The truth is income taxes are dischargeable in bankruptcy if 3 reasonably simple conditions are met;  debts to the government are generally dischargeable in bankruptcy.

Please reread that line, and get that bit of law in your head.

Because you wouldn’t know the truth of the statement above from reading the blog of this lawyer (who puts himself forward as an expert on bankruptcy law) whose opening line is utterly and absolutely wrong on the law.

Is Vincent Howard of Orange County  really giving this information out to his clients? I surely hope not.

We routinely tell our clients, he assures us, “that tax debts are not dischargeable in bankruptcy. The public policy goal of this rule is clear: bankruptcy must not allow debtors to escape debts to the government…”

Hogwash!

The Simple Truth About Discharging Taxes In Bankruptcy

The Bankruptcy Code starts from the proposition that all unsecured debts are dischargeable, and calls out the exceptions in Section 523.

A bit oversimplified, the rule is this:   income taxes can be wiped out in bankruptcy if the return was due without penalty more than three years before the bankruptcy case is filed;  if the return was filed late, it has been on file for two years; and the taxes in question were assessed more than 240 days before the bankruptcy was filed.

So, the correct statement of the law is that some income taxes cannot be discharged;  other, older income taxes can be discharged.

Discharge Of Debts To The Government

Despite what the Howard Law Firm says, debts to the government are generally dischargeable.  Debts for overpayment by the Social Security Administration can be discharged;  SBA loans, guaranteed by the government are dischargeable.  Again, nondischargeability is the exception, not the rule.

Just Because The Website Says So, Doesn’t Make It True

Perhaps the democratization of publishing that came with the internet and blogging software was a mixed blessing.  For every genuine contribution to the public’s understanding of  bankruptcy law, there’s some lawyer writing about bankruptcy to get his name before his community, without regard to the accuracy of the information he puts out.  And if he genuinely believes the law is as his blog states, then he stands to harm his clients.

As lawyers, we have a duty to the public to get this stuff right.  The public is injured when someone who has the credentials that suggest he is a reliable source spreads inaccuracies.

Bankruptcy law is complicated, sometimes uncertain, and these days, evolving as the courts interpret the mess that is “bankruptcy reform”.  But the law about the dischargeability of taxes hasn’t changed markedly in more than three decades.

If you are a consumer or small businessperson trying to get your arms around what bankruptcy offers, read on here.  Test propositions about the law across several sites.  Buy an hour of an experienced  bankruptcy lawyer’s time and double check what your internet research has turned up.

The world of bankruptcy information on the internet is a jungle.

I am a mortgage law attorney.  I am not a bankruptcy attorney. I never have been.

But in the current financial climate, I see clients in my office daily who desperately need to file bankruptcy…And they won’t.

The reasons they give, and the parade of horrors they’ve built up in their minds about bankruptcy, are the subject of this brief missive.

I’ve listed the six misconceptions below in the rough order of the frequency with which  I hear them.

Consider this my humble attempt to obliterate those “…nattering nabobs of negativism.” as Vice President Spiro Agnew once put it.

Bankruptcy Turns My Credit into Poo for Ten Years

Nope. Not so.

It will indeed be on your credit report for up to 10 years. Some say it is there forever because bankruptcies are public records that are not expunged over time if you know how to look them up.

But if you mean your credit rating? You mean that three digit number thing you’re obsessed with now, that you never even used to look at?

Plan on it returning to the 725-750 range after about two years if you’re busy paying your bills on time post-bankruptcy.

Think about it. You score can’t get much lower after you file, and every bill you pay on time makes it go up. Your credit rating plotted over time looks more like a fetal heartbeat than a gut wrenching roller coaster ride.

No. It just ain’t so.

A Bankruptcy Will Strip Me Naked

I love this one. Bankruptcy is an incredibly powerful debt management and restructuring tool. Just ask WAMU, Lehman Brothers, Worldcom, General Motors, Enron and PG&E to name just a very, very few.

There are several types of bankruptcy filings. Each is a different highly specialized type of tool to be used to achieve very unique purposes.

Corporations use bankruptcy very strategically. The sharpest corporations know exactly to the day when they will file and to the day when they will emerge from bankruptcy. They emerge with the appetite of a hibernating Grizzly bear that slept late into summer.

