Northern California Bankruptcy Lawyer

On The Bankruptcy Soapbox

The Soap Box

Don’t File Bankruptcy In December

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wait to file bankruptcyBankruptcy can provide tax relief,  if your timing is right.

File bankruptcy before the end of the year and you fix only a part of your tax problems.  Any taxes for the current year aren’t part of the bankruptcy.

Tax troubles are at the heart of so many bankruptcy filings.  It makes sense:  bankruptcy is a powerful and predictable tool to get out of tax debt.

Yet I’ve been telling clients for weeks now:  don’t file bankruptcy…..yet.

Wait til January.

Why wait to discharge taxes

Because most people who owe back taxes are facing similar trouble for the current tax year.

Come the end of this tax year on December 31st, they’ll owe taxes for 2019 because their withholding doesn’t match the taxes due in April, 2020.

In Chapter 13, which is almost always the better chapter for tax troubles, the Chapter 13 plan doesn’t address tax years that aren’t closed when the case is filed.

That means that your liability for the year in which you file bankruptcy doesn’t get priority for payment over your credit card debts.  In fact, the open tax year often can’t be paid through the plan.

And I hate to see money go to general unsecured creditors when tax debt remains.

So, I’m counseling clients to wait til January to file.  Get this current year’s tax troubles rounded up and corralled in the Chapter 13.

Buy yourself 5 years to pay whatever you owe for this year along with the taxes that brought you in my door in the first place.

Tax liens in bankruptcy

Another one of Chapter 13’s superpowers is the ability to cut tax liens down to size.

No matter how huge the tax liens are, in Chapter 13 those liens get paid only the value of your possessions when you file your case.

Really, the liens get paid only the equity in your assets that remains after liens that were filed before the tax lien.

So even if the tax lien is $100,000, if the equity in your possessions is only $10,000, that’s what you pay over the 5 years of the plan.

And after the case is  over, the balance of the lien is voided along with the tax liability that it secured.

Pretty neat, eh?

When IRS threatens to levy

A notice of intent to levy is often what makes folks call up a bankruptcy lawyer.  That notice seems to promise doom and the end of life as you know it.

Know that an actual levy is the IRS’s last resort.  There are processes and procedures built into the Service’s collection process.

A levy gets only what’s in the levied bank account on the day the levy is served.  If the bank balance is tiny, the IRS’s recovery is tiny.

Usually, if you engage the IRS in discussions about a payment plan, or even make a payment on your debt, your case becomes a lower priority for an understaffed IRS.

It depends on the numbers, of course, but usually, the advantages to waiting til January 1 outweigh the risk of collection between now and then.

Once your case is filed, the IRS, along with every other creditor, is forbidden to continue collection action.

Before you file bankruptcy

There’s lots to do to prepare for a bankruptcy filing.  These weeks won’t be wasted.

Why your bankruptcy papers are critical

Your bankruptcy attorney will need lots of paper from you to get your schedules right and to calculate a plan to get you out of debt.

Some of the things you’re likely to need include:

  • Pay stubs for the past six months, including December’s
  • Tax return
  • Contract for any financed vehicles
  • Tax notices from federal and state
  • Appraisal or broker’s opinion on the value of your real estate
  • Proof that your retirement accounts are exempt
  • Bank and investment account statements

You also need to prepare to get your tax return for this year filed quickly after your bankruptcy is filed.  You have 45 days from the filing of your Chapter 13 to get the return filed.  So start gathering whatever you’ll need to get the return on file promptly after your bankruptcy case is filed.

And, readjust your withholding for next year so you are adequately withheld for the coming year.  Owing more taxes once you are in bankruptcy is grounds for the dismissal of your case.

Find a good bankruptcy lawyer

Bankruptcy is difficult enough.  You need to have confidence and rapport with your bankruptcy lawyer.

Use the time between now and the first of the year to interview a bankruptcy lawyer and find one with experience in tax matters.

How to interview a bankruptcy lawyer

It’s equally important to find a lawyer to whom you are willing to confide your secrets and your worries.  The problem I can’t protect you from is the one you don’t tell me about.

So when you hear those screeching commercials that say “don’t file bankruptcy”, you can add, “yet”.

File bankruptcy at the right time for the right reason.

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.

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

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_optThe tax filing deadline approaches.

So why is a bankruptcy lawyer talking about taxes?

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

All too often, it’s tax troubles that brings a family to me for help.

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

How Consumer Remedies Were Gutted By Little- Noticed Tax Code Changes

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Tax code changes effective in 2018 inflicted a crippling blow to consumers who must sue to enforce their rights.  And few have yet noticed.

The tax deduction for miscellaneous itemized deductions under IRC Section 212 is gone. So now, consumers who prevail under statutes that award attorneys fees to the successful plaintiff are denied a deduction for the legal expense of winning that victory.

