Settling Debts vs. Filing Bankruptcy: What Option Is Best for You?


My clients often ask whether a debt settlement or bankruptcy is best for them. In my opinion, if you are eligible for bankruptcy, bankruptcy is a much better option most of the time. Let me explain why.

Chapter 7 Bankruptcy vs. Debt Settlement

If you qualify for Chapter 7 bankruptcy and your assets can be protected, you generally do not have to pay back any of your debt. There are exceptions for tax debt and priority debts like child support or alimony, but credit cards almost never have to be paid back.

If you are eligible for this option, another benefit of discharging your debt in bankruptcy is that you will not have any income tax consequences. This is because any debts discharged in bankruptcy are excluded from your gross income, according to IRS' own rules. In comparison, any debts you settle or which a creditor voluntarily chooses not to collect may cause you to receive a 1099-C, and you may have to pay income taxes on any amount in excess of $600 which you were forgiven or did not have to pay. This is known as “cancellation of debt income.”

So, unfortunately, if you choose to settle your debts for less than you owe, you may end up owing the government taxes.

Chapter 13 Bankruptcy vs. Debt Settlement

If it turns out you are only eligible to file Chapter 13 bankruptcy, this is still a better alternative to settling debts in most cases. Just like in Chapter 7 bankruptcy, you do not have the taxable income problem if you receive a discharge. Your money and payments also go further in Chapter 13 because you’d pay your unsecured debts back at 0% interest, often for pennies on the dollar.

If you must pay secured debts in your Chapter 13, then you can often repay them over 60 months, possibly lower your interest rate, and pay any arrears you owe on secured debt interest-free. If you owe taxes, you can also derive a lot of benefits from Chapter 13, including eliminating penalties, stopping further interest from accruing, amongst other benefits.

The Automatic Stay & Bankruptcy in White Plains

One of the best parts of bankruptcy is the automatic stay. When you are negotiating settlements or working with a debt consolidator, you may end up getting sued by your creditors and have a judgment entered against you. While this is not fair and may have other legal implications, it does happen. But in a bankruptcy, all lawsuits and collections must stop, and creditors cannot pursue you except through official channels under bankruptcy law. They have to stop the harassment and your debts will be dealt with in the bankruptcy court.

So, if you are interested in saving money, avoiding potential tax problems, and stopping creditor harassment, a bankruptcy in White Plains can be a good way to accomplish all of these things.

Questions or interested in a free bankruptcy consultation? Contact Natasha Meruelo, Esq. through our site’s contact form or call me at (914) 752-5098. The first consultation is always free.

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