Your credit score is an important figure that can play a role in multiple different areas of your life. A low credit score could affect your ability to obtain a loan such as a home mortgage, and your credit report may also play a role in issues such as housing or employment. If you are considering bankruptcy, you may be concerned about how it would affect your credit score. Fortunately, if you do receive debt relief through bankruptcy, this can provide you with the ability to begin rebuilding your credit, allowing you to pursue opportunities in the future.

How Bankruptcy Affects Your Credit Score

Bankruptcy will cause your credit score to decrease significantly, and having a bankruptcy on your credit report may be an indication to creditors that you may not qualify for certain types of loans. However, if you are considering bankruptcy, you are likely already struggling with debt, and missing payments on loans, credit cards, or other bills will also decrease your credit score. Ultimately, it may be more beneficial to go ahead with bankruptcy and then take steps to build your credit score back up once you have regained financial stability.

Ways You May Be Able to Increase Your Credit Score

Following bankruptcy, the best ways to improve your credit rating involve demonstrating that you are financially responsible. You can do so by making sure you consistently pay all your bills on time. You can also make sure you are prepared for emergencies by building up your savings as much as possible and avoiding unnecessary purchases.

A person who is struggling to pay their debts can gain many benefits by filing for bankruptcy, and the automatic stay is one of the most helpful of these benefits. This stay will go into effect as soon as a petition is filed in bankruptcy court, and it will prevent creditors from taking any actions to collect debts owed by the debtor. In addition to private creditors, such as mortgage lenders or credit card companies, the automatic stay applies to the IRS. Taxpayers who owe tax debts will want to understand what types of actions the IRS can and cannot take during the bankruptcy process.

The Automatic Stay and Tax Levies

There are a variety of methods that may be used to collect taxes. IRS tax levies may involve the garnishment of a person’s wages, the seizure of funds in a person’s bank accounts, or the offsetting of tax refunds that are due to a debtor. When a person files for bankruptcy, the automatic stay will prohibit the IRS from the beginning or proceeding with any of these tax levies. 

Specifically, the IRS is prohibited from:

There are many situations where businesses may have trouble paying debts and meeting other financial obligations while continuing to operate. In some cases, a business may seek to reorganize its operations and pay off as much of its debts as possible by pursuing Chapter 11 bankruptcy. However, this can be a long and involved process, and many small businesses may not have the resources to complete this type of reorganization while meeting all reporting requirements and paying the related costs. Fortunately, a recent change to the law has allowed some businesses to complete a Chapter 11 bankruptcy through a process that is faster and more efficient.

Small Business Debtor Reorganization

The Small Business Reorganization Act, which went into effect in 2020, created new procedures for a Chapter 11 bankruptcy. Because these procedures are outlined in Subchapter V of Chapter 11 of the U.S. Bankruptcy Code, this type of bankruptcy is often referred to as a “Chapter 5” case. Initially, Chapter 5 bankruptcy was available for businesses with aggregate debts up to around $2.7 million. However, the CARES Act of 2020, which provided relief for Americans affected by the COVID-19 pandemic, increased the qualifying amount of debt to $7.5 million.

One of the primary differences between a Chapter 5 bankruptcy and other Chapter 11 bankruptcy cases is that a creditors’ committee will not be created in a Chapter 5 case. A debtor’s plan for the reorganization of their business will not need to be approved by creditors. However, a business’s plan for reorganization must include information about the history of the business, an analysis that details payments that could be made to creditors in a potential liquidation of the business’s assets, and the amount of the expected payments that will be made to creditors under the plan. A bankruptcy court will generally confirm a reorganization plan if it treats creditors fairly and equitably, and creditors must receive an amount equal to or greater than what they would be able to recover in a Chapter 7 bankruptcy.

One of the benefits of filing for bankruptcy is that doing so places an automatic stay on collection actions by creditors. This means that creditors will be prohibited from making any attempts to collect debts while the bankruptcy case is ongoing, including contacting a debtor through phone calls, letters, garnishing their wages, or foreclosing on a person’s home. The automatic stay gives a person the opportunity to assess their financial situation and determine their options during the bankruptcy process without the requirement to repay certain debts during this time. However, there are certain types of exceptions to the automatic stay, and a person will need to understand how these will apply in their case.

Issues That Are Not Affected by the Automatic Stay

The following types of actions are not covered by the automatic stay in a bankruptcy case:

• Criminal cases - If a person is facing criminal charges, filing for bankruptcy will not affect these proceedings, and it will not stop the collection of fines, fees, or restitution that a person is ordered to pay to a victim.

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Debtors have multiple options for addressing debts through bankruptcy. For those who have secured debts such as a home mortgage or other loans where they wish to maintain ownership of the collateral, or in cases where a family’s income exceeds a certain threshold, Chapter 13 bankruptcy may be the best option. In these cases, the debtor will propose a repayment plan in which they will put their disposable income toward paying off as much of their debts as possible over a period of three or five years, and after completing all payments in the plan, they will receive a discharge of the unsecured debts that are remaining. However, debtors may be concerned about what will happen if they encounter financial difficulties that affect their ability to make these payments. In these situations, a debtor may qualify for a hardship discharge.

Eligibility for a Hardship Discharge

Typically, if a debtor does not make all of the payments in a Chapter 13 repayment plan, their bankruptcy case may be dismissed, and they will continue to owe debts to creditors. However, if a debtor becomes unable to continue making payments in their plan, they may ask the court to approve a hardship discharge, which will allow the remaining debts in the plan to be eliminated. To qualify for a hardship discharge, a debtor must meet the following requirements:

• The debtor must be unable to complete their repayment plan through no fault of their own and due to circumstances that are out of their control. For example, a serious illness may have caused a person to be unable to work full-time, leading to a reduction in income and an inability to make payments. A debtor will usually need to show that the conditions that have affected their ability to complete the repayment plan are expected to be long-term or permanent rather than a short-term or temporary setback.

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