Although the bankruptcy rules don’t specifically require you to be employed, your past and present income status can affect your ability to qualify for both Chapter 7 and Chapter 13 bankruptcy in entirely different ways.
For instance, you might not qualify for Chapter 7 bankruptcy if you’ve recently lost a high-earning position. By contrast, unemployed people won’t be eligible for Chapter 13 if the lack of employment income will prevent them from paying into a repayment plan. In this article, you’ll learn about the impact of unemployment on Chapter 7 and Chapter 13 bankruptcy.
Chapter 7 and Chapter 13 each offer unique benefits to filers. The first allows filers to cancel debt quickly while the second lets people keep property in exchange for paying into a payment plan.
Because each chapter has different qualification standards, how your unemployment will affect your bankruptcy will depend on some of the following factors:
(Find out about the different chapters in Should I File for Chapter 7 or Chapter 13 Bankruptcy?)
Chapter 7 bankruptcy wipes out qualifying unsecured debts, such as credit cards and medical bills. It works well for low-income filers who have little or no assets.
Debtors don’t lose everything in this chapter. They can keep the property they need to maintain a household and job, called exempt property. Nonexempt property that you can’t protect with an exemption gets sold and the sales proceeds are distributed to creditors.
In many cases, creditors don’t receive anything because the debtors don’t have any nonexempt property to sell—but that’s not always the case. The average Chapter 7 case takes approximately three to four months to complete.
Not everyone qualifies for a Chapter 7 debt discharge—the order that wipes out debt. However, being unemployed usually makes the bankruptcy process easier (but not always—more below).
A debtor must pass an income-qualifying test called the means test. The means test compares your household income against your state’s median income for a similar household. It’s a two-part test, but each part isn’t always required. Here’s what the test entails.
Passing the means test can be challenging if you’ve recently lost a high-paying job—at least temporarily. Even if you aren’t earning anything currently, you’ll still have to report the amount you received during the prior six months on the means test, and if the figure is high enough, you’ll fail.
The solution? Wait a few months. If you remain unemployed, your six-month average income will drop quickly. Keep in mind, however, that you’ll have to report any unemployment earnings you receive.
(Learn more by reading The Bankruptcy Means Test: Are You Eligible for Chapter 7 Bankruptcy?)
You could run into a problem if you find a job during your Chapter 7 case because the court looks at more than just the means test. It will also consider how much you have left over after you pay your bills each month. The court does this by deducting the reported monthly expenses on Schedule J: Your Expenses from your actual monthly income you report on Schedule I: Your Income. (Learn more in How to Fill Out Bankruptcy Forms.)
So, if you land a new job with a hefty salary and your expenses are low, you could end up with a substantial amount of discretionary income each month. In that case, the bankruptcy trustee assigned to your matter might recommend that the court convert your Chapter 7 to a Chapter 13.
If you are filing a Chapter 13 and you’re unemployed, you’ll likely have a difficult time getting your case approved (confirmed). Why? Chapter 13 allows a debtor to repay creditors over time and it takes income to do so.
Here’s how it works.
In a Chapter 13 bankruptcy, a debtor pays back all or a portion of debts through a three- to five-year repayment plan—a benefit that isn’t available in Chapter 7 bankruptcy. For instance, a debtor can catch up on mortgage arrears, get rid of a second mortgage, cram down car loans, or pay back nondischargeable debts such as domestic support or certain taxes through the repayment plan. Because it’s set up for monthly plan payments, Chapter 13 works well for debtors with regular income.
(You’ll learn more in Chapter 13 Bankruptcy.)
You can still file for Chapter 13 bankruptcy if you’re unemployed. However, if you don’t have employment income, you’ll have to show that you have some kind of income from a verifiable source and that you can afford your plan. Otherwise, the court will dismiss your case.
For instance, an unemployed debtor might have business or rental income that can be used to fund a plan. You can even use unemployment benefits, Social Security funds, or retirement benefits. As long as you can show that you have enough income coming in from some source, then your case will likely get approved by the court.