Personal finance
What a Bankruptcy Discharge Wipes Out and What Creditors Can Still Do
Bankruptcy attorney Barry Levine explains which debts a discharge clears, which taxes survive it, and why ignoring one court summons can end in an arrest warrant.
Financial Fresh Start With Bankruptcy Vs. The Mess of Debt Settlement
Video from Barry Levine.
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What debts does a bankruptcy discharge clear, and what can creditors still do to you?
A bankruptcy discharge clears most unsecured debts, such as credit cards and personal loans, and removes personal liability for any shortfall after a foreclosure. Trust fund taxes, like withheld payroll tax or unpaid meals tax, survive and must be settled separately. Until the case is filed, creditors can still sue, so a debtor should never ignore a court summons.
Bankruptcy attorney Barry Levine used an episode of his show, Bankruptcy Through the Looking Glass, to compare a financial fresh start through bankruptcy with the mess of debt settlement. Rather than speak in generalities, he walked through what a discharge actually does to each kind of debt, and where the law still leaves people exposed.
His starting point is that bankruptcy is definitive. When a case is filed, every debt is listed in a category: secured debt such as a mortgage or a car loan, priority tax claims owed to the IRS or a state revenue department, and unsecured debt such as credit cards and loans from friends.
Most of those debts are discharged when the case ends, but not all of them, and the months between hiring a lawyer and filing have their own traps. Barry Levine's advice covers the taxes that survive, the mortgage paperwork that can follow a borrower for years, and the one court hearing nobody should skip.
Key takeaways
- A bankruptcy discharge clears most unsecured debts, including credit cards and personal loans, once the case is complete.
- Trust fund taxes, such as withheld payroll tax or unpaid meals tax, cannot be discharged in a bankruptcy.
- Without a reaffirmation, a credit report can show a mortgage as discharged even after years of steady payments.
- Ignoring a post-judgment summons in Massachusetts can lead a judge to issue a warrant for the debtor's arrest.
1. Which debts a discharge clears and which taxes survive
Barry Levine sorts debts into three groups. Secured debts are tied to property, like a mortgage on a house or a loan on a car. Priority claims are taxes owed to the IRS or a state taxing authority. Unsecured debts cover everything else, from credit cards to money borrowed from a friend. Most of these are discharged at the end of a case.
Taxes are where the exceptions sit. Unpaid income tax can be dischargeable under certain circumstances, and he says that can often be worked out before filing. Trust fund taxes are different. These are amounts a business collects on behalf of the government, such as payroll withholding or meals and sales tax, and then fails to pass on.
He explains why struggling businesses fall into this trap: that cash is easy to tap because nobody is standing over the owner to make sure it reaches the IRS. Those taxes are non-dischargeable, so they have to be handled through a separate process with the taxing authority, such as an offer in compromise.
2. What happens to a mortgage after bankruptcy
Even a mortgage is affected by a discharge. The lender keeps its right to foreclose on the house, but the borrower's personal liability for any shortfall goes. Barry Levine gives an example: a house worth 600,000 dollars with 800,000 owed typically fetches about 60 percent of its value at a foreclosure sale, leaving a deficiency of 440,000 dollars.
A discharge wipes out that deficiency, so someone whose house is still underwater after bankruptcy could later walk away from it without the debt following them. Lenders dislike that outcome. Borrowers who want to keep the home can sign a reaffirmation agreement, which the court approves only if the payments would not impose an undue hardship.
Skipping the reaffirmation has a hidden cost. If the mortgage is not reaffirmed, the credit report shows it as discharged even when the borrower has kept paying. One of his clients made ten years of payments, then heard from the same bank that a mortgage discharged in bankruptcy could not be refinanced. That case led him to draft a reporting statute.
3. Why a lawsuit is no reason to panic, but a summons is
Clients pay a 250 dollar retainer and then clear the rest of his fee within about six months, with no interest, before the case is filed. In the meantime creditors may sue. Barry Levine does not fight those suits, because defending a claim that will be discharged would cost more than the bankruptcy. Instead he writes to the creditor's attorney.
The real danger comes after a judgment. In Massachusetts, a creditor can use supplementary process, which summons the debtor to the district court. Showing up and saying that a lawyer has been retained to file usually ends the hearing quickly. Ignoring the summons is another matter: the judge can issue a warrant, and a routine traffic stop can end in an arrest.
The final steps are simpler than most people expect. Before filing, the debtor completes an online credit counseling course that runs for an hour. After filing comes the 341 meeting of creditors, now held by phone, which he says is often over in about ten minutes. In his words, the wait to be heard is longer than the meeting itself.
