When you file for bankruptcy, whether an unsecured debt is a priority debt or a nonpriority debt will affect how that claim is treated. Read on to learn which debts are priority, which are nonpriority, and how they are treated in both Chapter 7 and Chapter 13 bankruptcy.
The two main types of debts are secured debts and unsecured debts. Secured debts are debts that are backed by collateral; car loans and mortgage loans are the most common types of secured debts. Unsecured debts are debts that are not backed by collateral. Unsecured debts basically include all other debts, such as credit card debt and medical bills.
In bankruptcy, unsecured debts are separated even further into two categories -- priority and nonpriority.
Priority debts are debts that the Bankruptcy Code has given priority over all other debts. Priority is granted to a certain debt either because the money is owed to the government or because public policy requires it, meaning that Congress has determined that giving the debt priority status suits the public good. The most common priority debts are:
Nonpriority debts are all unsecured debts that do not have priority. Most unsecured debts are nonpriority debts, such as:
Priority debts must be paid ahead of all other debts in a bankruptcy after the trustee pays administrative claims (trustees fees, attorney fees, and other costs of administering the bankruptcy estate).
Payment of priority debts in Chapter 13. If you have priority debts in a Chapter 13 case, they must be paid in full, sometimes with interest, through your Chapter 13 plan.
Payment of priority debts in Chapter 7. If you have priority debts in a Chapter 7 and the trustee has recovered money to repay creditors, the priority creditors must be paid first; if there isn't enough money to repay priority debts, nonpriority debts will not be paid at all. If there is money left over after priority debts are paid in full, it will be distributed pro rata to the nonpriority creditors.
Example 1. John filed Chapter 7 bankruptcy. He owes $30,000 in back child support and $40,000 in credit card debt. He has assets he cannot exempt, and the Chapter 7 trustee has sold them and obtained $20,000. The trustee's fees and costs for selling the property add up to $3,000. The remaining $17,000 is paid toward the back child support, and the entire $40,000 in credit card debt is discharged. John will still owe $13,000 for the child support after the bankruptcy is over.
Example 2. Michael filed Chapter 7 bankruptcy. He owes the IRS $15,000 in back taxes. He also owes $20,000 in medical bills and $10,000 in credit card debt. The Chapter 7 trustee recovers $25,000 for the estate. After the trustee's fees and costs of $4,000, there is $21,000 available for creditors. The trustee will pay the IRS in full. The remaining $6,000 will be distributed pro rata to the remaining creditors -- each credit card debt and medical bill will receive 20% of what they're owed (because $6,000 is 20% of $30,000, which is the total unsecured debt).