What Is Chapter 5 Bankruptcy?

If you’ve ever found yourself swimming in a sea of debt, you may have considered filing bankruptcy, which relieves the burden of insurmountable debt for many people. In the U.S., the federal court system grants this relief to petitioners under laws enacted by Congress, collectively called the U.S. Bankruptcy Code. The Code is divided into chapters, some of which lend their chapter numbers to the type of bankruptcy filing they describe, such as Chapter 7 and Chapter 11. But Chapter 5 is not a type of bankruptcy you can file; it’s simply one of the chapters in the Code that defines procedural guidelines for debtors and creditors (including creditors' estates).

Congress established bankruptcy law with a primary goal in mind – “to give an honest debtor a financial ‘fresh start.’ ” This federal statutory law is included in Title 11 of the United States Code. Federal courts have exclusive jurisdiction over bankruptcy proceedings, and these courts must follow the Federal Rules of Bankruptcy Procedure.

The bankruptcy ball is typically put in motion when a debtor voluntarily petitions a bankruptcy court by filing for debt relief. Less frequently, a creditor may initiate the bankruptcy process by filing an involuntary petition, which creates a bankruptcy estate. The Bankruptcy Code allows different types of debt relief and debt adjustment, depending on the debtor’s particular financial circumstance.

Filing bankruptcy is not a one-size-fits-all process. Individuals, businesses and even school districts may petition federal courts for debt relief. But each of these groups comes under different types of bankruptcy filings.

• Individuals – Chapter 7 or Chapter 13 bankruptcy, depending on the petitioner’s financial situation.
  
• Businesses – Chapter 7, if the business wants to liquidate debt, or Chapter 11, if the goal is to reorganize debt.
  
• Municipalities – Chapter 9 bankruptcy applies to cities, towns, villages, taxing districts, municipal utilities and school districts.
  
• Family farmers and fishermen – Chapter 12 is specifically tailored to these two professions.
  
• Parties from more than one country – Chapter 15 is structured for the inclusion of foreign courts, foreign creditors and other cross-border bankruptcy cases.

Chapter 5 of the Bankruptcy Code is divided into three subchapters, which are each further subdivided into sections.

1. Subchapter 1 – Creditors and Claims. Sections 501 through 511 in this subchapter cover topics such as how creditors file claims (Section 501), request administrative expenses (Section 503) and determine whether a claim that is secured by a lien on a debtor’s property is allowable (Section 506).
   
2. Subchapter 2 – Debtor’s Duties and Benefits. Sections 521 through 528 in this subchapter cover topics such as a debtor’s duties, which include filing lists of creditors, assets and liabilities (Section 521), the details of discharging debts (Section 524) and the duties and requirements for debt-relief agencies (Section 528).
   
3. Subchapter 3 – The Estate. Sections 541 through 562 in this subchapter cover topics such as what constitutes a debtor’s property (Section 541), statutory liens (Section 545) and postpetition transactions (Section 549).
   

Even if an individual (or a business) cancels or forgives the debt you owe, the IRS still considers the amount of your canceled debt as income for tax purposes. But this is not the case in bankruptcy proceedings. Although your bankruptcy-cancelled debts may reduce some of your benefits, the amount of these debts is not considered taxable income. IRS Publication 908 (Bankruptcy Tax Guide) notes that you'll still have to file tax returns (or extensions) that are due after you file bankruptcy, or you could jeopardize your bankruptcy filing status, which could mean dismissing your case.

Visit IRS.gov/forms and follow the prompts to view or download Publication 908. A bankruptcy attorney or tax professional may be a valuable resource to help you navigate the details of this publication as they apply to your specific case.