With tax season drawing to a close, one question that frequently pops up with debtors currently in Chapter 13 Bankruptcy (or at least among those who are required to pay in 1/2 of their tax refund) is whether they are close to completing their plan.
I’ll give a real simple case as an example. John Doe files for Chapter 13 Bankruptcy and has a $4,000 car loan that has to be paid in full. His income requires him to pay nothing to his unsecured creditors, but he has to pay in 1/2 of this tax refunds. After a year in the plan, he has paid down the car loan to $2,500. He gets a $5k tax refund and pays in half – as he is obligated to – to the trustee. That should be enough to pay off the car loan and end the plan, right?
Not quite. Although it is true – the trustee will use the tax refund to pay the car loan first (secured and priority creditors get paid in full before any money goes to unsecured creditors) – the tax refund money is earmarked for unsecured creditors. Therefore, John will have to continue making plan payments pursuant to the terms of his Chapter 13 Plan, and those future payments (which would undoubtedly equal or exceed $2,500) will then go to unsecured creditors.
Why is this? Well, since secured and priority creditors are required to be paid in full in Chapter 13, most plans are required to fund those creditors in equal monthly payments over 3-5 years. Tax refunds are the result of over-withholding taxes, which reduces disposable income. Since plans require that all disposable income come into the plan, tax refunds are intercepted and earmarked for unsecured creditors.
There are, of course, exceptions (and unspoken truths and loopholes) to what I’ve just said. But that is the main principle of the matter.
So, can you ever get out of a plan early? Yes. But with some caveats.
First, you may be eligible to convert to Chapter 7, but the factors that go into such a determination are too numerous for me to list in this article, so you should speak to your attorney if you think conversion is something you want to consider. If you filed a Chapter 13 because you were ineligible to file Chapter 7 due to a prior bankruptcy, you won’t be able to convert. Also, generally, there must be a change in financial circumstances such that you can no longer have disposable income.
Second, you can get out of a Chapter 13 Bankruptcy at ANY TIME if you can pay off all claims in full (the caveat here being that the claims deadline must pass, which is about 90 days after the 341 hearing for most creditors, but 180 days after filing for government creditors). You’re not getting a discharge, but you’re ending the bankruptcy.
After 36 months, below-median debtors (assuming they’re in Chapter 13 for longer than 36 months to begin with) can buy out of a Chapter 13 early by paying off any balance owed on secured and priority debts plus any obligations to pay unsecured debts up to that point. The plan must also be amended to shorten the length of the plan.
At present, many circuits have held that above-median debtors cannot get out earlier than 60 months (since that is their applicable commitment period) without paying all debts in full. It has not yet been established in the Eastern District of Wisconsin whether an above median debtor can buy out between 36-60 months with the benefit of a partial discharge on unsecured debts, but if and when that challenge is made, it is unlikely to go in the debtor’s favor.
On a side note: Last week, I discussed conduit mortgage payments. For those who will be making post-petition mortgage payments directly to their lender and have pre-petition arrears, be advised that your first mortgage payment is due with the first contractual due date after your bankruptcy case is filed. Keep this in mind when planning to file your case. I get a lot of clients who schedule their appointment toward the end of the month, and their mortgage due date is the first of the month. They are unprepared to make their first mortgage payment within a few days. On the other hand, if you file early in the month, you have most of the rest of the month to get ready to resume mortgage payments (just make sure that your reinstatement quote that you provide your attorney includes the current month’s mortgage payment!).