Taxes Archives - Northern California Bankruptcy Lawyer

Tax Deductions Hidden In Chapter 13

Don’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.

How to find the mortgage interest paid by Chapter 13 trustee

What your tax professional should know about tax and bankruptcy

When your Chapter 13 plan struggles

Image courtesy of 401(k)calculator.org

Bankruptcy Discharge Slays IRS Form 1099

By Cathy Moran

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

Keep Your Tax Refund Through Your Bankruptcy

By Cathy Moran

For most of us, finding out that we are getting a sizable tax refund is great news.

But if you’ve recently filed a Chapter 7 bankruptcy, hold your celebration.

That refund may not be yours.

You have a bankruptcy estate

When you file bankruptcy, all of your assets become a “bankruptcy estate”. The estate includes your real estate; tangible things like cars and household goods; bank accounts; and legal rights.

Those legal rights might include the right to file a lawsuit; your share of a class action suit; an interest in the estate of someone who has died; or your right to get back money you overpaid in taxes.

It’s not possession of the asset on the day your bankruptcy case that counts. It’s whether the facts that entitle you to money have taken place.

So the refund is part of the estate even if you don’t receive it for months after your bankruptcy case is filed.

Tax refunds for closed tax years

If the tax year has ended when you file a bankruptcy case, any refund that follows from filing the tax return is property of the bankruptcy estate.

You may be able to claim an exemption in the refund. An exemption removes the exempt asset from the estate and thus from the control of the bankruptcy trustee.

You get to keep your exempt assets.

If there are no exemptions available to protect the refund, the trustee will likely demand the turnover of the money.

When you file mid year

A tax refund for the year in which you filed your bankruptcy case is a bit different. Only a fraction of the tax year ran before you filed.

Most trustees want the turnover of a fraction of the tax refund when you actually receive it. If you file your bankruptcy case on April 1, 2017, one quarter of the 2017 tax year has run.

The trustee will want one quarter of your refund.

Do some simple tax planning

Let’s start with the mid year bankruptcy filing, where a fraction of the current year’s tax refund will be forfeit to the bankruptcy trustee.

You can fix that: see that there is no tax refund next spring.

Reduce your withholding after the bankruptcy is filed to eliminate the refund. You don’t have to continue to overpay.

A tax refund, after all, is just tangible evidence that you are paying too much tax each paycheck. It may seem like found money when the refund check arrives, but it’s really just a loan you make to the government. And you’re earning no interest on the loan.

File after refund spent

If you haven’t filed a bankruptcy case yet, consider waiting until after you have received the refund.

Once it’s paid to you, the refund is just money, money that you can spend on things that are either necessary or are exempt.

My favorite use of a pre filing refund is to fund your contributions to this year’s IRA. Most people who need bankruptcy relief also need to get serious about retirement savings, too.

The only limits on what you can do with a refund you get before you file are the same as the rules about other transfers: you can’t give money or things away to frustrate your creditors.

Or, as any experienced bankruptcy lawyer will tell you, you can use your refund to pay for the bankruptcy case.

The sooner you get out of debt, the sooner your financial life starts to make sense.

Image courtesy of Flickr and Great Beyond

How To Wipe Out Tax Penalties In Bankruptcy

By Cathy Moran

Tax penalties seem like a further insult when you’re having trouble paying the tax itself.

Everything seems subject to an additional penalty: failure to file timely; failure to pre pay sufficiently; failure to be accurate.

They mount up quickly, often equaling the unpaid tax.

Bankruptcy can not only eliminate your liability for certain taxes, it can wipe out the tax penalties as well.

Here’s how it works.

Three rules for discharging tax penalties

Penalties for dischargeable taxes are dischargeable

Tax penalties are tied to a particular tax year. If the tax for that year is dischargeable in bankruptcy, the discharge wipes out the penalties too.

The formula for a dischargeable tax, roughly speaking, says you can get rid of an unsecured tax if 1) the return for that year was due more than three years before the bankruptcy was filed; 2) if the return wasn’t filed on time, it’s been on file for at least two years; and 3) the tax for that year was assessed at least 240 days before bankruptcy.