The mistake most consumers make is that they rush into bankruptcy in great haste after pulling a phone number out of the yellow pages. This alone is huge mistake and often results in the consumers’ downfall.

Consumers need to consult with, and plan their filings the same way GM and PG& E did. A well timed and well considered bankruptcy can produce astonishing results for individuals.

Step one is to avoid “F&F” bankruptcy attorney. (The ones who File and Forget.) Consumers need to seek out skilled bankruptcy attorneys who are well versed in what each type of bankruptcy can do for the individual consumer and when.

Please don’t dig up the cheapest bankruptcy attorney you can find when there is hundreds of thousands of dollars of debt you personally owe. The results of picking the low price leader are uniformly bad.

And the cost to fix the situation is far higher than getting it right the first time.  Some screwups just can’t be fixed.

I’ll Lose My Home if I File Bankruptcy

Nope. Not necessarily so.

Someone likely to lose their home in bankruptcy is probably equally likely lose it without filing. It just may take longer for the house to ripen into full blown economic gangrene that rots and falls off your economic body.

Currently tens of millions of homes are so far underwater that in a Chapter 7 filing, the debtor commonly keeps the house as long as they continue to make the mortgage payment. But they can often get rid of mountains of other debts.

Meanwhile in Chapter 13 debtors can strip off no-equity junior mortgages and encumbrances on the house and permanently discharge them for pennies on the dollar.

In a Chapter 11 debtors may be able to cram down their rental property mortgages to the current fair market value of the property, AND KEEP their no equity home in the bargain.

The United States Government and the lending industry actually caused the massive underwater mortgage problem. Their policies are causing the problem to get worse.

There is no reason debtors shouldn’t make lemonade from the lemons the government and the lending industry are busy growing.

I Owe Income Taxes So Bankruptcy Is Useless

I hate it when I hear this. Bankruptcy is one of the only ways to permanently get rid of income taxes.

We’re living in an era when the IRS, in the Bay Area, will not settle your tax debt unless you are unemployed, on kidney dialysis, and on a heart-lung machine.

Income taxes are dischargeable in bankruptcy if they meet the tests under the Three Year Rule, The Two Year Rule, and the 240 Day Rule. Three special time periods have to run out.

There are complex rules for figuring out if they have run, and certain things the taxpayer may have done can keep these time periods from running out.

“F&F” attorneys don’t have a clue about any of this. That’s why you need a specialist who knows what they CAN do in bankruptcy, how to do it and most importantly when. By the way, the same rules apply to the California Franchise Tax Board as well.

The corollary is that I Owe California Sale Taxes So Bankruptcy Is Useless

See the misconception immediately above. Not true.

The identical general set of discharge-ability rules applies to liability for California sales taxes. The State Board has admitted this in writing while commenting on a proposed piece of legislation. (Oops…)

See Staff Legislative Analysis 2008 for a proposed bill that would stop the accrual of interest on unpaid sales and use taxes for a small business during the pendency of a Chapter 7 Bankruptcy proceeding. Proposed Section 6593.7 for of the Revenue and Taxation Code.)

With My Income, I Will be Forced to File a Chapter 13 and Pay All the Debt in Full

Please see a solid bankruptcy specialist before concluding this is true.

It is true that there is now a Means Test for deciding whether or not Chapter 7 is available.

But it takes a damn good bankruptcy specialist to model what will happen. Depending on what you want to achieve, a Chapter 13 might actually be preferable.

Many Chapter 13 plans pay little or nothing to unsecured creditors.  It may be termed a repayment plan, but that doesn’t mean creditors necessarily get anything.

I Owe Too Much to File Any Bankruptcy

Nope. That’s like being too good looking.

It is not how much you owe. Just ask General Motors.

It is how much money and or property you have that is not subject to any debts. Where you have lots of money or other property which can be liquidated to pay your debts, filing bankruptcy may not be useful because you end up paying all the debts in bankruptcy or most of them.

It’s not the amount of debt. (except in Chapter 13.) There is NO debt limit in Chapter 7 and none in a Chapter 11 proceeding.

Wise up by shedding these bankruptcy bloopers.  Good legal advice from an experienced bankruptcy lawyer may set you free.     

