Northern California Bankruptcy Lawyer

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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

Bail Yourself Out Of Payroll Tax Trouble

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parachute-851318_640 (1)

Business owners with unpaid payroll taxes are in deep trouble.

There’s no corporate shield when it comes to payroll taxes. Even if the employer is a corporation, the corporation’s managers are personally liable for the trust fund portion of unpaid payroll taxes.

The trust fund portion of the tax (the amount withheld from employees’ checks) can be assessed against anyone  who could have paid that money  to the IRS.

You are in the IRS’s cross hairs, personally, if the business hands out “net” checks to employees with sending the withheld money in.  A bankruptcy discharge is no help here. [Read more…]

Free Tax Preparation Offered In Bay Area

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Households with an annual income of $54,000 or less can have their tax returns prepared for free through the United Way’s Earn It, Keep It, Save It program.

Too many Californians – far too many here in the Bay Area – work hard yet find themselves unable to meet their most basic needs. Furthermore, tax season can be stressful time for many people, as they round up tax documents and receipts, and make sense of confusing tax forms. Those of us who can afford it may pay for tax software that walks us through the process, or we may pay a tax preparer to file on our behalf. But the cost for paid preparers can be costly, and tax software varies widely in price. For low-income families who may not be able to afford these services, tax time can be a significant source of stress, and securing a full refund is not assured. Additionally, many of these families face additional challenges in doing their own taxes –English may not be their primary language or they may have limited computer skills. This is why EKS is so important in our community.

Find a location near you.

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Print list of locations

Earned Income Tax Credit

The Earn It, Keep It, Save It campaign is particularly focused on enabling qualifying individuals and families to access this tax credit that stands to put real money in the pockets of working families.

Too many families miss claiming the EITC.  Something like 20% of the families that are eligible fail to take advantage of this support for low and moderate income folks.

Even if you owe no taxes, you can claim the tax credit and receive a check.

Generally, the lower your income and the more children you have, the larger the payment you’re entitled to.

California puts money in pockets, too

California has a state version of the Earned Income Tax Credit.  The California rules are set out in this fact sheet from the Franchise Tax Board.

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

 

Bankruptcy Busts Taxes If The Timing Is Right

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taxes dischargeable

Got unpaid taxes for 2014?  April 17, 2018  those taxes reached the end of the line as priority claims in bankruptcy.

They 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 17th  is important if you have old taxes you haven’t paid.

Assuming you filed your 2014 return by the April deadline.  If you got an extension, the date is October 16, 2018.

Three rules govern discharge of taxes

To wipe out taxes in bankruptcy, three rules must be met.  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 2014 was due April 15, 2015.  You start counting from then.

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

Tax filing date doesn’t matter

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.

Other bankruptcy rules apply

The other two rules governing discharge of taxes still have to be met.

The “two year rule” says that if the tax 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.

The 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 over the life of 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, 2018 to discharge 2014 taxes, any tax you may owe for 2018 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, 2019 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

 

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Last Minute Tax Break For Distressed Homeowners

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tax break

 

Days before the end of the tax year, the massive tax bill changed the rules retroactively.  And for once, the change benefited individual taxpayers.

The tax bill revived, for tax year 2017, the exclusion from income accorded to phantom income upon foreclosure, short sale, or loan modification.

The provision that created an exception protecting struggling homeowners from a tax hit for debt canceled upon foreclosure of their principal residence. It expired with tax year 2016.

So, for instance, if you got a loan modification in 2017  that reduced the principal on your home loan, that reduction was once again going to be treated as income, and subject to tax.

But Congress restored for one more year the qualified principal residence indebtedness exclusion.  (That’s a mouthful).

The details are beyond me.  NCLC reported the change here.   Kenneth Harney of the WashingtonPost talked about the exclusion in the middle of his look at real estate and tax issues.

A Google search for the IRS publication on cancellation of debt tax issues seems to be wrong, now that the tax bill is law.  It treats canceled mortgage debt as if the exclusion wasn’t available in 2017.

Confusion seems to be inevitable.

 

 

IRS Shakedown Happening In Bankruptcy Court

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The latest IRS scam is happening in bankruptcy, out in the open.

