Northern California Bankruptcy Lawyer

On The Bankruptcy Soapbox

The Soap Box

About Cathy Moran

I'm a veteran bankruptcy lawyer and consumer advocate in California's Silicon Valley. I write, teach, and speak in the hopes of expanding understanding of how bankruptcy can make life better in a family's future.

Bankruptcy Busts Taxes If The Timing Is Right

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taxes dischargeable

Got unpaid taxes for 2015?  Three tax discharge timing rules control when those taxes can be wiped out in bankruptcy.

On April 15, 2019  those taxes reached the end of the line as priority claims in bankruptcy.  Or, the magic date may be October 15, 2019, if you got an extension to file the return.

As non-priority claims, the taxes lose their protected status and can be discharged in bankruptcy.

Discharged, as in, no longer a personal liability.  No longer entitling the IRS to levy and garnish because of a bankruptcy discharge.

Taxes are collectible for 10 years from assessment, outside of bankruptcy.

That’s the view from 30,000 feet on discharging taxes in bankruptcy.  Let’s look at the details and see why  April 15th  is important if you have old taxes you haven’t paid.

Three year rules to discharge taxes

To wipe out taxes in bankruptcy, three rules control.

The first one, the “three year rule”, says taxes can’t be discharged until three years have passed since the tax return was last due.

Taxes newer than that are priority claims.  Priority tax claims aren’t dischargeable.

There are a couple of wrinkles in the three year rule.

First, the rule starts running from the day on which the tax return was last due without penalty.  Without an extension of time to file, that’s usually April 15th.

So, the return for 2015 was due April 15, 2016.  You start counting from then.

Unless you got an an extension, 2014 taxes became dischargeable in bankruptcy on April 16 of this year.

Filing your tax return before the deadline doesn’t get you a head start on the three year rule.

Even if you got an extension and actually filed your return in June, the controlling rule still starts counting from the last day on which you could have filed the return:  October 15th.

Two year rule

The second rule governing the discharge of taxes is the “two year rule”.

The “two year rule” says that if the tax return wasn’t filed on time, it has to have been on file for at least two years to be discharged in bankruptcy.

So, even taxes where the three year rule is met don’t go away in bankruptcy if the return was late and hasn’t been on file for two years.

Recent assessment rule

The third rule, the “240 day rule”,  says that taxes assessed within 240 days of the bankruptcy filing aren’t discharged, even if the other two rules are met.

Tax year must be closed

There’s an additional strategic issue involving taxes and bankruptcy in Chapter 13.  A Chapter 13 plan can provide for payment of taxes  that aren’t dischargeable through the Chapter 13 plan.

But, BUT, the tax year must be complete in order to include the tax in the payment plan.  So, if you file in October, 2019 to discharge 2015 taxes, any tax you may owe for 2019 won’t be included in the bankruptcy case.

Depending on the amount you expect to owe for this year, you may be well advised to wait til January 2, 2020 to file your bankruptcy case.

The important point is well-advised.  Discharging taxes in bankruptcy is highly detailed.  Get good advice from an experienced bankruptcy attorney.

More about taxes in bankruptcy

Tax liens after bankruptcy

What about unfiled tax returns

Chapter 13 is a tax tool

 

Image copyright Fotolia.

Bankruptcy Means Test: New Numbers, Little Impact For Bay Area

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We have new numbers! The new income figures for California bankruptcy cases used in bankruptcy’s means test are out.

They become effective for cases filed after November 1, 2019.

The new median income numbers won’t create the same stir as the Powerball jackpot, but they are the starting place for people in need of relief from bills they can’t pay.

The means test divides debtors (the people who need debt relief) into two groups.

Those below the median state income get to file bankruptcy, no questions asked.

Those above the median income have to jump through another hoop, the means test, to determine if a government watchdog will claim their filing is “abusive”.

People above the median still get to file bankruptcy.

The means test doesn’t bar the door to bankruptcy. It just influences which chapters are available and what the debtor has to pay if they elect Chapter 13.

Bay Area median income

The means test looks at the median income by family size.  The median for families in San Mateo, Santa Clara, Alameda, and Santa Cruz counties is

  • $59,286 for a family of one
  • $77,860  for a family of two
  • $86,665 for a family of three
  • $99,512 for a family of four

For families larger than four, the median is increased by $9000 for each member above four.

