankruptcy laws also requires having effective legal representation. Our team of experts at SYK can help you make the right decisions and provide the advice you need in the event of bankruptcy.
Nicholas D. Rogers joins SYK Estate Planning and Taxation practice with a passion for helping individuals, small business and nonprofits. His practice includes a focus on estate planning, federal and state tax controversy, business formation and planning, as well as trust and estate administration.