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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

 

Five Tax Tips For Two Cents

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8328967338_37e260ff6b_h_optTax season approaches.

There’s a surprising degree of overlap between bankruptcy and tax I’ve found over three decades as a bankruptcy lawyer.

Here’s my two cents on what I know about taxes.  It’s not a lot, but what I know is both simple and critical.

File those tax returns

Lots of folks who end up in my office discussing bankruptcy held off filing their returns because they figured they couldn’t pay the tax that would be due.

Bad decision.

Without a return, taxes never die

The IRS will not descend on you the week after you file a return with tax due but no check.  They’re still opening envelops.

But filing a return gets all kinds of time periods running that may benefit you:  the 3 years til the taxes are dischargeable in bankruptcy;  the 10 years til the tax collection statute runs.

Whatever you do, don’t let the IRS file a tax return for you.

Don’t pay tax on discharged debt

If your debts were discharged in bankruptcy last year, that discharge has no tax consequences.

The Internal Revenue Code specifically excludes from taxable income any debts forgiven in bankruptcy.

Cancellation of debt is tax free

You may get a 1099 reporting the cancelled debt.  The creditor whose debt is forgiven is required to do so.

It’s up to you to assert that there’s an exception to tax.  And there’s an IRS form to rebut any tax consequences.  Get it and file it.

Claim deductions for Chapter 13 payments

If you’re in a Chapter 13 that catches up arrearages on real property loans, claim those payments as deductions of your own.  Just because the trustee writes the check, it’s still you paying the mortgage interest in that payment.

How to find and claim the deduction

The concept here goes beyond mortgage interest.  If the expense was deductible had you written the check, it’s deductible if the trustee pays it.

Get the trustee’s disbursement records in your case from  the trustee’s web site and get to deducting.

If you owe tax, fix your withholding

The return to be filed this spring can tell you if you are withholding enough money to pay your taxes.

If there’s a big number on the bottom line of the return for last year, and this year looks similar, increase your withholding now.

What Goldilocks knew about taxes

And if you think you can’t pay taxes as you go and support the rest of your living expenses, you need to look hard at the big picture.

It’s generally a poor decision to short the feds so you can pay AmEx or Visa.

Amend old returns if you missed something

If you missed a deduction or otherwise overpaid your taxes in a previous year, you have only three years to amend that return and claim a refund.

Time running out to claim prior year tax breaks

Lower income families often miss the fact that they get a tax credit (that’s real money, not just a deduction) under the Earned Income Tax Credit.  Find out if you are eligible.

More

Discharging taxes in bankruptcy

The tax filing extension can be dangerous

Wiping out tax liens

Pay No Tax On Discharged Debt

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1099 tax

When it’s tax time,  questions about forgiveness-of-debt income are everywhere.

Questions start when you receive a Form 1099 from a creditor.

But for my bankruptcy clients, the answer is simple:

Debt forgiven in bankruptcy is not taxable.

Tax on cancelled debt

Debt may get cancelled in lots of ways:

  • in a short sale;
  • by compromising a debt
  • by lender compliance with a settlement agreement with the feds;
  • in a bankruptcy; or
  • in a foreclosure.

Lenders and debt collectors believe themselves bound to send out a 1099 whenever they handle a transaction that may implicate cancellation of debt.   They aren’t rendering an opinion on the tax treatment of the event.  They are just reporting it to the IRS.

Receipt of a 1099 is not the final word on the topic; it’s only notice that the transaction in question has been reported to the IRS.

Cancellation of debt “income”

The standard rule is that debt that is cancelled is treated as though you had received that much cash, and that pseudo-cash is treated as income.  And, if it’s income, the IRS thinks it’s taxable.

The exceptions to recognizing that transaction as income  found in IRC 108 include

  • insolvency at the time, and
  • discharge of the debt in bankruptcy.

Qualified principal residence exclusion available for tax year 2017

You have to file an IRS form to rebut the 1099.  It’s form 982 and right at the top are the boxes to check to invoke the exceptions.

The form also includes a worksheet to see if you are insolvent for the purposes of this provision of law.

If the 1099 got the facts wrong

Remember, too, that if you did not have personal liability for the debt, the cancellation of that debt is not even forgiven debt.  There was no debt.

You may have no personal liability because of a previous bankruptcy or by reason of California’s anti deficiency laws.

Also, there is special legislation dealing with cancellation of debt upon loss of a primary residence, excluding phantom income from qualifying transactions.

Here’s the IRS on the subject:  http://www.irs.gov/taxtopics/tc431.html

More

Deductions hidden in Chapter 13

File even if you can’t pay

Discharging taxes in bankruptcy

Don’t Brag About What You Saved Unless It’s True

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saving spending

It’s a mark of our consumer economy that we use the word save in connection with our spending.

I saved $15 on this blouse.