While the median income figures are the same for all Bay Area counties, the deduction allowed for housing varies from county to county.  This table shows county by county how much a California debtor can deduct from their income for the cost of housing a family of their size.

If you are above median

Lots of people above the median income pass the second part of the means test with flying colors.

Why it’s a mistake to do the means test yourself

It’s just another form to fill out.  As I explained in another means test post,  the high cost of housing in the Bay Area makes it relatively easy to pass the test.

All Congress managed to do by imposing a means test on bankruptcy is to drive up the cost to debtors for filling out a tedious form.

More

How the means test works

Cheat sheet for passing the means test

Figuring what you pay in Chapter 13

Life And Death of Debt In California

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statute of limitations on debt

CPR has its place when human life is involved. Human life is precious.

But when what’s dying is the legal right to collect a debt?   Not so fast.

You don’t want to breathe new life into an old debt that is legally dead.

Yet you can do that, unintentionally reviving a debt that is legally dead  by giving it new life when it’s approaching its life’s end.

California statute of limitations can be tricky.  I  originally intended in this post to explain the rules around the statutute of limitiations.  I wanted to show you how to keep from unwittingly extending your legal exposure to a debt.

I’ve concluded that the law is simply too complicated and evolving to provide a nuanced, reliable guide so you can avoid screw ups.

So, I’m adopting the Nancy Reagan approach to the statute of limitations.

Just Say No! 

NO, I don’t owe it.

NO, I won’t pay it.

While it may stretch the truth as to whether you owe it, it’s simple and safe.  It keeps you from adding to your exposure to old debts.

Admit nothing.

Avoid extending the statute of limitations

The statute of limitations allows enforcement of a legal right through the courts only if brought before the running of the statute.

Broad brush, you can extend your legal exposure to an old debt in two ways:

  • Make a payment on the debt
  • Admit that you owe the debt

Important to note that either of these ways of extending the life of a debt are acts that you, the person who owes the money, take.

The debt collector can’t extend the statute unilaterally.  Only by getting you to do something against your interests is the life of the debt prolonged. Here’s how they try to do it.

Payment breathes new life

Making a payment on the debt is putting your money where your mouth is:  you wouldn’t pay anything if you thought you didn’t owe money.

So payment is seen as proof that you owe the money.

Payment starts the statute of limitations clock running again, from the beginning.

That’s where the debt collector’s request for a “good faith” payment on a debt you can’t pay off at this time is so insidious.  The debt collector cares far less about the amount of that “good faith” payment than he does about the fact that you’ve just extended your legal exposure to the debt for an entirely new period.  What that period is we’ll discuss below.

Admitting the debt is fatal

An admission that you owe the debt, even without payment, can reset the SOL clock.

California law provides that only an admission of the debt in writing can extend the statute:

No acknowledgment or promise is sufficient evidence of a new or continuing contract, by which to take the case out of the operation of this title, unless the same is contained in some writing, signed by the party to be charged thereby, provided that any payment on account of principal or interest due on a promissory note made by the party to be charged shall be deemed a sufficient acknowledgment or promise of a continuing contract to stop, from time to time as any such payment is made, the running of the time within which an action may be commenced upon the principal sum or upon any installment of principal or interest due on such note, and to start the running of a new period of time, but no such payment of itself shall revive a cause of action once barred.  Code of Civil Procedure 360.

Yet there are precious few cases on the subject.

And while traditionally, the statute of limitations that applies to any collection suit was the law of the state where the defendant lives, recent cases make that less certain.  Topping off the uncertainty, the 9th Circuit Court of Appeals recently ruled that in bankruptcy, the statute of limitations of the state whose law applied to the contract controlled, not the shorter statute where the debtor lived.  Sterba

All of which makes saying nothing, or saying no, the safest course of action if you have an old debt that you can’t pay.

Why have a statute of limitations

Pubic policy says we want legal disputes resolved sooner rather than later.  If a lawsuit is involved,  we want the evidence  available and memories fresh.

It’s the legal version of  SNOOZE, YOU LOSE.

A debt collector or a debt buyer has the same statute of limitation as the original creditor.

