Bankruptcy V.S Debt Negotiation. Which is right for you?
Bankruptcy is not the solution to every financial problem. There is an alternative method known as Debt Negotiation. There are pluses and minuses to each approach. The purpose of this article is to give you a basic overview of the difference between Bankruptcy and Debt Negotiation.
As soon as you file for Bankruptcy the automatic stay goes into effect. This means that your creditors cannot engage in any activities for purposes of collecting a debt. They can’t call you, they can’t write you, they can’t sue you, and they can’t garnish you. If there is an ongoing civil lawsuit against you the filing of the Bankruptcy will stop that lawsuit. Everything has to stop. That is not the case with Debt Negotiation. In Debt Negotiation there is no automatic stay. That means your creditors can call you and write you. Somebody may sue you. All things being equal, Debt Negotiation can be a somewhat bumpier ride due to the lack of an automatic stay.
In a Chapter 13 Bankruptcy, the amount you repay to your general unsecured creditors can be anywhere from 0% to 100% depending on how much you are able to repay. This is partially a function of how much disposable income you have per month after your out-of-pocket expenses are subtracted from your household income. In Debt Negotiation, the amount you repay to your general unsecured creditors can typically be negotiated down to about 40 to 45 cents on the dollar to your unsecured creditors. For a definition of “unsecured creditors” see my article entitled “The Difference Between Chapter 7 and Chapter 13 Bankruptcy, and Which Chapter is Right For You.” An important limitation to Debt Negotiation is that credit unions, unlike banks, do not negotiate debt. This is in contrast to Bankruptcy, in which your creditors do not get to decide whether they will participate in the process. When you file for bankruptcy, a credit union is compelled to participate in that process.
When creditors voluntarily forgive some of your debt pursuant to Debt Negotiation, you may possibly get hit with an income tax bill as a result of the forgiveness of debt. The Internal Revenue Service (“IRS”) does not consider a loan to be income because there is an obligation to repay. When the obligation to repay is destroyed as the result of a voluntarily forgiveness of debt by your creditor, it becomes income to the extent the debt was forgiven. For example, you get a loan for $1,000.00. You are not taxed on the loan because you have to pay it back. But if your creditor accepts $500.00 and forgives the rest of the debt, the $500.00 you no longer have to pay becomes income subject to taxation. There is something called an insolvency exception whereby the IRS does not tax you for the debt which was forgiven. The determination whether you fit into the insolvency exception is beyond the scope of this article.
A discharge of your debts in bankruptcy never results in a tax obligation as the result of the elimination of the debt. There is an IRS Publication which specifically states that discharge of debt in bankruptcy does not create a taxable obligation.
The above information is a general overview and is not intended to be used as legal advice. If you are considering either filing for bankruptcy or negotiating your debts with your creditors, the best thing to do is call our office at 248-557-3645 and schedule a free consultation so you can receive advice which is tailored to your specific circumstances.
By: Michael Benkstein, Esq.
Managing Attorney, Bankruptcy Department
The Law Offices of Joumana Kayrouz, PLLC