Now usually when I write about IRS scams, I’m talking about genuine bad guys either pretending to be the IRS to hijack your money or pretending to be you to the IRS, to hijack your money.

But nobody is pretending in the trick I first saw last week.  The IRS is simply trying to collect the Affordable Care Act penalty twice.

What the IRS did

My client filed Chapter 13, owing income taxes.  The most recent of those taxes must be paid in full to get a Chapter 13 discharge.  So, the amount that must be paid is critical to the success of the plan.

The IRS filed a proof of claim for the unpaid income taxes.

But then, weeks later, the IRS amended their claim to add an “excise tax”, for the penalty under the Affordable Care Act, for not having health insurance.

The IRS conveniently “overlooked” the fact that the filed tax return already included the penalty on line 61 of the 1040.

So, they wanted to get paid twice by putting a benign label, “excise tax”, on the form, and hoping that you didn’t dig deeper.

No right to double payment

The tax law for the years in question, 2015 and 2016, imposed a penalty for not having insurance, to be collected by the IRS.

The IRS form includes a line where you add the penalty to your taxes if you didn’t have appropriate insurance.  So when my client filed his return, he’d already added the penalty to what he owed.

And the IRS dutifully used his return to claim payment for the unpaid amount.

OK.

But it’s not OK to double dip and add a duplicate penalty with another name.

When I challenged the IRS agent who filed the claim, his response suggests that he’d not looked at the client’s tax return;  he’d just added the penalty to the claim by rote.

Conversations with fellow bankruptcy specialist William Brownstein suggests the IRS confusion runs more broadly on this issue.  He reports the IRS assessing non-bankrupt tax payers with penalties for not including form 1095-B with their returns, even though the form itself says “don’t file with your return”.

So, the first step is to eliminate the duplicate claim.

But there’s more.

Is the ACA penalty entitled to priority payment

Recent taxes are given a priority for payment under the Bankruptcy Code.  If the ACA penalty is a “tax” within the meaning of the Bankruptcy Code, it must be paid in full in Chapter 13.

But, is this exaction a tax?

A Louisiana bankruptcy court recently said no in a case called Chesteen.  It’s not a tax, it’s a penalty.  And as a penalty, it isn’t entitled to payment in full, and as a penalty, it is dischargeable at the completion of the plan.  Great work by NACBA member Rachel Thyre Anderson, who reports that the decision has been appealed.

Where do we stand on ACA penalty

While the issue of whether the penalty is a tax or not may not yet be settled by the Chesteen decision, it is clear that the IRS, at best, only gets to collect the penalty once.

If the penalty is properly included on the tax return as filed, then any additional “excise tax” that claims priority status should be challenged.

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

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

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

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

Nope.  It doesn’t work that way.

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

Relax, breathe deeply, and file the return.

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

Taxes: Building Block of Financial Literacy

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financial literacy building blocks
You’re a first time employee.  Congratulations.

Welcome to the world of tax forms, withholding, and tax deadlines.  

Taxes are the price we pay for civilization, according to Oliver Wendell Holmes.

In fact, the first day on your new job you’ll be presented with an IRS form w-4. It’s like a rite of passage into adulthood.

Even families that talk openly about money don’t often discuss the arcane details of the W-4.

My sons certainly hadn’t prepared their own returns when they left home. They were daunted by the 207 pages of instructions for the IRS 1040, the standard income tax form.

So here, in more than 140 characters, and less than 207 pages, is my guide to income taxes for the beginning taxpayer.

You pay a portion of your income for taxes

Wages, commissions, interest paid to you on your money, and gain on the sale of assets are all forms of income.

The starting proposition is that income is taxable.

Gifts and loans are not income. Gifts might be taxable to the person who gave you the money, but not to you, if you’re lucky enough to be the recipient of the gift.

Not all  income is taxable

You get to deduct from your gross income certain exemptions and deductions.

The balance after subtracting those amounts is your taxable income.

That creates the appeal of “write offs” and “deductions”.  Those items reduce the total on which you figure your tax.