When does the limitations clock start running

The SOL clock starts running on the limitations period upon the last activity on the debt.  That activity could be a payment on a debt;  it could be a charge on an open account.

If there are neither charges nor payments on a contract debt after that, the period runs for four years in California. 

Once the limitations period has run, the person who owes the debt has a slam-bang winner of a defense if the creditor files a lawsuit to collect. 

Cheat sheet on statute of limitations from the California Courts

More from the FTC on time barred debts.

More here on debt collection lawsuits

  What to do when you’ve been sued

Fighting back against wage garnishment

 

 

Make Sure Your Mortgage Is Current At Bankruptcy’s End

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What do you really owe on your home mortgage when you get to the end of your Chapter 13 case?

For years, homeowners couldn’t tell where they were or how to get answers.

But with the recent changes to bankruptcy rules, you don’t have to wonder where you stand with your mortgage lender.

  • Are you really, fully current with the mortgage?
  • Are there fees and charges that you don’t know about?
  • Are you ready to emerge from bankruptcy 100% paid up?
  • Is the lender really poised to start foreclosure?

Starting December 1, 2016, your Chapter 13 trustee is required to flush out any surprises that lurk in your home loan servicer’s accounts.

And a federal judge stands by to sort it out.

When my client’s Chapter 13 case was through,  she was $62,000 better off, because of the rule.

Let’s hear it for Bankruptcy Rule 3002.1.

Why we needed this rule

Rule 3002.1 addresses the lack of transparency that used to exist about your home loan during a Chapter 13.

The Chapter 13 runs 3 to 5 years, and the automatic stay limits the lender’s ability to let you know what’s happening with the loan.  (This assumes that the lender ever really wanted to let you know what’s happening, but that’s another rant, another day.)

Lots can happen during those years. Too often, before the rule, debtors would get their Chapter 13 discharge and a foreclosure notice practically in the same day’s mail.

It might be late fees, forced placed insurance, or just plain accounting mistakes.  Whatever the reason, the consequences were horrific.

What the rule does

If your Chapter 13 plan provides for payment on your home mortgage, your lender (or the servicer for the lender) must give certain notices to you, the court, and the trustee during the case.

First, they must file a notice if the payment amount changes during the case.  The notice must be given at least 21 days before the change takes place.

Second, they must file a notice of any fees, expenses or charges added to the loan balance that were incurred after the case was filed.  The notice must be given within 180 days of the time when the charge was incurred.

If you dispute that the charge is allowable, you have a year from the filing of the notice to file a motion and schedule a hearing before the court about the charge.

Current at case end

When you’ve made the last payment to your Chapter 13 plan, the trustee must file a notice of final cure payment and send the notice to you, your attorney, and the creditor.

The notice says that the trustee believes you to have cured any pre bankruptcy default and alleges that you are fully current with payments and fees that came due after you filed.

The mortgage lender must file a responsive pleading within 21 days.  If the lender claims that there are unpaid amounts, they must itemize the fees and expenses that they claim are still outstanding in a payment history.

Bingo:  you have visibility.  And you have a right to file a motion before the court to determine if you’ve cured the default and paid everything that is required of you afterwards.

If the lender screwed up

Chances are pretty high that the servicer has screwed up.  Often that takes the form of failure to have given you timely notice of fees added to the loan.  Remember, notice must be given within 180 days of when the fees were incurred.

If the lender has failed to give proper notice, the judge can bar the lender from offering evidence in the hearing to determine if you’re current and can award you your attorneys fees caused by the failure.

The rule in action

A lender’s failure to follow the rule in the case of one of my clients resulted in the lender having to forgive some $62,000 in post filing fees and taxes they’d paid without telling my client.  In addition, they paid my fees for getting the charges  wiped out.

You can read the court’s opinion with the details of each blunder the bank made.

I believe that such results are just the tip of the iceberg in this field.

Get through the maze

The beauty of Rule 3002.1 is that it gets to the heart of your dealings with your home mortgage lender while you still have access to a bankruptcy judge to make things right.

It’s up to you and your attorney to see that the trustee gives the required notice.  If the trustee doesn’t, the debtor can.

Then you need analyze the response of the lender and challenge behavior that isn’t compliant with the law.

Don’t miss out on getting all the relief that Chapter 13 entitles you to.