That’s well and good for today.  You bought something you wanted, or maybe even needed.

But unless you put the savings aside for later, you did nothing more than spend somewhat less today, without thought for tomorrow.

Your savings on today’s purchases won’t be available to buy necessities in your old age.  The money you “saved” is gone, spent today on something else.

Our language doesn’t help

We are aided and abetted in our savings mind-game by English usage. Saving is a virtue we applaud.

But “save” has two, almost opposite, meanings.

According to Merriam Webster, save means both

a: to put aside as a store or reserve : accumulate

  • saving money for emergencies

b : to spend less by 

  • save 25 percent

Don’t confuse the two.

The more meaningful savings are when money gets set aside for use later,

-to pay for an emergency

-to fund a big purchase

-to support a comfortable old age

We suck at savings

Actually, lots of us are good at “saving” in the Definition B sense.  We comparison shop, we follow the sales, we use coupons and garner reward points.

It’s the savings as creating a reserve that we flunk. 

Average monthly social security check is $1400.

 Too many Americans couldn’t handle a $400 emergency.  Half of Americans have less than $1000 in savings.  Half of Americans have no retirement savings.

What will we tell ourselves in our old age about our prowess at saving?  Will we have a slick word-game that puts food on the table or gas in the car?

How about making Definition A our go-to plan for savings.

More

The second-best reason to contribute to a retirement plan

But my home is my retirement plan

How to open an IRA account

The Letter That Makes Debt Collectors Go Away

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stop debt collectors

You can make debt collectors stop.

You have a solid legal right to be free from harassing debt collection.  All it takes is a letter to the collector.

We’ll show you how to write that letter and exercise your right.

If you live in California, that letter will not only stop professional debt collectors, it will stop the  creditor itself from nearly all contact about the debt.

Understand, this right doesn’t make the debt go away.  It doesn’t keep the creditor from suing you.  It keeps them from using all their weapons to get you to pay without suing you.

Suing you is time consuming and expensive to the collector.  They want to harass, shame, or frighten you until you pay just to get them off the phone.

Write a do-not-contact letter

Here’s a template letter invoking your right to be free of collection.

Dear Collector:

Please take notice that I elect to exercise my rights not to be contacted by you about this alleged debt as provided by the federal Fair Debt Collection Act (15 U.S.C. 1692 b.  )

Do not contact me further about this debt except in strict compliance with the law.

Very truly yours,

YOUR NAME

Simple, huh?

California residents have more rights

While the federal FDCPA applies only to collectors hired by your creditor, California’s Rosenthal Fair Debt Collection Practices Act goes further.  It applies the same do-not-contact rules to the original creditor as well.

So, in California, you can add a reference to California Civil Code Section 1788.17, which is where the Rosenthal Act is found.

Make the  creditor give up

You may want to add a paragraph to your letter if there are facts that suggest that there is no point in suing you to collect.

More about your debt collection rights

This letter only says they can’t harass you;  they still have the right to sue you.  You just want to give them facts that suggest that a judgment against you is worthless.

So, throw in any relevant facts such as your age, employment, health, or family situation that support your contention that you’ll never be able to pay.

I’m 68 and living on Social Security.

I’m permanently disabled.

I’m the sole support of a handicapped child.

You get the idea.

I suggest that people with tax problems make clear to the collector that paying the taxes comes first.

Make a record

Your case is strengthened by a line that identifies the debt you’re talking about.

It’s also strengthened by sending it to a named individual, preferably the President of the collector or of the creditor. Nothing keeps you from sending copies to the name the collector is using (it’s often not their real name) AND to officers of the collector.

Keep a copy of the letter.  Send it by means that will get you a receipt showing that it was delivered.

Then if you get communications that are not consistent with the rights you’ve claimed, keep notes about phone calls or copies of letters.  Those documents can support your claim to statutory damages and payment of your legal expenses.

Enjoy peace at home and at work.

 

 

 

4 Compelling Reasons To File The Tax Return Even If You Can’t Pay

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Should you file the tax return if you can’t pay the tax?

You got to the bottom of your tax return and the amount you owe is bigger than your checkbook balance.

  • Scared of filing the return for fear of immediate collection action?
  • Scared of even calculating how much you owe?  think an extension of time to file looks good?
  • Fearful that you’ll be hanging a sign around your neck:  squeeze this guy?

Nope.  It doesn’t work that way.

The IRS does not start harassing nonpayers for money on April 16th.  Or even September 16th.  They haven’t even posted the returns that have been filed by then.

Relax, breathe deeply, and file the return.

There are far more advantages to getting the return on file than risks in admitting you owe money you can’t pay. [Read more…]

What Kenny Rogers Teaches Us About Getting Out of Debt

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You’ve got to know when to hold ’em,

know when to fold ’em;

know when to walk away,

know when to run...

