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Taxes and bankruptcy – debunking a myth

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2334280048_61c3a13b9a_zLots of people think, “bankruptcy can’t help me with my tax debt.”

Lumping tax debts in with child support and alimony—which indeed cannot be legally written off, or discharged—is wrong. But taxes and bankruptcy can be confusing, because these are complicated areas of law.

The fact is that bankruptcy can discharge taxes of many types and in many situations. Sometimes ALL of a taxpayer’s taxes can be discharged, or most of them. But there ARE significant limitations.

Even if you cannot discharge your taxes in bankruptcy, filing a bankruptcy case can still help by:

1. Keeping the taxing authorities from garnishing your wages and bank accounts, and from “levying on” (seizing) your personal and business assets.

2. Stopping them from filing tax liens and from piling on greater penalties and interest.

3. Avoiding monthly tax payments, all the while penalties and interest continue to accrue.

Overall, bankruptcy gives you breathing room from your creditors, including the IRS, or the state or local taxing authority, that you can’t get any other way. It gives you a lot more control over a very powerful class of creditors. And your tax problems are resolved as part of your whole financial package, so you don’t find yourself working hard to deal with your taxes while worrying about being blindsided by other creditors.

If you have tax debt or any other kind of unmanageable debt, call me for a consultation: (201) 676-0722, or email me at weilattorney@gmail.com.

 

Photo credit: Liquidnight

Can you keep all of your stuff in bankruptcy?

Can you really keep everything you own all the way through bankruptcy?  You can usually keep items that you own outright (on which you do not owe any money) and you can usually keep those items on which you are making payments to a creditor (like your home or car), IF you can meet certain conditions. Most people who file for Ch. 7 bankruptcy can keep what they own because of laws known as “exemptions.”

Most people know that a they can get a discharge of debts in exchange for liquidating their assets – in other words, selling off your stuff.  BUT, don’t forget that you can keep whatever that the law protects. And MOST of the time, the law protects ALL of your stuff! So most people who file a Chapter 7 get a bankruptcy discharge without forking over any of their stuff.

“Exemptions” are listings of the types of stuff that the law protects from your creditors – these listings generally are found in statutes and they are generally limited by certain dollar amounts.  Exempt items are protected from the Chapter 7 trustee, who acts for the benefit of your creditors.

Exemptions can be complicated.  The Bankruptcy Code contains a set of federal exemptions and each state also has its own listings.  Some states, such as New Jersey, give you the choice to use either the federal or the state exemptions.  Other states only allow you to use the exemptions provided under state law.  If you have moved from another state fairly recently, you may have to use the exemption rules of your prior state.  Because each state’s rules can differ from one another, quite a bit of money might be at issue, depending on what day your bankruptcy is filed.

Once you know which set of exemptions you are going to use, it may not be crystal clear whether all of your stuff is protected. So deciding whether an item is exempt – protected – is often more complicated than scanning a list of exemptions and fitting all your assets in.  And what if you own one or more items that don’t fit any of the listed exemptions? Can the items be protected? These are all issues that you should discuss with a bankruptcy attorney before making any major decisions about your stuff.

Call (201) 676-0722 for a free New Jersey bankruptcy consultation.

Business debt can allow you to qualify for Ch. 7

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If you owe more business/non-consumer debt than consumer debt, then you avoid not only the “means test” but also some other roadblocks to a successful post-business Chapter 7 bankruptcy case.

What’s the “Means Test” and Why Does It Matter?

Bankruptcy law says that if your income is more than a certain amount, you have to pass a means test to be able to go through a Chapter 7 case successfully. One way to avoid this means test is by having less income than the permitted median family income for the state in which you live. But the median family income amounts are relatively low. If your income is above the applicable median amount, you have to go through the entire means test at the risk of being forced into a 3-to-5-year Chapter 13 payment plan instead of a three-month Chapter 7 liquidation.

Debtors with More Non-Consumer Debts than Consumer Debts

You can skip the means test altogether if your debts are not primarily consumer debts. This way you could be eligible for a Chapter 7 case even if your income is above the median level. Indeed, you avoid other kinds of “presumptions of abuse” as well, not just the formulaic means test, but also the broader “totality of circumstances” challenges. Congress decided that if most of your debts are from a failed business venture, you should be allowed a fresh start through Chapter 7, regardless of your current income and expenses.

What is a “Consumer Debt”?

The Bankruptcy Code defines a “consumer debt” as one “incurred by an individual primarily for a personal, family, or household purpose.”

The focus is on the reason why you incurred the debt. If you made a credit purchase or took out the loan for your business, then it may not be a “consumer debt.” That is a factual question that must be decided separately for each one of your debts.

“Primarily Consumer Debts”?