Discharge the tax, discharge the penalty.

Penalties tied to events more than three years before filing are dischargeable

If the failure that triggered the penalty happened more than three years before filing, the penalty is dischargeable.

It’s dischargeable even if the the tax for that year isn’t dischargeable, for instance, because the returns weren’t filed on time. see 11 U.S.C. 523(a)(7).

All tax penalties wiped out in Chapter 13

That’s right: all tax penalties are discharged by a Chapter 13 discharge. Hard to beat, right?

Chapter 13 requires that you pay in full the priority taxes and the interest that accrued up to the date the bankruptcy case was filed. But at the end of the case, all tax penalties are wiped out, even on the priority taxes. More on taxes in Chapter 13.

Fraught with rules

So much of discharging taxes depends on knowing the maze of rules that apply to taxes in bankruptcy. It’s critical to get a tax transcript to verify the dates of all the important transactions.

Get experienced legal help if you want to discharge taxes and tax penalties. This is not the time or place for the cheapest or closest bankruptcy lawyer in town.

Image courtesy Flickr and Sharon Drummond

Skip Bankruptcy’s Means Test

By Cathy Moran

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.

Cheat sheet to pass means test

Discharging taxes

Got A 1099? How To Avoid Paying More Tax

By Cathy Moran

One of life’s persistent gotcha’s is the tax consequence of having debt forgiven.

Did you compromise a debt, eliminate it upon foreclosure, or have your creditor simply wipe it out without payment. You may have a tax problem.

The tax code treats the forgiveness of debt as income, even though you never saw a penny of cash.

But there is hope (or a loophole, depending on your perspective).

Exceptions to canceled debt as income

Five exceptions will excuse you from paying taxes on canceled debt.

Insolvency is one.

If you are insolvent, the forgiven debt doesn’t get added to your taxable income.

Bankruptcy is the other big exception. Debt wiped out in bankruptcy does not get added to your taxable income.

The bankruptcy exception often makes bankruptcy superior to debt settlement, and sometimes is itself the driving reason to file a bankruptcy before a foreclosure.

Are you really insolvent

Like much of the tax code, it isn’t simple to know if you are insolvent for these purposes.

The huge difference between the IRS treatment of your net worth and the way we address insolvency in bankruptcy is that the IRS includes retirement assets in the solvency calculation.

The last time I wrote about cancellation of debt and the possible tax surprise on foreclosure or short sale, I couldn’t lay my hands on the form the IRS provides to calculate insolvency.

Found it!

IRS publication 4681 contains the worksheet along with an explanation of the application of the principal that, absent an exception, debt canceled without payment is just like cash in the bank for tax purposes.

So, if you got a form 1099 indicating your debt was canceled and it wasn’t a bankruptcy discharge that canceled it, get out the worksheet and see if you were insolvent when the debt was canceled.

If you were insolvent by the IRS reckoning, check the box on Form 982 and submit it with your return.

Pay No Tax On Discharged Debt

By Cathy Moran

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

Deductions hidden in Chapter 13

File even if you can’t pay

Discharging taxes in bankruptcy

Old Tax Liability Discharged In Bankruptcy, If….

By Cathy Moran

Discharging tax debt in bankruptcy gets lots of families out of a horrible hole.

The tax debt is large, swelled by interest and penalties. Collection often compromised their ability to stay current on more recent years.

Bankruptcy can save their bacon because taxes found on returns due three years ago or more are generally dischargeable in bankruptcy.

But there is a key that opens the door to discharging taxes in bankruptcy.

When old taxes live on

The man in my office expected to wipe out his liability for several years of taxes that were now four and five years old in a Chapter 13 case. Chapter 13 would allow him five years to pay the more recent, non dischargeable taxes through his reorganization plan.

Only the rule for discharging taxes in bankruptcy has three prongs:

the three year rule,
the two year rule, and
the 240 day rule.