Bill Purdy is a tax and mortgage law attorney in Soquel, California helping homeowners statewide with foreclosure and loan modification issues and the taxes that may follow.  He’s written recently on Foreclosures & 1099′s  and Four Don’ts When You’re Behind on Your Mortgage.    

Image courtesy of Leo Reynolds

I cringe when a client says that they’ve researched bankruptcy on the internet before making an appointment with me.

For every sound, balanced, nuanced article on consumers and their debts, there are bunches of sloppy, inaccurate sites, often trying to make bankruptcy so frightening that you’ll buy whatever they’re selling.

But when a group of bankruptcy lawyers, trying, I’d assume, to provide useful information on bankruptcy get it so wrong, I’m perplexed.

Bankruptcy Home, which identifies itself as a group advertising site for bankruptcy lawyers, has community property absolutely wrong.  At least California community property, which is all I’m licensed to deal with.

When one spouse in a community property state files bankruptcy, the site says, the debtor must include the value of one half of the community property.  Wrong, wrong, wrong!

I don’t know whether these lawyers haven’t read the bankruptcy code or haven’t read the site that they pay for.  Neither alternative is flattering to them.

All Community Property Comes In

Here’s what  section 541 of the bankruptcy code says:

 (a) The commencement of a case …creates an estate. Such estate is comprised of all the following property…

(2) All interests of the debtor and the debtor’s spouse in community property as of the commencement of the case that is—

 (A) under the sole, equal, or joint management and control of the debtor; or

(B) liable for an allowable claim against the debtor, or for both an allowable claim against the debtor and an allowable claim against the debtor’s spouse, to the extent that such interest is so liable.

Image courtesy of Tambako the Jaguar.

In my bankruptcy alphabet, T stands for Tension. I’m not talking so much about the tension the person filing bankruptcy feels, though that is real and not to be discounted.

I’m talking about the tension in the law that balances the interests of creditors with the interests of debtors.

Bankruptcy law in the US recognizes that the society as a whole benefits when individuals are relieved of oppressive debts.  Tom Friedman of the NYTimes in particular applauds the positive impact on innovation when the price of failure is not lifelong indebtedness for the entrepreneur.

Where in the past, those unable to pay their bills were tossed into prison until they paid (please tell me about the logic of that approach), now debtors walk out of bankruptcy with their exempt assets to facilitate a fresh start.  Here in Silicon Valley, they often join a start up, or found a start up.

Creditors, in the push-pull of a bankruptcy case, share in any non exempt assets the debtor has, according to the priority of their particular claim.? The means test provides an (imperfect) brake on high income individuals dumping their debts in Chapter 7.  Some debts are simply non dischargeable because we’ve made a collective decision that policy reasons favor the creditor.  Think recent taxes, child support, drunk driving judgments and intentional bad acts:  they are all non dischargeable and survive the bankruptcy.

Creditors who bargained for collateral generally get to keep their lien on the asset despite the bankruptcy.

In reorganization cases, judges have to modulate the tension between the desire of the debtor to reorganize and the creditor’s desire to cut their losses and get out.

The recognition in law  of the interests of both sides of the debtor/creditor tension is a strength of our American approach to debt and credit.  Don’t let anyone tell you that bankruptcy costs our economy too much.

This sermon has been brought to you by the letter T.

Jay Fleischman, from his lookout in New York City, thinks T is for Trustee.

Image courtesy of Leo Reynolds.

“D” is for discharge in my bankruptcy alphabet.

Getting a discharge of debts is the goal of most bankruptcies.  The discharge is the court order, issued at the conclusion of a case, that wipes out the filer’s personal liability for most debts that existed when he began the case.

Not everything is discharged. The Bankruptcy Code lists a number of debts that will survive the proceeding.  Some are nondischargeable just because of the nature of the debt:  recent income taxes, family support, drunk driving judgments.

Some debts are non dischargeable only if the creditor files a timely adversary proceeding in the bankruptcy case and proves that his claim falls within those debts non dischargeable because of the debtor’s bad behavior:  debts incurred by fraud, misrepresentation, breach of fiduciary duty, theft or willful and malicious injury.

Student loans are dischargeable only if the debtor brings a successful adversary proceeding to prove that repaying the debt imposes an undue hardship on the debtor and his family.

