Bankruptcy

• Bankruptcy is the legal process of eliminating some or all or your debts. There are two primary types of personal bankruptcy that include Chapter 7 and Chapter 13. Chapter 7 involves the liquidation of your personal property. Generally, with Chapter 7 bankruptcy, most of your debts are eliminated. Chapter 13 is reserved for consumers looking to restructure debt rather than completely eliminate it. In order to qualify for Chapter 13, you must have a stable source of income. Homeowners can use Chapter 13 bankruptcy to avoid foreclosure.
  
  

Insolvency

• A business is insolvent when it is unable to pay its bills and service its debt. Personal insolvency means the fair market value of your assets is less than your liabilities. Consumers use insolvency to avoid various forms of tax penalty such as cancellation of debt tax after foreclosure. The IRS allows insolvent taxpayers to claim exclusion as long as they have a legitimate claim. Proving insolvency is a complex process. Generally, the help of a tax professional is needed to determine the extent to which you are insolvent before you can file it on your income tax return.
  
  

Debt Overload

• Excessive debt can lead to insolvency and bankruptcy. Though taxpayers can claim certain exclusions due to insolvency, there are few other benefits to insolvency. Instead, many people who are insolvent end up filing bankruptcy if they are not able to get their debt under control. The type of bankruptcy filed depends on your income. In order to file Chapter 7 to eliminate your debt, your income must fall below the median income for your state. If you have enough disposable income to repay some of your debts, you may be forced to file Chapter 13 instead.
  
  

Considerations

• Legal protection from creditors is one of the primary benefits of bankruptcy. When the court files a motion to stay, all collection activities from creditors must cease immediately. If you are insolvent, creditors can continue to aggressively pursue your outstanding debt even if you are unable to pay. Bankruptcy has long-term negative consequences, however. To reverse insolvency, repaying your debts puts you back on the path to building your credit rating. After bankruptcy is filed, your score drops as much as 240 points and remains on your credit report for up to 10 years. Obtaining new credit, especially for major purchases such as a home or car, is extremely difficult after filing bankruptcy.