The Bankruptcy Code does not make this crystal clear, but generally, if the total amount of consumer debt is less than the total amount of non-consumer debts, your debts are not primarily consumer debts. And then you do not have to mess with the means test.

Seemingly Consumer Debts May Not Be

Small business owners often finance the start-up and operation of their businesses with what would otherwise appear to be consumer credit—credit cards, home equity lines of credit and such. These may qualify as non-consumer debts in calculating whether you have primarily consumer debts. Your use of various forms of personal credit to fund your business is something to discuss with your attorney.

Unexpectedly High Business Debts Can Help

Sometimes business owners end up with business debts larger than they thought they would have when their business closed. For example, if you had to break a commercial lease when you closed your business, the unpaid lease payments you owe could be huge. Or your business closure may have left you with other unexpected debts, such as obligations to business partners or litigation resulting in damages owed. The good side of larger-than-expected business debts is that they may allow you to skip the means test and other grounds for dismissal or conversion to Chapter 13, allowing you to discharge your debts through Chapter 7.

For bankruptcy in Northern New Jersey, call: (201) 676-0722.

What happens to general unsecured debt in Chapter 7?

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Examples of general unsecured debts include credit card debt and medical debt.  If you are thinking about filing for bankruptcy, you should know how these general unsecured debts are handled.

Secured debt usually is tied to your most important possessions, such as your home or your car. So it’s understandable that being able to keep these types of collateral will drive your bankruptcy decisions.  Likewise, your “priority” debts tend to involve your most aggressive creditors and often can’t be discharged in bankruptcy, so these also grab our attention. But it’s more likely that you owe more in general unsecured debt than in secured and priority debts combined.

What happens to general unsecured debt in a Chapter 7? It depends on 2 things: 1) “dischargeability,” and 2) asset distribution.

Dischargeability

Dischargeability refers to whether you are able to get a discharge of that debt in bankruptcy. The dischargeability of most general unsecured debt is not challenged. In the rare case that your discharge of general unsecured debt is challenged, you may have to pay back some or all of that particular debt. But this would depend on whether the creditor is able to show that the debt fits within some narrow grounds for non-dischargeability, such as fraud, misrepresentation, or other similar bad behavior on your part.

Asset Distribution

If everything you own is exempt, or protected, then your Chapter 7 trustee will not take any of it from you – this is called a “no asset” case. But if you have an “asset case,” where the trustee takes some of your assets for distribution to your creditors, your general unsecured creditors will not necessarily receive any of those assets. The trustee must first pay off any priority debts and must pay the trustee’s own fees and that of any other professionals who were hired. Only if any funds remain will the unsecured creditors get to share in the leftovers.

To summarize, in most Chapter 7 cases your general unsecured debts will be discharged, preventing those creditors from ever being able to pursue you for them. Also, these creditors will receive nothing from you, so long as all your assets are exempt. Relatively rarely, a creditor may challenge the discharge of its debt. And if you have an asset case, the trustee may pay a part or—very rarely—all of the “general unsecured debts,” but only if the priority debts and trustee fees do not exhaust all the funds being distributed.

 

What’s involved with discharging my debts under chapter 7?

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Discharge of debts

The point of filing bankruptcy is to get relief from your debts. So, when and how DO those debts get discharged in a regular Chapter 7 bankruptcy?

Here’s what you need to know:

1.      You’ll receive a discharge of your debts, so long as you play by the rules. Under Section 727 of the Bankruptcy Code, the bankruptcy court “shall grant the debtor a discharge” except in relatively unusual circumstances:

  • If you’re not an individual:  Corporations and other kinds of business entities do not receive a discharge of debts, only human beings do.
  • If you have received a discharge in an earlier case too recently. You can’t get a new discharge of your debts in a Chapter 7 case if:
    • you already received a discharge of debts in an earlier Chapter 7 case filed no more than 8 years before your present case was filed, or
    • you already received a discharge of debts in an earlier Chapter 13 case filed no more than 6 years before your present case was filed (except under limited conditions).
  • If you hide or destroy assets, conceal or destroy records about your financial condition.
  • If in connection with your Chapter 7 case you make a false oath, a false claim, or withhold information or records about your property or financial affairs.