More

RESPA to the rescue:  send information

Mortgage statements after bankruptcy

What’s discharged in a bankruptcy

 

Stop Making Quarterly Tax Payments

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quarterly tax paymentUncle Sam expects a quarterly tax payment from the self employed.  Since you don’t get a paycheck with regular tax withholding, the burden’s on you.

Lighten the burden. Make this the last quarterly tax payment you pay.

Seriously.  Don’t make any quarterly payments for this coming year.

Think I’m advocating tax resistance?  No way.

The tax collectors  have more weapons than you want to encounter.  It’s like the advice from the era of newspapers:  don’t pick a fight with someone who buys ink by the barrel;  

Don’t spit in the face of the tax man.

Give up making them quarterly, I say.

Pay taxes monthly, just like every other recurring bill in your life.

Why quarterly tax payments invite trouble

Folks who get a paycheck have their income tax liability, or at least some estimate of that liability, deducted from each paycheck.  No fuss, and, well,  only some bother.

Their take home pay has already paid the taxes.  The paycheck is what is available to pay the bills.

Not so the self employed.

We are expected to make quarterly estimated tax payments in January, April, July, and October.

I’m sure the quarterly arrangement was seen as a convenience when instituted.

But it’s not necessarily convenient.  You have to set aside money regularly so you have a fistful come quarter day.

If you free lance or run a small business, budgeting may be the hardest think you do.  Who knows, in this economy, how much you’ll make this quarter, or how you’re going to pay the bills?

Quarterly payments invite us to fudge.

Get caught not having prepaid enough and you get  hit with penalties.

Get really behind, and it’s tax liens and levies.

Pay this year’s taxes monthly

My charge?  Add Uncle Sam to your list of creditors that you pay monthly.

Most creditors expect monthly payment:  the rent, the car payment, the credit card.  Add your estimated taxes to that list.

Income taxes are a cost of doing business.  No reason not to pay them as you go, just like the folks on salary do.

  • You avoid the need to set up a separate savings account in which to accumulate the taxes to be paid quarterly.
  • You resist the temptation to use those savings for some intervening crisis.
  • You escape the urge to make no provision “just this month”.

Making regular and smaller payments makes it easier to get the total bill paid in a manner that avoids penalties for not paying regularly.

Send your monthly income tax prepayment to the same place the quarterlies were headed.  Write on your check your Social Security number and “estimated 2017  tax liability”.

Take care of taxes monthly and you don’t find yourself in a tax hole come next April.

Here’s the IRS  on making estimated tax payments.

More on taxes

Unfiled taxes live forever

Dig out of payroll tax trouble

  Getting rid of tax liens

Find the mortgage interest deduction in Chapter 13

Image courtesy of Wikimedia.

Tax Deductions Hidden In Chapter 13

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taxesDon’t miss the tax deductions hiding in your Chapter 13 plan payments.

The same, very important debts that your Chapter 13 plan pays are often tax deductible.

And you are still the person who’s paying, even if the trustee writes the check.

Deductions in bankruptcy

Let’s look at some common deductions lurking in the Chapter 13 disbursements.

Mortgage interest  If your Chapter 13 plan is catching up on delinquent mortgage payments, the claim of the lender is probably mostly interest.

Taxes  Property taxes paid through the plan should be deductible.  Likewise, state income taxes paid by the trustee are deductible.

 Business expenses  If you operate a business in Chapter 13 or operated one before you filed, you may be paying business leases, sales taxes, or vendor debt through the plan.

Get the info you need

In my experience, you have to dig out the information on deductible payments;  I have not seen lenders sending 1098’s reporting mortgage interest paid to debtors when the checks come from the trustee.

Step by step to claiming the mortgage interest deduction

But most if not all Chapter 13 trustees are on the web, and debtors can access the trustees reports of which creditors have been paid this year.

Pull up the report of last year’s disbursements and flag the payments that are deductible.

Save the printout of the trustee’s report in case of question  by the taxing authority.  The IRS will not have gotten a matching report from the lender who got the money and hasn’t reported it to you and the IRS.

How to treat 1099’s on foreclosures and short sales

Go back to prior tax years

If your plan is paying deductible expenses and you’ve been in the bankruptcy case for several years, you may want to look at prior year trustee reports.  Overlooked deductions might justify going back to amend a prior return.