Turns out that the returns for those four and five year old taxes were never filed. He prepared the returns, but didn’t file them because he couldn’t pay the tax due.

So those old taxes failed the two year rule:

taxes for years where the return wasn’t filed on time are only dischargeable when the return has been on file for two years.

The story gets worse: because the taxes are not priority claims under the bankruptcy code, they don’t get the same special treatment that the more recent tax debts get as priority claims.

The non dischargeable but non priority taxes will get the same fractional payment in Chapter 13 that the medical bills will get, but the tax will survive the bankruptcy and be collectible later because these taxes are non dischargeable.

So, even if you can’t pay the tax now, not filing the return is not a meaningful long term strategy.

File the return and get the two year clock ticking for bankruptcy relief.

Four reasons to file even if you can’t pay

Outside of bankruptcy, the 10 year statute of limitations on collection of federal taxes doesn’t start running until the taxes are assessed by filing a return.

Filing returns without any records

Got no records for the unfiled tax year? That’s often why a tax return goes unfiled. Without records, it’s hard to calculate what you owe, or what’s owed to you.

The IRS can help.

You can request a Wage & Income transcript from the IRS for free. It will tell you what items of income have been reported to the IRS from your employer, bank, or mortgage lender.

Under certain circumstances, that may be as good as you can do. If you get better information after you’ve filed the return, you can amend the return for three years from filing.

The key is to get a return on file and get those assorted time periods running.

Image: Erulisseuiin

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

By Cathy Moran

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.

Easy tax payment plans available

If you can’t pay the full amount of the tax owed, send a partial payment with your return. Reduce your debt to the tax folks as much as you can.

Nothing requires that you enter into an installment agreement for payment. Simply send money regularly toward retiring the tax.

Put your name, social security number and the tax year you want the money credited to on the check.

If you feel the need for a formal payment agreement with the feds, you can set up a payment plan, online, if you owe less than $50,000.

Separate penalties for failure to file

If you fail to file a tax return and don’t get an extension, you expose yourself to a separate penalty for failure to file the return.

That’s on top of the penalty for failure to pay as required.

So, it’s expensive to try to drop out of sight.

Filing returns start clock ticking on escape options

Taxes don’t live forever.

There’s a collection statute of limitations that makes taxes uncollectable. Bankruptcy laws permit the discharge of taxes of a certain age long before they expire of old age.

But both escape routes for delinquent taxes start counting from the filing of your tax return. (More precisely, the statute of limitations starts from assessment, but filing the return is a self assessment).

Last year’s figures drive this year’s withholding

The most important reason to prepare last year’s tax return now is to get your withholding right for the current year.

Extensions to file are seductive, but dangerous. It delays adjusting your withholding long into the current tax year to match your actual tax liability. You don’t want to be in the hole again, do you?,

If you put off calculating just how much you owe for last year til October, you have only a few months before next April to get this year’s taxes paid in.

Closing your eyes to an underwithholding problem won’t make it go away.

Calculate what you owe, make a plan to pay it if possible, and fix your withholding or quarterly payments so you’re OK next year.

Tax on cancelled debt

Tackling tax liens in Chapter 13

Stop making quarterly tax payments

Chapter 13 Fixes Tax Trouble

By Cathy Moran

Chapter 13 bankruptcy offers powerful alternatives to fighting with the IRS.

When you’ve got tax troubles, it’s easy to feel powerless.

After all, you’re confronting a federal agency who wrote the tax rules. And they have hordes of employees with nothing else to do.

Chapter 13 can turn the tables on the IRS (and state tax agencies, too).

Back taxes in Chapter 13

In Chapter 13, you can

impose an interest free repayment plan for recent taxes
discharge all unsecured tax penalties;
eliminate or reduce tax liens;
discharge older taxes completely.

In contrast to IRS installment plans and offers in compromise, Chapter 13 plans need only to meet the statutory requirements of bankruptcy law to be accepted by the court. The IRS has limited say as to the terms of the plan.

Chapter 13 and enforced by a judge in the event of disagreements between debtor and taxing authority.

