Priority Debts in an Asset Chapter 7 Case

Posted by Kevin on July 22, 2020 under Bankruptcy Blog | Comments are off for this article

Your Chapter 7 trustee may pay your priority debts—in full or in part—through the proceeds of the sale of your unprotected, non- exempt assets.  

Our last blog post was about what happens to priority debts in a no-asset Chapter 7 case. Most consumer “straight bankruptcy” Chapter 7 cases are no-asset cases. This means that the bankruptcy trustee does not take anything from the debtor because everything is protected and “no assets” are distributed to creditors.  Hence, the name.

No-Asset Case Even If Some Assets May Not Be Exempt

To understand how this actually works, sometimes from a practical point  of view, a Chapter 7 case is a no-asset one even when not all assets are exempt. That’s because the bankruptcy trustee has some discretion about whether to collect and liquidate an otherwise unprotected asset. Here are three reasons why he or she may not pursue an asset:

• The value of the asset, or the amount beyond the exemption, is too small to justify the trustee’s collection efforts. Example: A vehicle worth only a couple hundred dollars more than the vehicle exemption.
• Finding and/or selling the asset may be too expensive compared to its anticipated value. Example: A debt owed to the debtor by somebody who can’t be located and likely has no reliable income.
• The asset could be more of a detriment than a benefit to the trustee. Example: real estate with hazardous waste contamination.

Usually your bankruptcy lawyer will be able to reliably predict whether your Chapter 7 case will be an asset or no-asset case. But not always. Trustees have wide discretion about this. Moreover,  before filing, your lawyer doesn’t know which trustee will be assigned to your case.  And some trustees are more aggressive than others.

Paying Priority Debt through a Chapter 7 Asset Case

If you know that you will have an asset case, you may be able to pay a priory debt through your case.

In our last blog post our main point was that in a no-asset Chapter 7 case you have to pay any priority debts yourself directly to your creditors after completing the case. But in an asset case, the trustee is required to pay any of your priority debts before any other debts. The trustee collects and liquidates your non-exempt assets (any not protected by exemptions). From the proceeds he or she then pays you your exempt amount,  and then pays his or her fee, and then pays debts only to the extent there’s money available.  Priority debts get paid before general unsecured debts.

For Example

Assume you owe $4,000 to the IRS for last year’s income tax.  That tax is a priority debt.  You also owe $75,000 in medical bills and unsecured credit cards.  Those are general unsecured debts.  If you filed a Chapter 7 case in which everything you owned was protected, that would be a no-asset case. The IRS debt can’t be discharged (legally write off). So you would have to make arrangements to pay it after your Chapter 7 case was over. Most likely the case would discharge the $75,000 in other debts.

But now assume that you have a boat that you no longer want because it costs too much to maintain.  There’s usually no exemption for a boat. So the Chapter 7 trustee takes and sells your boat for $5,000. The proceeds of that sale go first to pay the administrative fee of the trustee (since there is no exemption for the boat, the debtor gets nothing).  A trustee gets a fee of 25% on the first $5000 of assets that are distributed.  So, the trustee gets $1250, the IRS gets $3750 and general, unsecured creditor get nothing.  You would be required to pay the IRS $250.

Conclusion

In some circumstances paying a priority debt in a Chapter 7 case is not a bad deal. This is especially true if you have an asset not protected by an exemption that you don’t mind surrendering.