As income increases so do taxes

The range of income subject to a given tax rate is a “bracket”,

Each successive bracket applies a higher rate to the income that falls in that bracket.

There were 7 tax brackets for 2017.

Here are the brackets for a single taxpayer.

  • Up to $9,325: 10%
  • $9,326 to $37,950: 15%
  • $37,951 to $91,900: 25%
  • $91,900 to $191,650: 28%
  • $191,650 to $416,7004: 33%
  • $416,700 to $418,400 : 35%
  • $418,400 or more: 39.6%

If you are lucky enough to have more than $418,400 in annual taxable income, you don’t pay 39,6% on all of that income.

Each tier of your income is taxed at the rate for that tier, or bracket.

So, your first $9,325  in taxable income triggers a tax at 10% , or $932

If you actually had a total of $25,000 in taxable income, you pay tax of 15% on all the income over the $9,325.  You would have $16,075 of taxable income subject to the 15% rate, for a tax of $2411 on the excess over the first tax bracket.

Your total tax on $25,000 in taxable income would be $3343 ($932 + $2411).

Understand the marginal tax rate

We often speak of our marginal tax rate. That’s the percentage of the last dollar you make that’s owed as tax.

Looking at the tax table, a single tax payer who had $37,950  in taxable income was in the 15% bracket.  If he had earned one dollar more, tipping into the next bracket, he’d pay a tax of 25% on that extra dollar that falls in the higher bracket.

His marginal rate is 25%.  That doesn’t mean he pays 25%  of his income in tax.

He pays the higher rate on just the income that exceeds the top of the lower tax bracket.

Effective tax rate vs. marginal rate

Our fictional single tax payer with taxable income of $36,251 had a marginal tax rate of 25%.  That tells you how much of any increase in taxable income he’ll get to keep.

His effective tax rate is the percentage of his total income that is paid in tax.  That’s a far lower percentage.

It’s lower because there are adjustments “above the line” that reduce the income on which you pay tax, and then there are deductions and exemptions that further reduce the amount of income that is subject to tax.

Our examples here look at the taxable income so we could understand tax brackets and tax rates.

Tax withholding

Tax law requires that we pay this year’s taxes in advance, even though the final tax return for this tax year isn’t due til next spring.

Employers are required to withhold your estimated taxes from your paycheck.  You, however, get to tell them how much tax you expect to owe.

Whoa! How can you know how much you’ll owe next spring if you’re a new taxpayer.  Don’t worry, there’s a form for that.

IRS form w-4 includes a worksheet where you calculate how many tax allowances match your situation. It’s 8 lines and produces an approximation of what you’ll owe.

Your employer uses the number of allowances you claim to figure how much tax to withhold from each check.

The approximating your taxes is tricky:  withhold too little, and you pay a penalty with your return for having paid too little in advance:  withhold too much, and you get a refund with your return, for having made an interest free loan to the feds.

You can change your w-4 if your circumstances change during the year or you get a better estimate on what you are likely to owe.

Taxes for the do-it-yourselfer

If you are new to the tax paying world, your financial life is probably fairly simple. Take the time to learn how to prepare your own tax returns while things aren’t too complicated.

There is free tax software available through the IRS, as well as the commercial tax software.  My experience is that the big tax preparation services don’t always do a good job.  You’ll probably get a  better product and save some money preparing your own return.

Another time, we’ll look at exemptions and deductions and other tax mysteries.

Tax Refund & Bankruptcy

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The prospect of a tax refund makes most of us light up  even when we haven’t even calculated what the refund might be.

But if you’re thinking of filing bankruptcy before you actually see Uncle Sam’s check, take a minute to plan.

Your right to that refund is property of your bankruptcy estate even if you haven’t filed the return. 

The right to a refund exists as of the end of the tax year.

And unless you have an exemption available to protect the refund, you could end up having to sign the check over to a Chapter 7 trustee.

California’s bankruptcy exemptions can protect $28,000 in any kind of property.

I’m seldom an advocate for spending, but here I go:  collect the refund and spend it before you file.

Tax refund is just money

Once you receive your refund and deposit it, it no longer has any special character in bankruptcy.  It’s just cash. [Read more…]

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