Chapter 13 Bankruptcy Hardship Discharge and its Tax Rules

If you have filed Chapter 13 bankruptcy in order to better get a hold on your debts and finances but are having problems with your payments, then you may have the option for a Chapter 13 hardship discharge of some of your debts.

Hardship Discharge

When you file a Chapter 13 bankruptcy you are in effect making an agreement between yourself and your debtors, promising them that once you make all of your promised payment that you agree to have the debt dropped or discharged. However, when life happens you might succumb to undue hardship that enables you to file a hardship discharge.

When you request a hardship discharge, you are simply saying that you cannot afford the amount that you initially promised, due to circumstances beyond your control. Another qualifying requirement is that the creditor that you owe the debt to would have to have to have had received at least what he or she would have received had you filed a Chapter 7 bankruptcy.

If you were granted a hardship discharge certain debts will not be discharged. Such debts include but are not limited to:

Your retirement plan loans,
Divorce or separation agreement debts,
Homeowner association fees, and
Bankruptcy case fees.

When Are You Eligible for a Chapter 13 Bankruptcy Hardship Discharge?

Additionally there are three stipulations that will enable the hardship discharge to come into fruition.

The first is as was mentioned earlier, that there are circumstances beyond your control that impede your form complying with the payment plan.
The second stipulation is if the creditors have received as much as they would have received under a Chapter 7 bankruptcy.
The third and final stipulation is that you have exhausted all possibilities and a modification of the initial payment plan is not feasible whatsoever.

Each stipulation must be met in order for the hardship discharge to be processed.

You cannot apply for a hardship discharge if you have already received a discharge within two years of a previous filing of a Chapter 13 bankruptcy and within four years of filing a Chapter 7 bankruptcy. In order to receive a hardship discharge, you must have also completed a pre-approved course in financial management.

Tax Rules

Under the law, you are generally taxed on discharged debt as 1099 misc. income. This can significantly increase your tax bill, as you may have to pay "self employment" tax- which is tax for self employment and medicaid that adds up to 15 percent. You will also have to pay ordinary tax on the discharged amount of debt. In addition, this can sometimes push you into a higher tax bracket.

Getting Legal Help

If you are considering applying for a hardship discharge, take into account all of the above-mentioned factors as they apply to your situation. Additionally, you may want to consider speaking with a bankruptcy attorney about the proper strategy as relative to your particular situation. A bankruptcy attorney could assess where you stand before you even apply for a hardship discharge and can help you to understand what impact the discharge will have on your taxes.

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