Tax returns are generally amendable for three years.

Check it out

Take this post with a grain of salt, or rather, take it to a tax professional.

I am a bankruptcy lawyer and what I know about taxes, I’ve learned on the job.  But I am convinced that Chapter 13 debtors are missing legitimate tax deductions by overlooking what the Chapter 13 trustee has paid on their behalf.

What your tax professional should know about tax and bankruptcy

Image courtesy of 401(k)calculator.org

When Can I File Bankruptcy Again

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filing bankruptcy againRemember the old high school cheer:  two, four, six, eight, who do we appreciate?

Turns out, that’s not just a cheer, it’s shorthand for the rule on when you can file bankruptcy again.

And it points out that when you can file again depends on what kind of bankruptcy you filed last time.

Here’s how it works.

If prior case was Chapter 13

You are eligible to file another Chapter 13 case TWO years from filing an earlier Chapter 13. [ This had to be a drafting error since nearly all Chapter 13’s run at least three years.  But I’ll take it.]

If you now want to file Chapter 7, you must wait SIX years.

If prior case was Chapter 7

You can file a Chapter 13 case FOUR years after an earlier Chapter 7.

But if you have your eye on Chapter 7, the wait is a whopping EIGHT years.

Put another way

Starting with the kind of case you filed before, as we did above,  is one way to look at eligibility.

But here’s how it looks if you know what kind of case suits your current situation best.

  • To file Chapter 13, your prior case must be at least TWO years ago
  • To file Chapter 13 when the earlier case was Chapter 7, the wait is FOUR years
  • To file Chapter 7 with an old Chapter 13 filing, the wait is SIX years
  • To file Chapter 7 following an earlier Chapter 7, EIGHT years must elapse.

Intervals between discharges

We’ve talked about the time between cases, and really glossed over the real measurement.

The statutory intervals really measure the time between cases in which a discharge is available.  The two, four, six, eight rule limits when you can file a new case in which you can get a discharge of your dischargeable debts.

When you don’t NEED a discharge

There are time when the discharge is less important than the automatic stay.  Most frequently, these are cases of “Chapter 20“, a Chapter 7 followed immediately by a Chapter 13.

The debtor doesn’t get a discharge  in the 13 following the 7, but they do get a stay of collection action and a court-enforced repayment plan.

Chapter 20 works well when the debts that survived the Chapter 7 aren’t dischargeable anyway.  These are times when the debtor really just needs time and space to pay off the nondischargeable debt that is left from the Chapter 7.

The Bankruptcy Code limits the frequency of getting a discharge, not the filing and completion of the bankruptcy case.

Counting between bankruptcy cases

It shouldn’t be complicated to count to eight, but it CAN be confusing.  Where do you start counting?

Count from the filing of the first case to the filing of the second case.

And count only cases in which you got a discharge.  If your earlier case was dismissed or concluded without a discharge, it doesn’t count.

So, let’s have a cheer for bankruptcy relief.

More

When bankruptcy’s automatic stay doesn’t apply

Is It Safe To File Corporate Bankruptcy? 5 Questions To Ask

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risk of business bankruptcy

When your incorporated business fails,  you personally may still be  at risk.

I know you incorporated to separate yourself as the owner from the risks of the business.  The corporation is a separate legal person, distinct from the individuals who own the stock in the corporation.

But when the business has to shut down, the actual degree of separation is tested.

You need to know if the business can safely file bankruptcy.

Or, will using bankruptcy to shut down the business drag the owners down as well?

Can this corporation safely file bankruptcy?

Businesses looking to go out of business typically file Chapter 7.  The business closes, a trustee is appointed, and any valuable assets are sold for the benefit of creditors.

The trustee then controls the corporate checkbook and the timeline on which creditors get paid through the courts.

Bankruptcy trustees are further empowered to recover money paid by the debtor corporation where the transfer is a preference or a fraudulent transfer.  That’s the beginning of the complications in a business Chapter 7.

Before choose bankruptcy as the method for winding down, consider these five potential complications.

1.   Owe payroll taxes?

Corporate officers may have personal liability to the IRS and any state taxing authority for amounts withheld from the paychecks of employees.  Liability may extend to anyone with signature authority on the corporate bank account

This liability exists whether the corporation files bankruptcy or winds down outside of bankruptcy.