So goes the gambler’s advice to the young card player in the hit Kenny Rogers song.

Hum along as we think about how we play our cards when we’re in debt: the hardest call is to know when to fold and file for bankruptcy.

Do you play a bad hand

With few exceptions, everyone wants to repay the debts they consider legitimate.

  • Paying your debts fits our self image and our values.We make heroes of  people who’ve scrimped, worked two jobs, gone without, to pay their debts in full.
  • Congress in 2005 made much of taking “personal responsibility” for your debts.  The pro creditor Congressmen cast bankruptcy as the choice of those unwilling to shoulder the consequences of their actions.
  • Those peddling credit shout that bankruptcy will cripple you in the credit market til the end of time.

If you’re in debt, it’s hard to know how sort your choices and to know which to discard and which to hold on to.

No one talks about the big picture cost of paying off debt.

No one talks about those whose bull headed commitment to payment blinded them to other needs and other financial threats.

No one talks about those who sacrifice and still fail to pay their way out of debt.

No one talks about debt-ridden elders with no hope of better times ahead.

So how do you assess your cards, so to speak, when choosing between get out of debt strategies?

Just like playing cards, the decision to commit to paying off your debts depends on the relationships between the cards you hold. It’s the relationship between the factors that are important, not hard and fast rules.  Let’s look at the factors.

cards-suits-pixabay

How much do you owe?  

HOLD:  the smaller your total debt, the more likely you can pay it off.

FOLD:  the larger the total debt, the longer it will take and therefore the more likely other events interfere.

How old are you?

HOLD:  the younger you are, the longer your remaining working life and your chances to catch up on other needs when debts are paid off.

FOLD:  the closer you are to retirement, the less likely it’s smart to continue struggling with debts.

Do you owe taxes, support, or mortgage arrears?

HOLD:  if  these critical kinds of debts form no significant part of your debt, a payment plan for other debts is OK

FOLD:  paying unsecured bills when you owe taxes, back family support or are behind on house payments is risky

How well are you fixed for retirement?

HOLD:  try to pay your debts if you have a solid pension or substantial retirement savings

FOLD:  if you are behind on saving for old age, your money is better spent on retirement than old debts

Do you have any reserves for emergencies or job loss?

HOLD:  if you have money available for the unexpected or the temporary loss of income, try to pay off debt

FOLD:  with no reserves, you make yourself even more vulnerable diverting money to existing debt

The biggest loss

What you want to avoid is throwing money after old debt in a campaign that can’t succeed, or that risks even more than your pride if you don’t make.

To live paycheck to paycheck, and starve your savings trying to do the impossible is not smart.  And it’s not necessary.

Kenny Rogers’ gambler told him:

That the secret to survivin’
Is knowin’ what to throw away
And knowin’ what to keep

Keep paying on old debts only if you hold the cards to succeed.  Otherwise, fold ’em, file bankruptcy, and draw some new cards for a fresh start.

More

What is life after bankruptcy really like?

What should bankruptcy cost?

Credit scores heal

Home Remedies For Foreclosure Breed Bankruptcy Tragedies

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Warning: virulent outbreak of do-it-yourself bankruptcies all around.

Symptoms:  panic over prospect of foreclosure

Supposed remedy:  file your own skeleton Chapter 13 bankruptcy

Prognosis: enjoy the stay for about 2 weeks, followed by foreclosure relapse

Homeowners facing foreclosure

Three different would-be clients called in a 10 day period this month, facing foreclosure.  And all three had the same tragic, but avoidable story.

I was on the trail of an epidemic.

Each had filed an emergency bankruptcy petition to address a looming foreclosure.  They then did nothing to file the balance of the schedules necessary in their cases.

How dismissal differs from discharge

Without schedules,  the case was dismissed, automatically. No court hearing, just tossed out for failure to follow the order that says “you’ve got two weeks to file the rest of the papers”.

And they did the same thing all over again a little bit later, again filing only the bare minimum of paperwork, before the second case is dismissed.

With two cases dismissed in the past 12 months, there will be no automatic stay in a third case.  Nothing arising from bankrutpcy, then, prevents the lender from foreclosing.

As a bankruptcy attorney, my bag of remedies was essentially empty.

Why homeowners sucked in

I understand the appeal of the automatic stay: it’s a lynch-pin of bankruptcy relief.

The automatic stay is powerful:  it applies to all creditors, it makes actions in violation of the stay void, and it becomes effective instantly upon filing bankruptcy.

The necessary paperwork to initiate a case is minimal, and the filing fee is just over $300.

Pretty seductive if you are panicked about losing your home.

Multiple filings labeled abuse

The pattern of debtors filing, getting dismissed, and filing again irked lawmakers back when the last round of bankruptcy amendments passed Congress in 2005.

