Misconception 1: You will lose everything if you file bankruptcy.
Reality: Even in a liquidation bankruptcy a debtor is entitled to claim his state law exemptions, which allows a debtor to retain substantial (perhaps all) property. Certain other forms of bankruptcy allow a debtor to keep everything he owns, even non-exempt property.
The most commonly filed type of bankruptcy is under chapter 7 of the bankruptcy code, and which is commonly referred to as the liquidation or “fresh start” bankruptcy. In a chapter 7, a debtor’s non-exempt assets are liquidated to pay creditors. To the extent the debtor has insufficient (or no) non-exempt assets to pay creditors, most forms of unsecured are then discharged as part of the process.
While a debtor is required to surrender non-exempt assets to discharge debt in a chapter 7, he is allowed to claim his state law exemptions and retain all qualified exempt property. Every state has a body of exemption laws that effectively shield certain assets from the reach of an individual’s creditors. In other words, there are certain things under state law that can never be taken from you by your creditors. Those state law rights are recognized in bankruptcy.
Nevada happens to have amongst the most generous state law exemption rights in the nation. Notably, Nevada law allows an individual to protect up to $550,000 of equity in a primary residence, up to $500,000 in retirement accounts, up to $15,000 equity in a motor vehicle and usually all household goods, furnishings, clothing, art and jewelry.
While most people envision a chapter 7 liquidation bankruptcy case when thinking about bankruptcy, other forms of bankruptcy exist that allow a debtor to retain all non-exempt property. For example, while in a chapter 7 debtor gives up non-exempt assets to discharge debt, in a chapter 13 a debtor will retain all of his non-exemption property. Rather than surrendering non-exempt property, the debtor is required to make monthly payments for a period of time to pay back a portion of his debt, while discharging a portion of his debt.
Misconception 2: Bankruptcy is only for those at the doorstep of financial ruin.
Reality: Often times, the most beneficial bankruptcies are filed as financial tools to allow individual or business to preserve assets, restructure and reduce debt, and ultimately avoid financial ruin.
While bankruptcy certainly provides a safe harbor for those in financial ruin, it can also provide protection and benefit for individuals and businesses trying to reduce their debt load, restructure their financial affairs and create net cash flow. For example, the bankruptcy code allows a debtor to modify various forms of secured debt, even without the consent/agreement of their creditors. Certain secured claims can be reduced to the current market value of the collateral, interest rates can be reduced and repayment terms can be extended. Bankruptcy also provides a means of terminating bad lease agreements and capping the damages of the landlord. In many cases, most of the capped lease damages are ultimately discharged as part of the bankruptcy.
Bankruptcy can also provide some unique benefits for individuals with tax liabilities. While tax liabilities cannot be discharged in bankruptcy, penalties can be discharged. In addition, by creating a structured repayment of the actual tax liability through a bankruptcy, the debtor will be able to repay the tax liability without any further accruing interest or penalties. Specifically, once a bankruptcy is filed, the amount of the tax claim is fixed as of the date of filing. While that liability must be paid in full, interest is not required.
Misconception 3: It is impossible to file bankruptcy these days.
Reality: Some form of bankruptcy relief is still available to everyone who is an honest, but unfortunate debtor.
In 2005, bankruptcy law was changed to make it more difficult for an individual with regular disposable monthly income to file a chapter 7 bankruptcy. The purpose of the law changes was to force more people to file chapter 13 bankruptcies, where creditors usually receive some small return on their claim through monthly payments made by the debtor. The law was not intended to, and in fact did not, eliminate the ability for an individual to file bankruptcy.
While the test used to determine whether one qualifies for a chapter 7 is complex and involved, it can be generally stated that anyone with income below the median for the state automatically qualifies for a chapter 7. Even individuals with earnings greater than the state median may still file a chapter 7, if their monthly obligations (including secured debt payments, living expenses, child costs, etc.) leave them with little to no “disposable” monthly income.
In addition, anyone whose debt is considered “primarily business debt”, as opposed to “primarily consumer debt”, automatically qualifies for a chapter 7.
For those that do not qualify to file a chapter 7, bankruptcy still affords relief under either chapter 11 or 13.