The income is taxed but the cost of producing that income is no longer deductible.

So, a large hunk of a consumer’s recovery goes, not to the injured consumer, but to the IRS.  Or even, all of a consumer’s judgment is consumed by taxes.

What happened to consumer litigants

IRC Section 212  has long allowed individuals to deduct the ordinary and necessary expenses incurred to produce income. At least partially.

That is, until the Tax Cuts and Jobs Act, passed December, 2017, including this zinger:

Notwithstanding subsection (a), no miscellaneous itemized deduction shall be allowed for any taxable year beginning after December 31, 2017, and before January 1, 2026.  Section 67(g)

So the deduction for the expense of producing income as a miscellaneous itemized deduction for individual tax payers vanished.  Poof.

The rational for its removal sounds great:

“Not that many taxpayers itemize their deductions so the deduction(s) won’t be missed.”

And thus, a bedrock principle of taxation, that the expenses of producing that income is deductible before tax is imposed, was cast aside.  With dire consequences for consumer rights, whether intended or not.

Tax changes abound

Miscellaneous itemized deductions weren’t the only victims of the 2017 tax act. HUGE things happened in the world of taxation on Jan  1, 2018 when the tax bill became effective.

For good or ill, perhaps wholly or partially dependent on your politics, the practical world of untold millions of individual taxpayers changed radically.

  • What would be alimony and heretofore deductible isn’t. (At least for most January 1, 2018 divorces.)
  • One very important protection afforded for debt relief from the disposition of a personal residence lapsed and has not been resuscitated.

There are many others.

But the devastation inflicted by Section 67(g) was initially far from obvious. It typically doesn’t become clear  until it’s time to file a federal tax return.

What had been a longtime method for getting at least some deduction for real expenses is gone.

Gone…

But thereby hangs a tale. Most taxpayers don’t itemize UNTIL THEY NEED TO DO SO. Now they can’t. Not even a little. And it gets much worse.

The power to tax….

The deduction allowed by  under IRC 212 prior to 2018 was already a ludicrously constructed monkey-motion system.  Lawsuit recoveries are typically reportable to the recipient in the GROSS recovery amount without diminution for attorneys’ fees payable to the attorney(s) whose services were indispensable in creating the income,

In order to get any deduction for attorneys fees paid, IRC Section 67 mandated:

The miscellaneous itemized deductions for any taxable year shall be allowed only to the extent that the aggregate of such deductions exceeds 2 percent of adjusted gross income.

This calculation often results in a sizeable bite coming out of the deduction the hapless taxpayer ultimately gets to take.

Now after Jan. 1, 2018, there is no deduction at all.

Picture the average non-itemizing single parent taxpayer suing for wrongful termination under this new tax regime.

  • The legal pushback from the errant employer is fierce and attorneys’ fees on both sides are high.
  • The settlement calls for $500,000 to be paid to the plaintiff .and,
  •  40% of the recovery goes to the plaintiff’s attorney as fees.

In the typical course of things post Jan 1, 2018, the plaintiff will be taxed on the FULL $500,000 recovery. Plaintiff gets NO deduction for the $200,000 in attorneys’ fees paid. None…

The plaintiff walks away (limps away actually) having paid taxes on AT LEAST $500,000 of income out of the $300,000 of money they actually net. (Yes, the attorney then pays tax on the $200,000 already included in the plaintiff’s income.)

Kinda discourages injured individuals from using consumer protection laws to protect themselves, doesn’t it?

Statutory penalties without deduction

If you perhaps think this isn’t so bad, picture the many hundreds of thousands of suits brought where the plaintiff is entitled to a fixed fee, fine or other relatively low statutory amount.

The purpose of these consumer lawsuits is to promote regulation of activities like as an example, lending-related abuses. In these cases the state consumer laws providing for the suits often allow the attorneys for the plaintiff to collect their fees from the lender or other business.

These suits now regularly result in the plaintiff being in deep debt to the IRS with insufficient funds to pay even the tax. AKA: Tax Hell.

Without direct decisive legislative change this horrendous damage will play out across the country for years.

It will continue until the right people suffer from its effects. Only then will there be any change(s).

 

 

 

The Tax Deduction No One Tells You About

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Money on the tableDid you file Chapter 13 to save your house from foreclosure?

Making payments to the trustee to catch up on the mortgage?

If you haven’t claimed a tax deduction for the bankruptcy plan payments that go to the lender, you’re leaving money on the table.

That’s money that fattens Uncle Sam’s coffers at the expense of your own.

You don’t really want to do that, do you?

Mortgage interest deduction

If your Chapter 13 plan is getting you current on your home mortgage, the plan is funneling a part of each month’s Chapter 13 payment to the lender.

Missed mortgage payment are largely interest, unless you are years in to a fully amortized loan.  So when your Chapter 13 plan proposes to get current on the loan through payments to the Chapter 13 plan, you’re proposing to pay the interest due.