More about “borrowing” from Uncle Sam

Filing corporate bankruptcy may preserve assets from other aggressive creditors from which those taxes can be paid.  That benefits the individual officers, since every dollar the trustee pays on payroll taxes reduces what they’ll have to pay.

But bankruptcy empowers the trustee to hire professionals, investigate the debtor’s books, and pursue recovery of money owed to the corporation, either under state law, or under bankruptcy law.

The expenses of that pursuit are paid ahead of the priority taxes.

Thus a bankruptcy filing could work to shrink the pool of money for payment of payroll taxes, and drag out the time before payment is made.

2.  Made guarantees?

Landlords often require the personal guarantee of the individual shareholders before they commit to a real property lease for the corporation.  Or the lease may have been in the shareholder’s name from the start.

Any individual guarantor on a lease gets no protection from his obligations to the landlord when the tenant corporation files bankruptcy.

A bankruptcy trustee calls the shots when a corporation files Chapter 7.  He’s got the keys.

Trustees are usually quick to either vacate the premises or surrender it back to the landlord, freeing the landlord to look for new tenants.

But  pre bankruptcy lease arrears have no priority for payment in the bankruptcy case.  If there is a dividend payable to the landlord, it may be small and far in the future.  The individual is on the hook in the mean time.

3.  Used corporate credit cards ?

Almost without exception, some living, breathing human being is personally liable for every credit card.  Even if the card has the business name embossed on it, the application for that card undoubtedly contains a promise of the owner to pay the card issuer.

So, any liability of the individuals on the credit card won’t be eliminated by the business’s bankruptcy.

It can get worse:  the corporation may not, in fact, be liable at all on the card.  Not all “business credit cards” are really issued to the business. They’re issued to the people who run the business.

Filing bankruptcy doesn’t make the situation worse:  if the corporation is liable and if there are assets to pay creditor claims, the credit card folks get something toward the balance.  Only it’s a long time down the road.

4.  Benefited from paying the bills?

File bankruptcy for the business, and you may get yourself sued by the trustee for an avoidable preference.

When you and the business are jointly liable for a debt, every payment the business makes on that debt reduces your personal exposure to the creditor.  And that, in the eyes of the law, is a preference.

Payments the business made on the joint debt benefit you.  If other bills weren’t getting paid, we have an unfair discrimination between creditors of the business.  The trustee is authorized to sue you to make it more fair to other creditors.

The problem of preferences is the only item on this list of complications that is unique to bankruptcy.  Depending on the facts of the business’s operation, filing a Chapter 7 may just invite a lawsuit against you as the shareholder.

5.  Enjoyed  business help with personal expenses?

The more corporate money that flowed to insiders, the greater the threat that a bankruptcy trustee will challenge the payments,.

“Challenge” here is shorthand for “sue you”, or at least look hard at expenditures that made life easier for shareholders at a time when other creditors weren’t getting paid.

Often, the facts are just the opposite:  the shareholders were putting more money into the corporation, or going without to keep the business afloat.

But the idea of a fraudulent transfer, a payment for which the payor did not get a fair return for its money, has a long lookback period.  A bankruptcy trustee could be looking back years to see if the shareholders got more than was fair under fraudulent transfer law.

And if the books and records are sketchy, the shareholders may end up spending lots of time producing documents or explaining what happened.

Even if the end result is OK, the experience can be unnerving.

The bankruptcy takeaway

How to close out a failed corporate business can be complex.  While I’ve listed the ways a corporate bankruptcy might end up biting the shareholders, the benefits can be equally significant.

File bankruptcy and much of the wind down work passes to the trustee.  The business creditors understand there is nothing available to pay their claims against the corporation.  Assets are distributed in an orderly and predictable manner.

Before you file bankruptcy for a corporation, make sure you’ve asked yourself the five questions I’ve laid out.  Take your answers to experienced bankruptcy counsel for a review.

More

Winding up a failed business

 

Skip Bankruptcy’s Means Test

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skip means test

The couple was despondent when another bankruptcy attorney told them that, despite $100,000 in old taxes, they couldn’t file Chapter 7.

This fine fellow told them that the means test showed they had $3000 of disposable income per month.  A Chapter 7 would be an abuse of  bankruptcy under the law.

