Debt due to another person’s fraud can’t be discharged in bankruptcy. Neither can these bills

For some individuals, the solution for eliminating crushing debt is to file for bankruptcy.

While the catalyst for going that route differs from person to person, it’s worth knowing which obligations can and cannot be discharged in bankruptcy. For instance, just last week, the U.S. Supreme Court ruled in a 9-0 decision that an individual cannot discharge debt that arose due to the fraud of another person.

Although the number of personal bankruptcies remains relatively low, it has been climbing. In January, there were 29,397 individual filings, according to the American Bankruptcy Institute. That’s up 5.5% from 27,866 in December and 19.3% from 24,645 a year earlier.

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However, filings plummeted through 2021 and 2022 as pandemic aid and programs (i.e., stimulus checks, enhanced unemployment benefits, lenders allowing pauses on mortgage or rent) eased pressure on household balance sheets.

“Steep bankruptcy [drops] abated over the past year as pandemic assistance programs and lender forbearance receded, while interest rates, inflationary pressures and debt loads grew,” said Amy Quackenboss, executive director of the institute. 

Total household debt stood at $16.9 trillion in the fourth quarter of 2022, according to the Federal Reserve Bank of New York. That includes $11.9 trillion in mortgages, $1.6 trillion in student loans, another $1.6 trillion in car loans and more than $990 billion in credit card debt. However, delinquencies have remained low.

First, while most forms of consumer debt — credit card debt, personal loans, medical debt, mortgages and auto loans — are generally fair game for either eliminating or negotiating a lower payback amount in bankruptcy, that’s not true for student loan debt.

“It’s really difficult to obtain full discharge of student loans,” said Michelle Bass, a partner at Wolfson Bolton Kochis and head of the law firm’s consumer bankruptcy practice group.

“You have to prove that your circumstances will never improve … and that being forced to repay them would be an undue hardship on you,” Bass said.

Other debt that cannot be erased include child support and spousal support (alimony). And, certain other debt owed as part of a court order during divorce may also be off-limits: support to the ex-spouse in the form of, say, continuing to cover a car lease payment.

“Many jurisdictions consider intent: Is [the payment] considered domestic support?” Bass said.

Additionally, if you incurred the debt by fraud — i.e., you knowingly led a lender astray in the application process — you may not be able to erase it.

“If the lender can show that you provided false or misleading information in filing the loan application, information you should have known was incorrect, that debt could be found non-dischargeable,” Bass said.

Also, if you run up your credit card beyond $800 (excluding what’s spent on necessities) within 90 days of filing, the law assumes it’s fraud, according to the National Consumer Law Center. Same goes for cash advances above $1,100 from a single creditor in the 70 days ahead of filing bankruptcy.

Taxes owed — unless older than the last three years of tax returns, generally speaking — cannot be discharged in bankruptcy either, she said.

Of course, “any tax debt incurred by way of fraud … would be nondischargeable under all circumstances,” Bass said.

There are several ways to file for bankruptcy. Most individuals typically choose between Chapter 7 and Chapter 13. Each has filing fees of a few hundred dollars, and enlisting an attorney can add $1,200 to about $3,500, depending on where you live and the complexity of your case.

Both Chapters 7 and 13 stop collection activity like calls from creditors or debt collectors, wage garnishments and, potentially, lawsuits from creditors. 

However, there are differences in who qualifies and how debt is treated in each option. Chapter 7 generally is for people who lack enough income to repay their debt and have little in the way of assets (they are subject to a “means test” before being approved). It also is the most common way to file individual bankruptcy.

This approach can quickly erase certain forms of unsecured debt, including from credit cards, medical bills and personal loans. It does not, however, necessarily stop your car from being repossessed or prevent home foreclosure, depending on the specifics of your case.

Meanwhile, Chapter 13 generally gives you three to five years to pay back certain debt and keep the asset (i.e., house or car). It also prevents creditors from garnishing your wages or putting a levy on your bank account. For this filing option, you must have sufficient income, and your debt must be below a certain amount (currently $2.75 million).

For individuals with debt above that threshold, Chapter 11 — which is largely similar to Chapter 13 — might be the best choice. This is the least commonly used option for individuals.

The good news is that your retirement assets — including 401(k) plans and individual retirement accounts that you own and contributed to — generally are protected in bankruptcy. (Inherited IRAs do not get the same protection.)

An exception to this broad rule applies to IRAs, both traditional and Roth: Up to a set amount per person — currently about $1.51 million — is safe from creditors. Any excess could go to pay off creditors, unless the judge rules otherwise.

A big downside of bankruptcy is what it does to your credit score, which may already be suffering if you’ve become 30 or more days late on a loan or other credit obligation. The filing remains on a credit report for seven to 10 years, although the impact decreases over time and your score will tick upward. 

“Whether they file Chapter 7 or 13, their credit is going to take a hit,” Bass said. “But most clients say it starts improving right away after a Chapter 7 discharge, and in Chapter 13, their credit starts to improve six to 12 months after filing.”

Regardless of which bankruptcy approach you take, you should be prepared to provide detailed information on your financial life to the court. That includes tax returns, bank statements, paystubs and the like.

Keep in mind, too, that having an initial consult with a bankruptcy attorney often is free. They also might have suggestions for handling your debt that does not involve bankruptcy.

“No one wants to call us and I know that … but usually after a consult they feel much better because they know their options and can make a game plan,” Bass said.