2018 Archives - Page 6 of 6 - Northern California Bankruptcy Lawyer

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

Settle 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.

How tax exception for forgiven debt works

The ugly truth about debt settlement

How bankruptcy deals with taxes

20 Years Of Bankruptcy In Brief

By Cathy Moran

Twenty years ago this month, Soapbox’s parent website, Bankruptcy In Brief, went live with four pages of basic bankruptcy information.

My law partner quietly thought writing about law for the internet was off base.

My lawyer colleagues thought I was giving away the store.

I persisted (which wasn’t then a catch phrase) because I was convinced that the public and the profession benefited from a better understanding of the law, starting with the little corner of the law in which I specialize.

Each page I wrote suggested another page that expanded or contrasted with what I’d just written. And I just kept writing. Bankruptcy in Brief now sports nearly 200 pages of information about insolvency, law, process, and how to decide if bankruptcy is right for you.

And I know it worked, because readers write, call, and arrive at my office clutching pages from Bankruptcy in Brief.

When negative changes to bankruptcy law gained strength in Congress, I found I had strong opinions that didn’t fit on Bankruptcy in Brief, where I sought to be explanatory and unbiased. So in 2004, this site was born, and I climbed up on my Bankruptcy Soapbox to advocate for sound bankruptcy policy, tell stories, and expose weaknesses in how bankruptcy actually works.

All the while, my primary focus has been on helping the public understand what their legal options are when faced with financial adversity.

So, I’m taking a brief moment for self congratulations, before I get back to the next post from here on my Soapbox.

The Unexpected Loss When Tax Returns Filed Late

By Cathy Moran

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.