Most people wouldn’t benefit from filing for Chapter 7 bankruptcy after receiving a large lawsuit settlement because, well, bankruptcy is for people who are bankrupt. Even so, it’s possible to keep a smaller award or a lawsuit settlement needed for your support.
Your state exemption law determines whether you can protect the money from a lawsuit award or settlement. If it’s not covered by an exemption, you’ll have to give it up.
In this article, you’ll learn more about what can happen to lawsuit settlements in Chapter 7 bankruptcy and when you might be better off exploring other options.
If you qualify for a Chapter 7 discharge, you can get rid of your nonpriority, unsecured debt. Some of the debt types most commonly erased include:
Find out more about debts that get discharged in Chapter 7 bankruptcy.
Nonexempt property is a different matter. You’ll turn over the property you can’t exempt to the bankruptcy trustee assigned to administer your case. The trustee will sell the nonexempt property and distribute the sale proceeds to your unsecured creditors.
If you own something of value—such as a lawsuit award—and your state considers it nonexempt property you’ll lose it in Chapter 7. It’s important to know what will happen to your property before you file. If you don’t find out that you’ll lose an asset until you file for bankruptcy, it’s unlikely the court will let you out of the case.
Here’s how it works.
Keep in mind that it’s not a good idea to “forget” about an asset. When you fill out your bankruptcy paperwork, you’ll sign a form declaring that your disclosures are true and correct.
If you don’t list the lawsuit settlement, the court might believe you’re attempting to hide it and view it as bankruptcy fraud. And the consequences of bankruptcy fraud are steep—you’ll face up to $250,000, imprisonment for up to 20 years, or both.
The exemption status of typical lawsuits, such as personal injury suits for automobile accidents, slip and fall accidents, dog bites, employment, malpractice, or products liability cases, is different in each state.
Some states allow you to choose between state and federal exemptions—and using the federal exemption scheme might be a better bet. People who live in one of these places will have that choice:
You can find the current exemption limits in Federal Bankruptcy Exemptions.
If you receive a large lawsuit settlement, you might be able to exempt it, but you might not. If you’re unsure, the best way to find out is by speaking with a local bankruptcy attorney.
A bankruptcy lawyer can review your financial situation and help you decide whether it makes more sense to:
For instance, a lawyer or accountant can explain the requirement to pay income tax on forgiven debt, and that settling a substantial amount of debt for less than what you owe might push you into a higher tax bracket, leaving you with a significant tax bill.
Because taxes are rarely dischargeable in bankruptcy, if you end up filing for bankruptcy later, you could find yourself stuck with tax debt.