And the bankruptcy discharge is final as to taxes included in the case.

Chapter 13 puts taxes first

The bankruptcy code gives a priority for payment to certain taxes. While priority taxes can’t be discharged in bankruptcy, in Chapter 13 they are paid ahead of all other unsecured debts.

Giving priority to recent taxes reverses the usual IRS rule that tax payments made outside of bankruptcy are credited to the oldest taxes, which may be dischargeable in bankruptcy.

And unlike out of court arrangements, the automatic stay holds all other existing debts at bay until the non dischargeable taxes are paid.

So, you get protection from credit cards and medical bills while your plan payments pay down the priority portion of your tax debt.

Which taxes have priority

Priority taxes are, broadly,

those taxes for which the return first came due within 3 years of the filing of the bankruptcy;
those assessed within 240 days of filing or assessible at the date of filing bankruptcy; or
trust fund taxes of whatever age for which the debtor is liable.

The priority amount includes the tax and the interest to the date of filing on the tax.

Penalties kicked to the curb

Penalties are often the curse of a tax problem. They swell an already troubling total debt and don’t represent the tax actually unpaid.

How much does a Chapter 13 plan have to pay

In Chapter 13. penalties associated with a priority tax are not priority claims.

Penalties get the same treatment as any other unsecured debt, which means they may get little or nothing through the plan.

Interest on tax debt

Interest on all unsecured claims in bankruptcy stops running upon the filing of the case.

Unsecured priority taxes are paid, then, without interest accruing after the filing of the bankruptcy. You do end up paying the trustee’s commission on all sums paid into the Chapter 13 plan,

So the actual cost of retiring priority taxes includes a mark up for the trustee’s expenses of administering the case.

The bankruptcy court also has jurisdiction to decide tax disputes related to Chapter 13 cases.

Discharge of taxes

You get your discharge at the end of the case, when all plan payments have been made.

Priority taxes will have been paid in full through the plan. Non priority taxes, unpaid interest and tax penalties are discharged.

The exception to the discharge of taxes deals with tax years more than three years old for which a return has not been on file for two years. Under the bankruptcy amendments of 2005, those taxes are neither discharged nor paid as priority, unless they were assessed within 240 days of the filing. Which is one of the reasons I harp on filing the tax return every year, even if you can’t pay the tax due.

Tax liens

Just because the IRS has a lien for a tax year, doesn’t mean that the feds have a secured claim for the entire amount of the tax (and interest and penalties>)

Bankruptcy has advantages

The decision to file bankruptcy has to consider lots of factors about your situation, your debts, and your assets.

But don’t swallow the idea that taxes aren’t dischargeable in bankruptcy, or assume that you have to deal directly with the IRS to resolve tax debt.

Bankruptcy, especially Chapter 13, is a powerful tool for tax troubles. And a bankruptcy filed before the return is due can address your taxes for the previous year.

Deductions in bankruptcy

Get the info you need

Go back to prior tax years

Check it out

More

Bankruptcy is exception to tax

Creditor is clueless

Fixing the 1099 problem

Other tax consequences of discharge

Tax action plan

You have a bankruptcy estate

Tax refunds for closed tax years

When you file mid year

Do some simple tax planning

File after refund spent

Three rules for discharging tax penalties

Penalties for dischargeable taxes are dischargeable

Penalties tied to events more than three years before filing are dischargeable

All tax penalties wiped out in Chapter 13

Fraught with rules

Who takes the means test

What is consumer debt

Skip the means test

More

Exceptions to canceled debt as income

Are you really insolvent

More on debt forgiveness

Tax on cancelled debt

Cancellation of debt “income”

More

When old taxes live on

Filing returns without any records

Easy tax payment plans available

Separate penalties for failure to file

Filing returns start clock ticking on escape options

Last year’s figures drive this year’s withholding

More

Back taxes in Chapter 13

Chapter 13 puts taxes first

Which taxes have priority

Penalties kicked to the curb

Interest on tax debt

Discharge of taxes

Tax liens

Bankruptcy has advantages

Categories