2.      ALL your debts will be discharged, UNLESS a particular debt fits one of the specific exceptions. Section 523 of the Code lists those “exceptions to discharge.” I’m not going to discuss those exceptions in detail here, but the main ones include:

  • most but not all taxes
  • debts incurred through fraud or misrepresentation, including recent cash advances and “luxury” purchases
  • debts not listed on the bankruptcy schedules on time (although there is a major exception to this)
  • money owed because of embezzlement, larceny, or through other kinds of theft or fraud in a fiduciary relationship
  • child and spousal support
  • claims against you for intentional injury to another person or property
  • most but not all student loans
  • claims against you for causing injury or death to someone by driving while intoxicated (also applies to boating and flying)                                                                                                                   

3.      A discharge from the bankruptcy court stops a creditor from ever attempting to collect on the debt. Under Section 524, the discharge order acts as a court injunction any act to collect a debt. If a creditor violates this injunction by trying to pursue a discharged debt, the bankruptcy court may hold the creditor in contempt of court and, depending on the seriousness of its illegal behavior, can require the creditor to pay sanctions.

Photo credit:  Alan Cleaver

Debts in bankruptcy and how they’re treated

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Debt-is-Slavery-How-the-Things-You-Own-End-Up-Owning-You-v.2
One of the most practical questions you’re likely to have if you’re considering bankruptcy is what will happen to certain  debts:  Will you still owe money to certain creditors? What if you want to keep debts, like a vehicle loan or a mortgage? How are  special debts, such as income taxes and child support, handled?

One of the most basic principles of bankruptcy is that it treats all creditors in each legal category the same as all the other creditors in that category. There are three main categories of debts. Not everyone has debts in each of the three categories, but many people do. You should be able to start dividing your debts among the three categories. Then bankruptcy and how it deals with each of your creditors will begin to make more sense.

The three categories of debts are: Secured debt; general unsecured debt; and priority debt.

Secured debt

All debts are either secured by collateral or not. Whether a debt is secured is often straightforward, such as with a vehicle loan in which the vehicle’s title specifies your lender as the lienholder. The lien on that title, together with the documents you signed with the lender, gives that lender certain rights as to that collateral, such as the right to repossess it if you fail to make payments as agreed.

In the case of every secured debt, there is a legally prescribed way to attach the debt’s collateral to the debt. In the case of the vehicle loan, the lender and you have to jump through certain hoops for the lender to become a lienholder on the title. If those aren’t done right, the vehicle might not attach as collateral to your loan.

Debts can be fully secured or only partially secured. If you owe $10,000 on a vehicle worth only $8,000, the debt is only partially secured—secured as to $8,000, and unsecured as to the remaining $2,000.

Debts can be voluntarily or involuntarily secured. Examples of the latter are judgment liens on your home, IRS income tax liens on all your personal property, and a mechanic’s or repairman’s lien on a vehicle that’s been repaired and the repair bill not paid.

General unsecured debts

All debts that are not legally secured by collateral are unsecured. And “general” unsecured debts are those that don’t belong to any of the categories of “priority” debts, discussed below. General unsecured debt is a default category—it applies if a debt is unsecured and non-priority. This includes every imaginable type of debt or claim. Common ones include most credit cards, medical bills, personal loans with no collateral, bounced checks, most payday loans (although those sometimes have collateral), unpaid back rent and utilities, balances left over after a vehicle is repossessed, many personal loans, and uninsured or underinsured motor accident claims against you.

Sometimes debts that used to be secured can become unsecured, and vice versa. An example of the first: once you’ve surrendered all the collateral—such as a car on a car loan—any leftover debt is unsecured. And an example of the second: an unsecured medical bill can become secured after a lawsuit is filed against you and a judgment is entered that results in a judgment lien attached to your real estate.

Priority debts

Priority debts are special because the law treats them as better than general unsecured debts. There are specific levels of priority among all the priority debts.

It’s all about who gets paid first (which often means who gets paid at all), which comes up in two main ways:

First, most Chapter 7 cases don’t involve the trustee receiving any of your assets for distribution to your creditors (known as “no-asset cases”). But in those cases where there are non-exempt assets (known as “asset cases”), the priority creditors are paid in full before the general unsecured ones receive anything. And the higher priority creditors are paid in full before the lower priority ones.

Second, in a Chapter 13 case, your plan must show that you will pay all priority debts before the completion of your case and then you must actually do so before you are allowed to complete the plan.

The most common priority debts for consumers or small business owners are the following, in order starting from the highest priority:

• Child and spousal support—amounts owed as of the time of the filing of the bankruptcy case;

• The administrative costs of the bankruptcy case—trustee fees and costs, and in some cases attorney fees;

• Wages and other forms of compensation owed to employees—maximum of $10,000 per employee, for work done in the final 180 days before the bankruptcy filing or close of business, whichever was first; and

• Certain income taxes, and some other kinds of taxes—some are priority but others are general unsecured if they are old enough and meet some other conditions.

Reading over and thinking about these categories of debts can give you a good sense of where your debts fall in the grand scheme of things if you were to file for bankruptcy.

 

Pre-Bankruptcy Tax Strategies

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taxes-646511_1280Get the maximum benefit from your bankruptcy against your taxes by following these sophisticated strategies.

