Northern California Bankruptcy Lawyer

On The Bankruptcy Soapbox

The Soap Box

The Flat Wrong 1099

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credit-squeeze-transparentWhen her soon-to-be-ex filed bankruptcy, my client got a 1099-C for the joint credit card.

The form claimed that the debt was cancelled.

Therefore, she had additional income equal to the card balance.

Only, none of the statements on the 1099 were true.

The debt wasn’t discharged as to the non filing spouse.  One spouse’s discharge does not discharge the personal liability of anyone else.

Further, the liability of the soon-to-be-ex wasn’t even discharged yet since it was the beginning of a 3 year Chapter 13.

The discharge doesn’t come until all the plan payments are made.

What to do?

Cancelled debt and taxes

Tax law requires the holder of a debt that is forgiven to report the forgiveness to the IRS.

The forgiveness can be voluntary, as in, we compromised the debt and now you owe less.

Or, it can be by operation of law:  you filed bankruptcy and discharged the debt.

Either way, the tax man sees the amount of money that you no longer owe as if it were cash income.

And, if it’s income, then you owe tax on the income.

No tax in bankruptcy

If my client was the spouse who had filed bankruptcy, she would properly have gotten a 1099-C, at the end of the case.  When the debt was truly gone.

But she wouldn’t have owed tax on the discharged debt, because bankruptcy is an exception to the rule.

Debt forgiven in any chapter of bankruptcy does not trigger cancellation of debt income.  Therefore, no tax.

Tax treatment of cancelled debt is one of the sterling features of bankruptcy that make it superior to debt settlement.

Attacking the erroneous 1099

Strike first, is my thought, when the 1099 is wrong.

The credit card company issued the defective 1099. Write the issuer and request an amended 1099.

The deadline for sending out 1099’s is about six weeks earlier than the deadline for submitting the 1099’s to the IRS.

Jump on the problem right away and attempt to correct the situation before it gets to the IRS.

When the IRS gets bad information

If you couldn’t head off a submission to the IRS that was wrong, tackle the problem in your tax return.

You can’t just file the return as if the IRS didn’t think you had this  extra “income”.  You have to address the error and overcome it.

The IRS has a form for claiming an exception to the cancellation of debt income rule:  Form 982.

Attach your explanation of why the 1099 is wrong to the 982.  There isn’t a box, or an “other” category on the form where you can provide further information, so you’ll have to attach your explanation to the form.

If not resolved at the issuer level, my client will have to point out that she hasn’t been relieved of the debt, since she hasn’t filed the bankruptcy AND that her spouse hasn’t yet been relieved of the debt yet either, as there is no discharge.

Wash, rinse and repeat

I’ve spoken as though the IRS was the sole taxing authority involved.

If you live in a state with an income tax, you must repeat the drill described for the IRS with your state tax agency.

Personal liability required

Probably the most common error in issuing 1099’s is the matter of personal liability.  If the debt cancelled was non-recourse, the borrower had no personal liability in the first place.

Cancellation of a non recourse debt doesn’t alter the borrower’s balance sheet.  The borrower wasn’t personally liable before cancellation, so there’s no cancellation of debt income to address.  More on the fictional 1099.

As I said, see above and wash, rinse and repeat.

More on tax

Discharging taxes in bankruptcy

Tax liens after bankruptcy

When tax debt is a life sentence

 

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.

 

Find The Lost Tax Deduction When Lender Misreports Mortgage Interest Paid

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How can you pay thousands of dollars in mortgage payments in a year, and get a  tax Form 1098 for a fraction of actual mortgage interest paid?

That’s what my client wanted to know.

His monthly mortgage payment is $2715.  The loan is currently interest only.  All the payments were made.

And yet, the Form 1098 from PNC says the year’s mortgage interest paid is only $1800.

So what happened to the other $30,780?  That’s a lot of money to go missing.

Welcome to the further screwed up world of mortgage loan servicing.

The short answer right now to the question I posed at the top is I don’t know yet.

But here’s what I suspect.

What servicer does with your payment

I’ll bet that PNC, the servicer I love to hate, has put the monthly payments in suspense, and has not posted them to the loan.

Federal law requires mortgage payments be posted the day of receipt

By holding them in suspense, they don’t show up as interest paid on the mortgage.

Why the payments were put in the suspense account I don’t know.

What it takes to get them out of suspense, we’ll have to see.

Getting your taxes right

My advice to the client and his tax preparer is to claim a deduction for all of the year’s mortgage payments.  It may conflict with the information provided by the servicer, but the servicer’s information doesn’t necessarily control.