The discharge can be denied as to all of the debts if the debtor commits one of those all encompassing bad-acts:  lies on the schedules, destroys or fails to keep appropriate records, or hinders the trustee’s work in the case.

Remember that the discharge eliminates the debtor’s personal liability for his debts.  Personal liability is the exposure that a person has to having their wages garnished or their bank account levied to pay a judgment.  Liens on assets survive the bankruptcy, but only as a charge on the asset.

A creditor with a lien on property of a debtor with a discharge can only take the property that is security for the debt.  The lienholder cannot look to the debtor to make up any difference between the value of the property and the original debt.  The discharge protects the debtor from that exposure.

Today’s explanation of bankruptcy was brought to you by the letter “D”.

In my friend Jay’s lexicon, D is for Debtor. What does he know?

Image courtesy of dumbledad.

Counseling, delivered by an approved provider, before the bankruptcy case is filed, is now a requirement enforceable by dismissal of the case.

That’s my “C” word in the bankruptcy alphabet.

Prebankruptcy counseling is supposed to insert an objective third party between the beleaguered individual who needs relief and the greedy lawyer who, according to legend, is hustling everyone into bankruptcy, even those who may have other alternatives.

The requirement for such counseling is largely built on myth.  Most importantly, in my 30+ years of experience, very few people are willing to even meet a bankruptcy lawyer unless their debt problems are serious, usually really serious.  So bankruptcy lawyers rarely come in contact with people who don’t need to file.

When I interview a potential client and recommend they don’t file, it’s usually because they have significant assets they’d lose in bankruptcy.  The cost of debt relief is simply too large relative to the cost and the loss.

But let’s assume I was more interested in my fees than my client’s welfare, Congress’s remedy in credit counseling doesn’t look at the value of the debtor’s assets and the exemptions available.  If they did, the “counselors”  would be practicing law.  The person at the end of the phone is certainly not licensed to practice law in California, or in reality, anywhere.

By requiring credit counseling, Congress managed to increase the cost to the debtor of filing a bankruptcy case.  It also spawned an entire industry. At the recent NACBA convention, there had to have been two dozen providers of credit counseling, clamoring for the attention of bankruptcy lawyers.

That’s the venial part of the story.  The sad part is that those who try to file bankruptcy without a lawyer frequently don’t know about the counseling requirement or the mechanism to seek a waiver.  Since 2005, the bankruptcy code requires the dismissal of cases where there is neither a credit counseling certificate or a properly obtained waiver.

Pro pers look dumbstruck when they learn that, having navigated the system sufficiently to have filed their case on their own, the case will be tossed out because they didn’t get credit counseling before they filed.

Maybe my “C” word should have been “Congress” who created this travesty. (Jay’s bankruptcy  “C” word is Creditor.)

As it is, this post is brought to you by the letter “C”.

Image courtesy of takomabibelot

May make you a felon.

Funny, the Las Vegas PR doesn’t mention criminal prosecution for unpaid gambling markers.

Yet Nevada treats gambling markers like negotiable instruments (i.e. checks) and failure to satisfy a marker within 30 days can lead to criminal charges.

Most bankruptcy courts have held that gambling debts are dischargeable in bankruptcy, since everyone who gambles expects to beat the odds and win. So, there is no intent to defraud within the meaning of §523.

But in the last couple of months, two of my bankruptcy clients whose bankruptcies successfully discharged gambling debts have been contacted by the Clark County DA’s office with respect to criminal prosecution.? Of course, what the county is trying to do is to pressure the gamblers into a restitution order rather than jail time.

Be forewarned if a jaunt to Vegas beckons.

Image courtesy of kaloozer.

Perhaps I shouldn’t be surprised that folks who didn’t take filing tax returns seriously in the first place continue to blow it off when bankruptcy is filed. But filing returns is mandatory and dismissal automatic under the provisions of bankruptcy reform.

What debtors need to understand is that bankruptcy is a benefit and to get the benefit, you need to play by the rules on the timeline created by the Bankruptcy Code.

But if a dispute arises, say about the allowance of an exemption or the application of the means test, and the debtor and the trustee can’t resolve the difference, it is the bankruptcy judge who makes the call.