As you probably are aware of, an individual can file either Chapter 7 or Chapter 13 under the bankruptcy code when he or she needs relief from accumulated debt.

In Chapter 7, debtor gets a fresh start in life, without having to pay anything to creditors. Debtor gets to keep most if not all of his assets, including the house, furniture, cars, retirement accounts, bank deposits etc., subject to qualifying under a system of asset exemption. In order to keep the asset, there has to be an applicable exemption under the law. For instance, if you have a 401K of $750K, can you keep this asset in Chapter 7? Yes you can. There is applicable exemption for qualified retirement accounts up to about a million $, therefore the Chapter 7 debtor with a 401k of $750K, can wipe out credit cards, medical bills, business credit lines and any other kind of debt which are not excepted from discharge, in any amount, even $500K or $50M, there is really no limit to the amount of debt that an individual can wipe out in Chapter 7, and still be able to keep his $750K of 401K.

Let’s say that debtor owed $100K of credit cards, $50K of business credit lines, medical bills of $500K because he guaranteed the hospital bill of his father who was visiting from abroad and did not have travel insurance but got a heart attack when they went to Disneyland. The Chapter 7 discharge will wipe out all $650K of debt while he keeps his $750K of retirement account. That’s a great deal. He gets a fresh start in life without $650K of debt but with his asset of $750K still whole. Now where in the world can you have such a great deal in life? Everything in your life stays the same; you don’t lose anything other than your accumulated debts.

But let’s say that you can’t qualify for Chapter 7, the next best alternative for debt relief is Chapter 13. This is sometimes called a financial reorganization. In the above example, let’s assume that debtor also owns a house with equity of $120K and he or she is not yet 65. Another modification we will make to the above debtor is that he does not owe medical bills of $500K, but he does owe $100K of credit cards and $50K of business credit lines. So he owes $150K of unsecured debt.

The question is: What is the minimum Chapter 13 payment that he will have to pay? Generally speaking, he will have to pay at least the non-exempt portion of any asset that he has. In this example, we said that his house has equity of $120K. This means that if he has another relative living in the house, his home equity exemption is $100K maximum. But because his total equity is $120K, there is $20K that is non-exempt asset. Therefore, in this example, his minimum Chapter 13 payment will be $20K over 5 years, or more or less $350 a month of 60 equal monthly payments.

Why is this the minimum? Because in a Chapter 7, creditors will have a right to get $20K, so in Chapter 13, creditors must at least get paid $20K over 5 years. Make sense? Of course, it does. In this situation, debtor’s household income and expenses must be able to show that he has at least $350 of disposable income every month. What is disposable income? Disposable income is net income (gross income minus allowable deductions such as social security and taxes, union dues etc.) minus allowable expenses.

Calculation is not that simple because not all expenses are allowable to be deducted. For example, charitable contributions are deductible without any set limit. But food expenses are subject to IRS standards for the size of debtor’s family in California. Rent is also subject to IRS standards depending on family size. There are laws that apply to allowable expenses that your lawyer knows. For instance, you may have two kids in college. He gives them allowances of $500 each per month. Sorry, that’s not an allowable expense.

What happens if all assets are exempt? The minimum Chapter 13 payment would then depend on the disposable income of debtor’s household using the foregoing described calculation method. There is no set formula for calculation. Lawyers have bankruptcy software that helps them do this calculation. But the software normally is not accurate because each case has subtle differences from other cases. So the lawyer’s experience comes into play in this calculation. It’s important to consult your case with an experienced bankruptcy lawyer. The calculation is almost an art.

What happens when you complete all plan payments? In this example, debtor will make 60 monthly payments at $350 per month. Upon completion all plan payments in 5 years, he will have paid the Chapter 13 trustee who has the responsibility of distribution these payments among all his creditors, a total of $20K. So what happens to the difference between his total debt of $150K and his total payment of $20K? In other words, what happens to the $130K that he did not pay? The $130K disappears and is wiped out by the bankruptcy court’s order discharging his debts. The $130K is forever wiped out. It doesn’t come back forever, even if debtor’s income increases ten times in the future.

If you need debt relief, please set an appointment to see me. I will analyze your case personally.

Lawrence B. Yang is a graduate of Georgetown University with a Master’s Degree in Law and specializes in Bankruptcy, Business, Real Estate and Civil Litigation.  He speaks English, Mandarin and Fujian and has successfully represented thousands of clients in California, including companies overseas.  Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 20274 Carrey Road, Walnut, CA 91789 or1000 S. Fremont Ave., Mailstop 58, Building A-10 South Suite 10042, Alhambra, CA 91803.