The tax benefit in homeownership revolves around the fact that mortgage interest is deductible if you itemize your deductions.  Interest paid reduces the income on which you pay tax.

And, you don’t forfeit that tax benefit when you file Chapter 13.

Yet, for reasons I cannot explain, mortgage lenders seem to have gotten a pass on the reporting requirements that govern non bankruptcy payment of interest.  They don’t report to the IRS and to you, the ultimate payor, the interest paid through the bankruptcy plan by means of a 1098 form.

Find the deductible interest

To claim your deduction, you’ll have to dig a bit.  All Chapter 13 trustees now have websites where you can access a report about distributions made to creditors by the trustee.

You may have to figure out whether the proof of claim for the mortgage loan was filed by the original lender or by the servicer, or sometimes by the trustee of the Wall Street trust that owns the note.

Step by step instructions to calculate mortgage interest paid by the trustee

The claim usually stands out because it will include the total balance owed on the loan.

Buried in that mass of numbers will be the amount paid to the mortgage lender.

Make sure to print out the reports that show the amount.  Since the IRS didn’t get a copy of a 1098 showing payment of mortgage interest from the lender, you may have to back it up from your files.

Deadline to amend back returns looms

If you’ve been in your plan for several years, think not just about the return due soon.  Consider amending earlier returns to claim the deduction, and get a refund of what you overpaid in taxes.

You get three years from when you filed the tax return to amend it.  The IRS has a handy, dandy fact sheet on amending returns.

Don’t leave your money on the table for Uncle Sam.  Claim that deduction.

Image courtesy of Flickr and TracyO

The One Person You Must Tell About Your Bankruptcy

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Spill the beans concept.Most people who file bankruptcy don’t want anyone else to know.

Some of my clients try to hide their break for financial freedom from friends and neighbors.

Others are worried about their boss finding out.

Occasionally, someone will try to keep it from their mate.

But trying to hide his bankruptcy nearly cost one client $103,000!

Because he hid his bankruptcy filing from his accountant.

It’s all about the tax

When my client got his bankruptcy discharge, stripping off the junior lien on his house, the mortgage lender dutifully sent him a form 1099.

The tax form correctly reported that $288,000 of debt had been forgiven in the last tax year.

And my client delivered the 1099 to his tax preparer, who in turn said,

That will be an extra $103,000 in tax, due and payable on April 15th.

Only, once the tax preparer got the news about the bankruptcy filing, it wasn’t so.

Debt forgiven in bankruptcy isn’t taxable

A discharge in bankruptcy is the first exception to the standard tax rule that debt that is forgiven is treated as if it were cash income.

When the discharge occurs by reason of a  bankruptcy case, the discharged debt is not taxable income.

Responsibility for connecting the dots on discharged debt falls to the debtor/taxpayer.  The creditor whose debt has become worthless is obligated only to report to the IRS that the debt has been forgiven, as a matter of law.

The 5 most common errors banks make on 1099’s

The creditor generates a 1099 form, without comment on the circumstances.

The taxpayer is charged with filing the form that says, in IRS speak, “yes, but….”

Yes, the debt was discharged;  but, no, the discharge didn’t increase my taxable income.

The “because” is the discharge in bankruptcy.

Accountant needs to know about discharge

Had my client told his tax preparer upfront about the bankruptcy, he could have avoided several hours of intense stress.

Retired and living with family, he probably doesn’t have $103,000 in net worth, much less that kind of money sitting around for Uncle Sam.

I’m an advocate for openness about bankruptcy.  It’s not shameful nor the mark of failure.

If everyone who had filed bankruptcy admitted it, those who are now struggling with the decision to file wouldn’t feel like they are the only ones  who ever chose bankruptcy rather than perpetual debt.

But regardless of whether you’re willing to share with others the fact you’ve filed bankruptcy and gotten a fresh start or not, share the facts with your CPA.

It will save you money.

More

Who profits when bankruptcy is source of shame

Tax deductions hidden in Chapter 13

Easy steps to maximize your bankruptcy discharge

Image © Fotolia 

Tax Form 1099 Needs A Closer Look: Chances Are It’s Wrong

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Tax attorney Bill Purdy says:  don’t take IRS form 1099 at face value.

Hundreds of thousands of taxpayers at this moment are looking at, or thinking about, Form 1099-A or Form 1099-C documents they have received.

  • Some arrived in the tax year a debt was allegedly cancelled.
  • Others are issued by financial instructions many years after they should have been issued.
  • Some should never have been issued at all.

Some taxpayers “feel” or outright suspect these 1099 forms must be wrong somehow. Others are dutifully resigned to paying the ordinary income tax that follows the way the form was filled out.

Look again!