After “reform”, every debtor gets a stay in their case.

File a second case within 12 months after the first was dismissed, and the stay lasts only 30 days.  The court will consider extending the stay if the debtor applies and gets an order within that 30 days.

File a third case, after two dismissals within 12 months, and there simply is no stay.

Chapter 13 can save your home

The tragedy in all of this is that Chapter 13 works, if you want more than just a two week stay.  Few problems that threaten foreclosure can be solved in two weeks.

How 13 can save your home

Understand that letting your case be dismissed cripples your  ability  to use bankruptcy in another case.

More

What should bankruptcy cost

How to interview a bankruptcy lawyer

Don’t wait til the day before foreclosure

Image courtesy of torange.biz.

Get The IRS To Feed Your Savings

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save refund

Lucky enough to get a tax refund this year?

Then celebrate America Saves week by telling the IRS where to put it.

I mean, where to deposit it.

Refund jump starts savings

A tax refund is the perfect place to boost your savings.  And you don’t have to choose between spending it all or saving it all.

Turns out,  the IRS has a form (you knew they would, didn’t you?).

Form 8888 allows you to split your refund between a savings account and your checking account.

You can even use the form to buy U.S. Savings bonds.

Or deposit it in your IRA or 401(k). You do have a retirement savings account, don’t you?

If not, get with it and open one.  The average Social Security check is $1300, not enough to live comfortably in old age.

Stand out with savings

A frightening fraction of Americans don’t have  enough savings to pay for a $400 unexpected expense.

Four hundred dollars isn’t much in today’s world.  And emergencies are seldom thoughtful enough to come in modest sizes.

The last government shutdown sent hordes of regularly employed folks to FOOD BANKS because they didn’t have reserves sufficient to go a month without income.

Hit the savings bank, not the food bank.  Stock up on cash.

Make saving a habit

Habits are powerful.  Bestsellers have been written about how they direct our behavior.

One healthy habit is to put yourself (and your family ) first when it comes to money.

Which comes first: getting out of debt or saving

Pay yourself first each month, preferably with an automatic deduction at work, if you get a paycheck.  If not, write the first check each month to yourself, before you pay the rest of your bills.

It doesn’t have to be a big amount to make it a habit.

Tips on saving

The non-profit America Saves site has savings tips and tricks to get you started.  Their tag line is right on:  Start small, think big.

 

 

Don’t Let The IRS File A Return For You

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SFR taxes

 

Bankruptcy works lots of magic with tax debt, but the magic fizzles out when it comes to SFR’s.

In my vocabulary, SFR is almost as doleful a phrase as KIA or DOA.

Three times in 10 days, I’ve had to explain to clients that the taxes associated with an IRS Substitute For Return are not dischargeable in bankruptcy.

It doesn’t matter how old the taxes are or how overstated the government’s number.

The 9th Circuit has clearly held that any return filed by a taxpayer after the IRS files an SFR is not a “return” for purposes of bankruptcy law.

I’m haunted by the client who explained that he was too stressed or depressed or distracted to file a return, so he “just let the IRS file the return.”

The taxes associated with the SFR would be fully dischargeable in bankruptcy when we met, had he only filed a return.  Now he has to wait out the IRS collection statute of 10 years from assessment.

Discharging taxes

One of bankruptcy’s greatest “tricks” is wiping out taxes long before the statute of limitations runs.

Applied to income taxes, bankruptcy allows the discharge of taxes, for which a return was filed, if the return was last due without penalty more than three years before the bankruptcy is filed.

The two other requirements are that if the return wasn’t filed on time, that it have been on file for at least two years, and the tax in question assessed more than 240 days before filing.

So, the first requirement for discharge is that a return was filed.

If it’s an SFR, it’s not a return.

Taxes die of old age

If there is good news here, it is that taxes assessed pursuant to an SFR are then subject to the same statute of limitations as regularly filed taxes.

As well, the statute can be extended by various tolling events.  Dense discussion of tolling events , starting at page six.

The bad news, experienced by one of my clients, is that the IRS can extend the collectability of a tax by seeking a judgment.

Note, too, that if neither a regular return nor an SFR is filed, the statute of limitations never starts running.

Get documents to file taxes

If you haven’t filed tax returns because you don’t have the necessary documents about your income and expenses for a past year, help is available.

Help, in fact, from the IRS. 

Get your tax transcript

You can order a transcript from the IRS that shows the information about that tax year that has been reported by others to the IRS.

Use that information, plus anything else you have, to do your best to file the return.

It’s a race to see if you get a return filed before the IRS files a substitute for return.

The good news is that the IRS gives you lots of notice that they haven’t gotten a return.  You get lots of warning that you are at risk of suffering an SFR.

Heed the warning, and keep your tax options open.

 

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Redwood City, CA 94063
Phone: (650) 694-4700

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