Northern California Bankruptcy Lawyer

On The Bankruptcy Soapbox

The Soap Box

The Tax Deduction No One Tells You About

By

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 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. [Read more…]

Long Term Tax Savings When You File Bankruptcy Rather Than Settle Debts

By

tax biteSettle your debts outside of bankruptcy and you may be bitten by taxes you didn’t expect years later.

Everyone I talk to would rather cut a deal with their creditors than file bankruptcy.  It’s universal.

But here’s the killer reason why bankruptcy alone protects homeowners from a unexpected  tax consequence down the road.

Debt forgiven outside of bankruptcy gets deducted from the basis of your home.   Result:  more potentially taxable capital gains on sale.

It works like this.

Tax treatment of cancelled debt

Debt forgiven in bankruptcy or while insolvent gets an exception from the standard tax rule that cancelled debt is taxable as income.  IRC 108.

But that tax benefit comes with a delayed cost.  The amount of the debt forgiven is deducted from the basis of your assets.

So if the tax basis in your home was $200,000 and the debt that was discharged or settled was $200,000, you end up with a house with zero basis.

Sell that house and every dollar you receive is capital gain.  Ouch!

Special tax rule for homes in bankruptcy

But wait! Wait!  There’s an exception to the reduction of basis rule that shields your principal residence from reduction in basis.  But that exemption applies only if  your debt was cancelled in bankruptcy and you claimed your home as exempt.

So, the basis in your home is not reduced if the debt was forgiven in bankruptcy, rather than an out-of-court settlement, and you claimed an exemption.   IRC 1017(c),

So, when you consider your alternatives for getting yourself out of debt, homeowners need to look beyond this year’s tax return to the point at which they may sell their house.  Every dollar in basis excludes that dollar from being taxed as capital gain.

More

How tax exception for forgiven debt works

The ugly truth about debt settlement

How bankruptcy deals with taxes

The Unexpected Loss When Tax Returns Filed Late

By

length Chapter 13 plan

File your tax returns really late and you may lose out on credit for toward your Social Security.

Betcha didn’t know there was a connection between income taxes and your Social Security benefits.  This was a new one for me.

I’ve written often about the negative consequences of putting off filing tax returns. But Harvard Law professor Keith Fogg pointed out another “gotcha”:

 A self employed tax payer does not get credit for contributing to Social Security  for the four quarters of the tax year if the self tax return if filed more than three years after it was originally due

Ouch!  You owe the tax and even if you pay the tax, it does not count toward your eligibility for Social Security.

So you may come up short, not because you didn’t work, or pay the tax, but because you didn’t file a timely return.

Filing counts

The self employed pay both the employee and the employer’s share of Social Security contributions on their income tax return.

In order to draw Social Security based on age, you need to have contributed to the system for 40 quarters.  To qualify for Social Security disability, you need 32 quarters of contributions.

Defenses & exceptions to the rule from Procedurally Taxing 

If you’re self employed and your  tax returns are filed more than 3 years late, the quarters in that tax year don’t count for either eligibility nor for lifetime contributions.

No refund for the tardy

Your tax refund is another benefit you lose out on when a return is first filed more than three years after it was due.

This rule applies to all taxpayers, not just the self-employed.  No matter the size of the refund you would have otherwise received, miss the three year statute, and you can kiss the refund goodbye.

Tax delinquencies drive bankruptcy filings

I’m a crusader for filing tax returns because most taxes for which a tax return is filed are ultimately dischargeable in bankruptcy.  It’s a myth that you can’t discharge taxes in bankruptcy.

There are timing issues, but the central premise is that only taxes for which an honest return has been filed are dischargeable.

So, for all these reasons, file the return, even if you can’t pay the tax right now.

Keep Your Tax Refund Through Your Bankruptcy

By

5642525578_b521dedaab_bFor most of us, finding out that we are getting a sizable tax refund is great news.

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

That refund may not be yours.

You have a bankruptcy estate

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

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

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

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

Tax refunds for closed tax years

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

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

You get to keep your exempt assets. [Read more…]

Cut Tax Liens Down to Size

By

Tax liens are no match for Chapter 13 when it comes to cutting the lien down to its real value.

On paper, a tax lien can quickly become huge.

In bankruptcy however, a lien is no bigger than the value of the assets it attaches to.

While in Chapter 7, liens pass through bankruptcy without change, in Chapter 13, liens are valued, then dealt with under the Chapter 13 plan.

The secured portion of the lien, that part of the lien for which there is collateral, is paid through the plan.  The unsecured portion is treated according to the standard rule for taxes.

Any unsecured portion of the lien that is a priority tax is paid according to its priority.  If the tax year for the unsecured portion of the lien is not priority, it’s paid (or not paid) just like any other general unsecured claim.

Understanding tax liens

Tax liens attach to all the assets  the taxpayer owns when the lien is filed, and to all assets acquired while the underlying tax is collectible.

Exemptions, either in bankruptcy, or under state law, don’t save assets from a tax lien.  The lien trumps the exemption.

The recorded lien reflects that amounts due on the tax years in question at the time the lien was recorded.  The actual amount due for the liened tax year depends on how much interest runs after recordation and whether payments are made to reduce the tax due.

