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Forgiveness of Debt in Bankruptcy: The Basics

By Tanya Roth, Esq. on March 24, 2010 12:45 PM

This week's Supreme Court decision in a bankruptcy case involving student loan debt, not to mention the soaring numbers of bankruptcies, has many people curious about the boundaries of debt discharge in bankruptcy.

Well, what is "discharge" in bankruptcy?

In a nutshell, discharge is essentially a forgiveness of debt. If discharge is granted by the Bankruptcy Court, then the debtor is released from the liability of paying that debt. This means that creditors cannot come after the debtor for the debt, once the discharge is granted.

Sound good? Well, not so fast.

To begin with, not all your debts can be discharged in bankruptcy. And the type of bankruptcy you file can also have an impact on which debts may be discharged in bankruptcy. So if you're thinking about declaring bankruptcy, make sure that the debts you are trying to wipe out can, in fact, be wiped out through the type of bankruptcy you are considering.

Debts not subject to discharge in bankruptcy include, but are not limited to:

  • Some tax debts
  • Employer trust fund taxes
  • Alimony or support debts
  • Fines and penalties to governmental units
  • DUI-caused personal injury debts 

Furthermore, with some debts -- secured debts -- the creditor holds a lien on a piece of property (or other collateral). A discharged debt does not equal a discharged lien. If your creditor has a lien on your property to secure payment of the debt, then be careful. You will need to get the lien cancelled in order to prevent the creditor from exercising his/her rights under the lien to take the property. 

Finally, be aware that certain tax rules apply to forgiveness of debt.  There is essentially a "forgiveness of debt tax." where the IRS sees your forgiven debt as income you earned. You might have to pay tax on that forgiven debt under certain types of bankruptcies.

In the recent Supreme Court case, the Court upheld a student loan discharge in bankruptcy.  Generally, student loan discharge cannot be discharged in bankruptcy, unless the debtor can show that they (or their dependents) would suffer undue hardship as a result of paying the loan.

The lesson:  Look at your debts and do your research.  Be wise about your debts and do your due diligence to determine if bankruptcy is even right for you. 

Bankruptcy is not always the answer.

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