If you don’t claim as large a deduction as you think you are entitled to, the IRS isn’t going to come back and urge you to correct an error that’s in their favor.

You may have to later convince the IRS that your calculation of the amount of interest you paid is correct and the servicer’s statement is wrong.  A copy of the monthly mortgage statement and a escrow analysis statement are a starting point.

Consider as well whether the same problem exists in prior years and if an amended tax return is worthwhile.

Lupe_MännchenTax sleuthing

In the meantime, I’m going to read the note and deed of trust that governs how the lender is supposed to credit payments.  Most security instruments set out the order in which payments are applied to amounts the borrower owes.

I’m hitting the RESPA regulations on suspense accounts and their use and misuse.

And then we’ll spring a Request for Information and a Notice of Error on the servicer.

I wonder how many other servicers will be outed when they produce palpably erroneous tax documents.

Related

Cancellation of debt and taxes

Tax deductions hidden in Chapter 13

Image of boxed money courtesy of Locomomo and Flickr

Avoid Paying Taxes On That 1099 Form, Legally

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IRS form 1099tax magnifiedIt’s tax time and the mails are full of IRS form 1099.

If you managed a short sale of your property; suffered a foreclosure; filed bankruptcy; or settled your debt for less than you owed, you probably got a 1099.

But that’s not the end of the tax story.

Receipt of the form does not mean  that you must include the reported sum as income.

Please repeat:

mere receipt of the form does not mean you are necessarily paying taxes on that money.

Form 1099 is an informational form.  It is sent out routinely and without much thought on the creditor’s part.

When real property changes hands or when a debt is forgiven,  the creditor involved is required to report the transaction to the IRS.  You,  the potentially affected taxpayer, get a copy.

Here’s the action plan to avoid paying more tax.

Claim the exceptions to the rule

The Internal Revenue Code starts with the proposition that debts that are forgiven increase your net worth.  In IRS-think, there must be a tax due.

But there are exceptions.  The three most important exceptions for my clients:

  1. Bankruptcy
  2. Insolvency
  3. Qualified mortgage indebtedness

Fit in one of these exceptions and the cancelled debt does not get added to your taxable income.

To establish your right to exclude the money shown on the 1099, you have to file IRS form 982.

If you don’t file the form and claim the exception, the IRS has no way to know that, despite the debt forgiveness, there is no tax payable.

Form 982 tax-avoiding choices

Form 982 lays out the possible reasons forgiven debt might not be taxable.

Bankruptcy–  A discharge in bankruptcy forgives the debt without tax consequences.  It’s the first exception found on Form 982.  Bankruptcy law is found in Title 11 of the United States Code. The tax exception applies to the discharge of debt in any chapter of bankruptcy.

Insolvency–  Perhaps,when the debt in question was forgiven, you still owed more to other creditors than the value of your assets.  You don’t have to include the forgiven debt in your income.  You were insolvent.  Note, however, that the solvency calculation here includes the value of retirement assets that your creditors can’t reach.  Many people who have little net worth outside of retirement savings are actually solvent when you add in pensions, etc.

Qualified mortgage indebtedness-  With the Great Recession and a slew of foreclosures, Congress enacted a short term safe harbor for the debt forgiven on a principal residence.  The loan must have been was used to buy or improve the home.  The law was recently extended to include tax year 2016.

In case of mistake

Another situation where you might get a 1099 but not owe tax is where you had no personal liability for the debt;  that is, the debt forgiven was a non recourse debt.  The foreclosure agent probably has no way to know whether the lender had a right to sue you.

When your debt wasn’t really cancelled

If none of the other exceptions to inclusion in income apply, make sure you consider whether you had personal liability for the debt.  If not, seek to have the 1099 corrected, or attach an explanation to your tax return with the facts of your situation.

Remember, just because they sent you the form doesn’t mean you owe the tax.

More on tax return issues

Mortgage interest missing from Form 1098

Tax deductions hidden in Chapter 13

Tax question roundup

Are you insolvent for cancellation of debt purposes

Consequences of unfiled returns

Image courtesy of IRS EIN

 

10 Things Tax Professionals Need To Know About Bankruptcy

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accountant-flickr-charlywkarlTax season approaches.

Tax preparers stand a good chance of encountering clients who either have filed bankruptcy, or who may benefit from a bankruptcy filing.

Here’s my list of bankruptcy nuggets that a good tax professional should have at hand.