At least 50% of the forms issued by financial entities are wrong in one or more respects. Recently, the average number of defective forms coming across my desk is running 75%.

Consult with someone very knowledgeable before OR even after you have filed and/or paid.

Didn’t that debt go away?

Canceled debts can exact a high price at the moment the debt dies, or many years later.

Many people assumed that following the Late Great Financial Unpleasantness, debts dried up and blew away like weeds that died for lack of water.

Some debts actually did die legally speaking. But even dead weeds can choke a garden.

Dead debts, like dead weeds, leave a stubborn root that looks bad on one’s credit record for a long time. That dead root runs deep and often has to be pulled or dug out.

What lenders should do

Lenders are responsible for issuing Form 1099-A and Form 1099-C. They are legally responsible for issuing these forms timely and accurately.

What happens if they don’t do so, you ask?

Absolutely nothing.

Given lenders and financial institutions of all kinds face no consequences if they don’t issue forms with the right information, there seems to be no incentive to get it right.

At least every other form 1099 of this type that I’ve seen in the last 10 years has been wrong in at least one, if not multiple, respects. Worse still, the vast majority of the errors are to the detriment of YOU the recipient/borrower.

Five frequently occurring errors

I hope this article gets readers’ financial juices flowing to the point where they double-check the reality of 1099’s.

Here’s a list of errors deserving of Dishonorable Mention for California taxpayers. While there isn’t time to review these in detail,  here’s the gist of each error and the likely effect:

1. California Statutory Purchase Money Debt Cancelled: Under California law, borrowers have no personal liability for loans used to purchase their residence. CCP 580(b). Yet following a foreclosure or a short sale, the 1099 form clearly (AND INCORRECTLY) says the borrower is personally liable for the debt. The cancellation of purchase money debt should trigger no tax.  But the form claims otherwise.

2. Debt Discharged in Bankruptcy: Lenders issue tax documents that blissfully ignore fact that debt was discharged during bankruptcy proceeding. In 2019, 1099 forms make no reference to debts discharged in bankruptcy. Thus taxpayers may not know relief from these debts is typically NOT taxable when the relief occurs in a bankruptcy proceeding.

3. Accrued but Unpaid Interest Forgiven: This is an odd exception but a very important one. There is no taxable debt relief to the extent payment of the amount forgiven would have been deductible to you the debtor. IRC Section 108(e).

Interest on home mortgages is the best example of this one. It is Box 2 on Form 1099-A and Box 3 of Form 1099-C. Especially in the case of mortgages that negatively amortized for years, the actual amount of forgiven principal is often far less than what is shown on the form thus reducing the amount of taxable debt relief.

4. Fair Market Value of the Property: Without going into great detail here, this number radically affects whether there is any taxable debt relief and the amount of it (if any). Financial intuitions use a dart boards, Ouija boards, soothsayers, the entrails of an owl, and basically any number they feel like using for the fair market value. Frequently the number supplied is ludicrously inaccurate AND on the low side. This usually increases your taxable debt relief. (Box 4 Form 1099-A Box 7 on Form 1099-C.)

5. The Old “Identifiable Event Ploy”: This is Box 1 on Form 1099-A and 1099-C. It is supposed to have the date that the debt relief actually occurred. It often has the date the creditor gets around to writing the debt off on their books and issuing the Form 1099-A or C.

Look at these instructions from the 2019 Form 1099-C:

“If an identifiable event has occurred but the debt has not actually been discharged, then include any discharged debt in your income in the year that it is actually discharged, unless an exception or exclusion applies to you in that year.”

Yes! That means lenders send out Forms 1099-A and 1099-C when an “event” occurs as far as THEY are concerned, not when debts are actually discharged by operation of law as with foreclosures, bankruptcies, and most California short sales.

This causes ABSOLUTE HAVOC. Many debtors believe they have lost the benefit of statutory exemptions that have now expired but hadn’t when the debt relief actually occurred.

Your to-do list

The rabbit hole goes deeper but please double check with a tax professional you can trust before you pay taxes based on these forms.

If you’ve already paid, explore filing an amended return.

The financial entities who prepared these forms do not give them even a cursory degree of care.

They did the same exact thing a decade ago when they booked millions of loans that should never have been made. Nothing happened to them then, and nothing will now.

It’s up to you.

     Guest author Bill Purdy is a tax and real estate lawyer with Simmons and Purdy in Soquel, California. I’m tickled to share Bill’s pointed perspective on this tax problem too many face.  

     Bill and his partner Pam Simmons are my go-to resource for all matters of tax and mortgage law.  Bill assists clients with outstanding federal and state income tax liabilities, Form 1099-A and 1099-C related issues, collection resolution, failure to file returns and employment tax related liabilities. 

More from the Soapbox on tax issues

Cathy’s tax tips

Tax deductions hidden in Chapter 13

The secret tax penalty for settling debt

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