Only Chapter 13 was possible, he said, and the monthly payment would be $3000.  That didn’t seem like any kind of relief from debts.

Only he never apparently considered the gating question:  were their debts were “primarily consumer debts”.

He forgot the gotcha baked into the means test:  it only applies to ***consumers.***

Only consumers have to prove they are worthy of the Chapter 7 discharge.

Folks with primarily business debts or, taxes aren’t subject to the means test.

So, lots of disposable income is not a bar to Chapter 7 when your debts are primarily taxes.

Who takes the means test

So, just why are some above median income families not subject to the means test?

Bankruptcy Code § 707 allows a judge to dismiss a Chapter 7 case  filed by an individual debtor under this chapter whose debts are primarily consumer debts …. if it finds that the granting of relief would be an abuse of the provisions of this chapter.

The means test is the tool for determining whether the debtor is (supposedly) able to pay their debts.

But,  the means test only applies to debtors whose debts are “primarily consumer debts”.

So, we need to know…

What is consumer debt

The Bankruptcy Code defines consumer debt:

 The term “consumer debt” means debt incurred by an individual primarily for a personal, family, or household purpose. § 101(8)

So, the gating question is:  why was the debt “incurred?”

Tort damages aren’t consumer debts either

Obviously, business debt was not incurred for a personal purpose.

Further, taxes are not incurred by choice, say the cases;  taxes are imposed by government.  And therefor, not a consumer debt.

And that’s the rule, even when the taxes are on personal, household income, or property taxes on the family home.

So, if the total of taxes (and other, non-consumer debt) is greater than the balance of the other debt a person owes, their debt is not “primarily” consumer debt.

And the means test ONLY applies to debtors whose debts are primarily consumer debts.

Skip the means test

The couple who were told that they couldn’t file Chapter 7 because of their generous income, in fact, can file Chapter 7 because their debt is overwhelmingly back taxes.

It doesn’t matter that most of their taxes are so old that the tax is dischargeable.

If it’s tax, it isn’t consumer debt.  And they don’t have to take the test.

 

Bankruptcy Discharge Slays IRS Form 1099

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In a duel between a Form 1099 and a bankruptcy discharge, bankruptcy wins every time.

The prize?  no tax on debt discharged in bankruptcy.

So, if you’ve already gotten your discharge, the creditor’s 1099, with your social security number on it, is no threat.

But you do need to file another form to secure the prize.

Bankruptcy is exception to tax

Normally, when an obligation is forgiven, the tax code treats the amount of forgiveness as if it were income.  And income is exposed to tax.

Insolvency is another exception to tax on forgiven debt

But forgiveness in bankruptcy in the first exception to the rule.

Debt forgiven in bankruptcy is not treated as income.

Creditor is clueless

So, if bankruptcy is outside the IRS rule, why are you getting a form 1099?

Because there’s another rule, requiring creditors to report to the IRS, just the way your employer is required to send the IRS your W-2.

And seemingly, the creditor can’t figure out that the reason its claim is worthless is because of the bankruptcy discharge.  So it’s easier for the creditor to just send out Form 1099, and make it your problem.

Fixing the 1099 problem

The solution is simple:  file IRS form 982.

Title 11 is the part of the United States Code on bankruptcy.  Cases are filed under different chapters of that title

Form 982 is your rebuttal to the report that you have taxable income because your debt was forgiven.  Check the very first box on the form claiming the bankruptcy exception.

This debt is excluded from income because of  Discharge of indebtedness in a title 11 case 

The IRS provides a set of instructions for filing  your “get out of tax” form.  Form  982 Instructions.

Other tax consequences of discharge

If you have real property, you may have to reduce your basis in assets by the amount of debt discharged in your bankruptcy.

But thankfully, there is an exception to this rule too:  no reduction in basis is required with respect to your principal residence claimed exempt in your bankruptcy case.  IRC 1017(c).

Tax action plan

So there you have the skinny on form 1099 and your bankruptcy discharge.

Bankruptcy has other tax implications:

Taxes dischargeable in bankruptcy

Unfiled tax years are never dischargeable

Chapter 13 gets an interest-free tax repayment plan

Your accountant needs to know about your bankruptcy

What to do with a flat-wrong 1099

 

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