Debts discharged in bankruptcy don’t trigger cancellation of debt income–

One of bankruptcy’s compelling features is that the debts cancelled by reason of the bankruptcy discharge don’t get included in the debtor’s income.  Bankruptcy, found in Title 11 of the U.S. Code, is the first exception on Form 982 to inclusion of forgiven debt in gross income.

IRS and state tax entities subject to the automatic stay  

A bankruptcy filing enjoins tax authorities from continuing collection action.  Thus the stay terminates garnishments and prohibits levies of the debtor’s assets.  It doesn’t, however, prohibit tax audits.

Bankruptcy can discharge income tax debt three years after return due

Taxes can be wiped out in bankruptcy if the return was due, including extensions, three years  or more before the bankruptcy is filed; any late filed return has been on file for 2 years; and the taxes were assessed more than 240 days before the commencement of the case.  More on overview of taxes in bankruptcy.

Chapter 13 is a quick and certain alternative to an OIC–

A  Chapter 13 plan is confirmed within weeks and binds the IRS just like any other creditor. The case discharges for all time the scheduled taxes, penalties and interest upon plan completion.  The plan must pay the priority taxes (those tied to returns less than three years old) and the interest on the priority tax as of the filing.  No new interest or penalties accrue during the pendency of the case.

Tax penalties are dischargeable

Penalties associated with dischargeable taxes are dischargeable;  all penalties are dischargeable in Chapter 13, and penalties associated with events more than three years past are dischargeable in Chapter 7 even if the tax isn’t dischargeable.

Chapter  7 estate, but not 13 estate, is a separate taxpayer

A bankruptcy estate owes the feds a return, and perhaps tax on capital gains it realizes by reason of sale or foreclosure.   Property remains property of the bankruptcy estate until the estate is closed or the property abandoned.

Tax attributes of the debtor pass to the bankruptcy estate  

The debtor’s basis, loss carry forwards, and exclusions are available to the Chapter 7 trustee, and revert to the debtor when the bankruptcy estate closes.

Debtor can elect short tax year for the year bankruptcy is filed  

A short year election can make tax attributes available to the debtor when he files the return for the pre bankruptcy portion of the year.  It can also quantify any tax due in the year of filing so that it is a priority claim for payment from the assets to be distributed in the bankruptcy case.

Tax liens generally survive the bankruptcy case

While lien survive as a charge on the assets the debtor owned at the filing of the case, the lien does not attach to assets the debtor acquires after the case is filed.  In Chapter 13, the lien need be paid only to the extent of the actual value of the assets subject to the lien.

Allowable deductions may be found in payments made on debtor’s behalf by Chapter 13 trustee

Chapter 13 plans often pay over time mortgage interest arrears  on the debtor’s home.  State taxes paid through the plan or business expenses including taxes may be deductions the Chapter 13 debtor can claim.

The rules covering federal taxes in bankruptcy are found in Pub. 902.  State taxes are subject to the same treatment in bankruptcy as federal taxes.

For more

For help with strategic use of bankruptcy to solve tax problems, look for a certified bankruptcy specialist in your community.

Some state bar associations and the American Board of Certification  certify lawyers who are specialists in bankruptcy.  Find California bankruptcy specialists by county.

Image courtesy of Flickr and CharlywKarl

Don’t File Bankruptcy In December

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wait to file bankruptcyBankruptcy can wipe out taxes, but there’s a catch.

File bankruptcy before the end of the year and you fix only a part of your tax problems.

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 2018 because their withholding doesn’t match the taxes due in April.

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.

The Truth About Tax Liens After Bankruptcy

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liens after bankruptcyWe have a lien on your name.  Not your property, your name.

That’s what the county tax collector told my client, years after he got his bankruptcy discharge.

And that multi-thousand dollar lien claim threatened to sink the refinance of his house.

Eventually, we got the county straightened out without going back to bankruptcy court, and the lien claim withdrawn, but only after educating the county on liens and bankruptcy.

Here’s what was wrong with the county’s claim they had a lien on my client’s name.

Liens attach to assets

The initial nonsensical claim is that a lien attaches to someone’s name.

A name isn’t property.  You can’t enforce a lien against a person’s name by seizing the name and selling  it.  That’s what a creditor would do with a valid lien that attaches to an asset.

Yet the tax collector claimed the lien was against the name of my client. Not a lien against his home, but a lien that entitled them to payment from a real estate refinance.  (Not logical, but this was a tax collector.)

Perhaps the tax collector was trying to say that the lien wasn’t one for real property taxes on that particular house.  Or she was saying that it wasn’t a consensual lien where the homeowner pledged his house as collateral for a loan.