Tax liens remain valid only as long as the tax that they secure remains collectible.  Taxes aren’t forever:  they can be discharged in bankruptcy or they can die of old age by reaching the IRS 10 year statute of limitations.

Valuing a tax lien

So, how does Chapter 13 treat tax liens? [Read more…]

Old Tax Liability Discharged In Bankruptcy, If….

By

metal-keyDischarging tax debt in bankruptcy gets lots of families out of a horrible hole.

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

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

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

When old taxes live on

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

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

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

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

So those old taxes failed the two year rule:  

 Exclamation-icons-2taxes for years where the return wasn’t filed on time are only dischargeable when the return has been on file for two years.

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

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

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

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

Four reasons to file even if you can’t pay

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

Filing returns without any records

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

The IRS can help.

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

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

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

Image: Erulisseuiin

Unfiled Tax Returns Are A Life Sentence

By

clock face blueTwo clients, each with $200,000 in tax debt,  came to my office this week.

One can escape it all now;  the other is facing several years before bankruptcy will do anything for him.

What’s the difference?

Filed tax returns

The first man had filed his tax returns, even though he hadn’t paid the taxes called for.

The second man had not filed returns for the last 10 years.

In each situation, the IRS computed their tax debt to be the same.

One I can help today, the other has to fend of the feds for at least two years before bankruptcy can help.

Why?  because you cannot discharge liability for tax year for which you have not filed a return.

Erasing taxes in bankruptcy

You CAN discharge most taxes. [Read more…]

California Law on Cancelled Debt Mirrors Federal Law

By

 

I’ve always assumed that California law excluded from income debt forgiven in bankruptcy, just as federal tax law does.

When a client asked me to confirm that the treatment was the same, I realized that this was one of those things I had just assumed.  As a lawyer, I ought to know the danger present in “assume”.

So I looked it up.   Bingo.  California Revenue & Taxation Code 17131 includes IRC 108 among the federal provisions that are the same in California tax law.  (There are too few of those places where the two are the same, for my tastes. But that’s another rant.)

Cancellation of debt income is one of those gotcha’s that lurk, undiscussed, in debt settlement arrangements.  The tax system treats the forgiveness or cancellation of an obligation to be the same as if you had received the amount forgiven in cash!  It’s taxable income, unless you qualify for one of the exceptions.

Bankruptcy is an exception to the rule that debt cancelled equals taxable income.  Debt discharged in bankruptcy is eliminated “in a Title 11 case.”

CAUTION California law on exclusion of debt forgiven in a foreclosure of a home IS NOT exactly the same as federal law.  At minimum, the amounts of cancelled debt differ.

Get tax advice from an experienced tax professional.  Asking your realtor is not good enough.

Image courtesy of YIM Hafiz

Can IRS Really Collect Interest On Taxes Paid Through Chapter 13?

By

interest on tax after bankruptcyAt the end of a Chapter 13, you may still owe some interest on taxes included in bankruptcy.

But not nearly as often as the IRS would have you think.

It’s a huge let down to think after all the payments in a Chapter 13, not everything went away.  But in a narrow slice of situations, it happens.

Here’s the deal:  if the tax is one that’s dischargeable in Chapter 13 according to the Bankruptcy Code, then no interest is due at discharge.

If, however, the tax was a non dischargeable tax which was paid in full through the plan, then the IRS is entitled to interest.

That interest covers the period after the filing of the bankruptcy case.  Any interest on the tax that accrued before filing is part of the tax claim in the case.

To figure out whether you really owe the interest on tax the IRS now claims, you need to know not just what taxes you paid in the case, but which ones were dischargeable. [Read more…]

Tax Liens Live On After Bankruptcy, Unless….

By

Tax ProblemsYou mean the tax liens won’t  go away when I get a bankruptcy discharge?

The client was startled that the lien would live on beyond his bankruptcy.

So, if all my debt doesn’t go away, what do I get from the bankruptcy discharge?  he asked.

I thought the tax debt went away when I filed.

It’s your personal liability that is wiped out when you get a bankruptcy discharge.

Liens live on.

What’s personal liability for debt

In a nut shell, personal liability is the right of your creditor to use the powers of the law to reach your wages and your assets to satisfy a  debt.

When you get a bankruptcy discharge, that personal liability is erased.  The discharged creditors can’t reach assets that you acquire after the bankruptcy, nor the assets that you exempted in your bankruptcy case.

So, get a bankruptcy discharge that wipes out older taxes and the IRS can’t garnish your future wages or  levy your bank accounts.  Further, the existing tax lien won’t attach to assets you acquire in the future.

Tax liens  on current assets

But liens, which are rights that others have in your property, survive a Chapter 7  bankruptcy.  Your property doesn’t necessarily get a discharge when you do.

 Stripping tax liens in Chapter 13

By “property”, we mean personal property and real estate.  A properly perfected tax lien attaches to all your personal property and to real estate in the county where it’s recorded.

The critical question is:  what is that tax lien worth?  Does it really attach to anything of value? [Read more…]

643 Bair Island Road
Suite 403
Redwood City, CA 94063
Phone: (650) 694-4700

Categories