But she definitely contended that the lien on my client’s name survived his bankruptcy.

Liens don’t snag post bankruptcy assets

The second bit of nonsense was the claim that the county had a lien in the house my client acquired after he filed bankruptcy.

The law on liens and a bankruptcy discharge is straightforward:

  • Liens that attach to an asset owned on the day you file bankruptcy survive the discharge
  • If the debt supported by the lien is not discharged, the lien attaches to property acquired after bankruptcy
  • If the debt is discharged, there’s no lien on newly acquired stuff.

It’s the last proposition that saved the day for this client.  The county’s tax claim was discharged in the bankruptcy.  My client didn’t own a house when he filed.  Therefore, the county got no lien on after-acquired property on account of a debt that was discharged.

Preventing post bankruptcy surprises

It’s not uncommon for creditors to pop up after bankruptcy with a claim inconsistent with the bankruptcy discharge. It happens because of ignorance, incompetence, and, occasionally, sheer greed.

Bankruptcy courts stand ready to enforce the rights that debtors get from bankruptcy.  But that takes time.

When a judgment lien pops up after bankruptcy

The trouble comes when the creditor stands to upset a real estate transaction that has a deadline, and possible costs associated with missing that deadline.  Like my client trying to refinance his house. Interest rates are going up.  Miss the deadline and pay a higher rate for the life of the loan.

If real estate is involved, start immediately to see what liens show in the public record. In California, where I practice, that means get a preliminary title report at the first opportunity.

Identify any liens that are unenforceable by reason of the bankruptcy discharge, or by reason of having been paid, died of old age or avoided in bankruptcy.

My attack on the county tax collector started with providing the creditor mailing list from the case, showing that the county had notice of the bankruptcy.  I sent them a copy of the discharge order and the schedule that showed that my client didn’t own the house when he filed years ago.

Having given the county good notice of the bankruptcy, way back when, my client avoided more than $10,000 in tax claims.

And his name was his own.

More

Dealing with tax liens in bankruptcy

When creditors ignore your discharge

The IRS after your bankruptcy case

 

 

If The IRS Comes Calling After Your Bankruptcy Discharge

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tax after bankruptcyIt’s scary, or infuriating, when the IRS continues to try to collect taxes discharged in bankruptcy.

What was the point of filing bankruptcy if the government ignores your discharge?

Yet IRS attempts to collect taxes from people with a bankruptcy discharge form the single largest group of cases in my law office today.

Why the IRS persists

Seldom is the IRS correct that taxes are still due.

Sometimes, the IRS is confused.  Other times, they appear to be indifferent to the bankruptcy discharge.

Too often, I suspect that their record keeping system is not up to the job.

But, whatever the excuse, you need to get it sorted out.  Let’s look at common issues found in IRS collection letters after bankruptcy.

Tax lien lives on

The most common letter from the IRS after a bankruptcy concerns tax liens that survive the bankruptcy.

A Chapter 7 discharge does not affect tax liens.  Tax liens pass through a Chapter 7 unaltered.

When a tax is discharged in bankruptcy, the tax lien does not attach to assets acquired after bankruptcy

Whether by design or not, the IRS letter to taxpayers emerging from bankruptcy with a surviving tax lien is poorly written.  It  doesn’t clearly spell out that the tax the IRS is trying to collect is just the sliver of taxes that attached to assets of value owned when the case was filed.

What to do?  Decide if the continued existence of the lien makes any difference in your economic life.  If you need to apply for significant credit, you may want to wipe out the lien by paying the value of the “stuff” it attached to when you filed.  If the lien attaches only to personal property with little real value, you may choose to simply let the lien die of old age.  Taxes are generally collectible only for 10 years from the date they are assessed, with some time added for time in bankruptcy.

IRS failed to credit taxes paid in Chapter 13

Can’t tell you how often this comes up.  The IRS is little better than mortgage servicers in keeping track of the money it is paid.

Occasionally, the confusion arises when only one of a married couple filed Chapter 13.  Somehow, the IRS didn’t connect the taxes paid through the Chapter 13 plan with the tax liability of the non filing spouse, even when the liability was joint.

Similarly, if the taxes arose in a business, the IRS may not have recognized that taxes paid by an individual or that individual’s Chapter 13 trustee were on account of business taxes.

What to do?  If a polite letter pointing out that the tax has been paid doesn’t fix the problem, the collection actions violate the discharge injunction in the bankruptcy case.  Brought to the attention of a bankruptcy judge, the IRS may get its knuckles rapped and be ordered to pay your attorneys fees and any damages you suffered.

IRS doesn’t understand the community property discharge

The Bankruptcy Code has been around in its present form for nearly 40 years, but the IRS can’t get its head around the community property discharge found in §524(a)(3).

That statute says that the bankruptcy discharge granted to one spouse protects a couple’s community property acquired after the bankruptcy filing from debts discharged in bankruptcy.

So, taxes discharged in one spouse’s bankruptcy can’t be collected from the community property of the spouse who didn’t file. (The non filing spouse may be exposed to collection if that spouse has separate property and is also liable for the tax).

What to do?  Start by educating the IRS.  Point out that your spouse has a discharge, you remain married, and your community property is protected from pre bankruptcy tax collection.  This one is trickier, since the IRS has legitimate rights to collect from separate property, if there is any.

You miscounted the passage of time

Consider whether the mistake might be yours.  The bankruptcy discharge doesn’t list the debts discharged in your case;  it simply says that the dischargeable debts are discharged.

The central factor controlling whether the unsecured portion of a tax is discharged is the interval between the assessment of the tax and the filing of the bankruptcy.  The calculation can be complicated by prior bankruptcy filings and other events that pause the clock.

What to do?  Get an experienced bankruptcy attorney or a tax professional to review whether the tax the IRS wants to collect was really discharged.  If it was discharged, go back to court for help from a bankruptcy judge.

IRS simply screwed up

It happens these days more than it used to.

The IRS is understaffed and technologically challenged.  They make mistakes.

If the IRS, or any other taxing authority, had notice of the bankruptcy filing, they are legally obligated to honor the discharge, even if it’s hard to do.

What to do?  First off, write a letter with the proof that the taxes are discharged.  Usually that means sending a copy of the bankruptcy schedules listing the IRS and a copy of the discharge along with the collection letter they just sent.  Most bankruptcy judges want you to give the offending creditor a chance to fix the problem before running back to court.  You set yourself up for a better result in court when you’ve made a business-like attempt at self help and been brushed off.

Bottom line

The bankruptcy discharge does apply to taxing authorities.  Just because it’s the IRS doesn’t mean they are right.

More

Discharging taxes in bankruptcy

Debt collectors after your discharge

Who to pay after bankruptcy

 

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

Audited? Did You Tell The State Tax Authorities?

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tax audit

We’re all about sharing these days, aren’t we?  So, did you share with the state tax authorities the outcome of your IRS audit?

While telling the Franchise Tax Board that you owe more taxes to the feds may seem like inviting trouble, you gain by doing so.

How?

You set those taxes owed to California up for discharge in bankruptcy.

And that’s a nice card to have up your sleeve.

Here’s why.

Taxes discharged in bankruptcy

A central requirement to wipe out tax liability in bankruptcy is the filing of a return.  Bankruptcy Code 523(a).

Taxes that are unassessed but still legally assessable when you file your bankruptcy case don’t get discharged.

If you owe more taxes as a result of an IRS audit, bankruptcy law treats any resulting increase in your state tax liability as one for which you haven’t filed a return.  That is, unless you have made a report or filed an amended tax return with the state.

No return or report, no discharge of the state tax increase.

Tax exposure under California law

California law requires that you share the results of a tax audit that increases your taxes to the Franchise Tax Board.

Edited for clarity, Revenue & Taxation Code 18622 provides:

(a) If any item required to be shown on a federal tax return, including any gross income, deduction, penalty, credit, or tax for any year of any taxpayer is changed or corrected by the Commissioner of Internal Revenue …, that taxpayer shall report each change or correction…, within six months after the date of each final federal determination of the change or correction or renegotiation, or as required by the Franchise Tax Board, and shall concede the accuracy of the determination or state wherein it is erroneous. For any individual …changes or corrections need not be reported unless they increase the amount of tax payable …for any year.

(b) Any taxpayer filing an amended return with the Commissioner of Internal Revenue shall also file within six months thereafter an amended return with the Franchise Tax Board…  For any individual …, an amended return need not be filed unless the change therein would increase the amount of tax payable…

So, if changes to elements of your return by reason of an IRS audit would result in you owing more state tax, you have to report that change to the FTB.  If you are required to file an amended federal return, you have six months to file an amended state tax return if you owe more state tax as a result of the audit.

Reporting requirement in other states

California isn’t alone in requiring you to share the audit bad news with the state.  The AICPA organization of CPA’s put out this summary of tax audit reporting requirements nationwide.

More on taxes in bankruptcy

Timing is everything when discharging taxes

Tax liens after bankruptcy

Chapter 13 is a tax tool

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