Pre-bankruptcy planning to position a debtor in the best way for discharging or for otherwise favorably dealing with tax debts is one of the more complicated tasks handled by a bankruptcy attorney. Do NOT attempt these strategies, including the five mentioned here, without an attorney, indeed frankly without an attorney who focuses his or her law practice on bankruptcy. Elsewhere in this website I make clear that you cannot take anything in this website, including what I write in these blogs, as legal advice. That’s especially true in this very sophisticated area. Also, I could write a chapter in a book on each of these five strategies, so all I’m doing here is introducing you to them, to begin the discussion when you come in to see me.

1st:  Wait out the appropriate legal periods before the filing of your bankruptcy case.

As you may know from elsewhere in these blogs, most (but not all) forms of income tax become dischargeable after the passing of specific periods of time. Much of pre-bankruptcy tax strategy turns on figuring out precisely when each of your tax liabilities will become dischargeable, and then either waiting to file bankruptcy until all those liabilities are dischargeable, or, when under serious time pressure to file, at least when the maximum amount will be discharged as is possible under the circumstances.

2nd:  File past-due returns to start the clock running on those as soon as possible.

If you know you owe taxes for prior years and don’t have the money to pay them, your gut feeling may well be to avoid filing those tax returns in an attempt to “fly under the radar” as long as you can. But irrespective of any other rules, you cannot discharge a tax debt until two years after the pertinent tax return has been filed. Get good advice about how to deal with the IRS or other taxing authority during those two years so that you take appropriate steps to protect yourself and your assets. You deserve a rational basis for getting beyond your understandable fears about this.

3rd:  Try to stay in compliance with the new tax year(s) while you wait to file your bankruptcy case, by designating tax payments to the more recent tax years instead of older ones.

Because recent tax year tax liabilities cannot be discharged in a Chapter 7 case and must be paid in full as a priority debt in a Chapter 13 case, you want to try to stay current on your most recent tax debts. It’s also usually a necessary step in keeping the IRS and its ilk from taking aggressive action against you, thus allowing you to wait longer and discharge more taxes. With the IRS in particular you can and should explicitly designate which tax account any particular tax payments are to be applied to achieve this purpose.

4th:  Avoid tax fraud and evasion, and whenever possible, withholding taxes.

Simply put, you can’t ever discharge any taxes related to fraud, fraudulent tax returns, or tax evasion, so avoid these kinds of illegal behavior. If you have any doubt, talk to a knowledgeable tax accountant or attorney. Unpaid tax withholdings also cannot be discharged, so either try to avoid them from accruing, focus your resources on paying them off, or just recognize that they will either have to be paid after your Chapter 7 case or as a priority debt during your Chapter 13 case.

5th:  Be aware of tax liens.

Tax lien claims have to be paid in full in Chapter 13, with interest, and can survive a Chapter 7 discharge. So try to avoid having the taxing authority record a tax lien against you—admittedly sometimes easier said than done. Or if that is not possible, at least refrain from building up equity in possessions or real estate. That equity, although often exempt from the clutches of the bankruptcy trustee and most creditors, is still subject to a tax lien. So any built up equity just increases what you will have to pay to the taxing authority on debt you might otherwise been able to discharge completely.

How to stop using your credit card for holiday gift-giving

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If you are thinking about filing for bankruptcy, do not accumulate any credit card debt for holiday gifts. Otherwise you may run into trouble over what debts are dischargeable in your case.  Instead, come up with thoughtful ways to express your love and appreciation for your loved ones that do not involve spending a lot of money on gifts this holiday season.

When money is tight, financial anxiety can cloud the holidays, making the temptation to use credit cards nearly irresistible. We live in a rather materialistic culture, so when we express our love and affection through gifts we tend to let price carry too much meaning, often by allowing the gifts we give to define our worth. That is particularly true with our close loved ones, whom we are reluctant to disappoint.

The feelings about expressing love through pricey gifts may be especially intense if there is tension in the marriage, or within the household, which is often the case when there are financial pressures.  But we all know that the price of a gift is not a true measure of our love and that gifts do not buy love. To help you follow your wiser impulses, here are three suggestions.

1.  Give gifts appropriate to your financial circumstances, no matter how modest they may be.  That is the only responsible way, and in fact shows your love—especially to family members—more than if you gave gifts you could not afford.

2.  Direct your energy toward coming up with a gift idea that reflects the connection between you and the intended recipient.  Make it a gift that the person will enjoy but also one that shows you really put thought into it.

3.  Communicate honestly with your loved ones about your financial circumstances.  Do this in a way that is appropriate for the relationship, which will be different for extended family, your significant other, and/or your children. This communication need not be negative.  Instead, it can be a constructive conversation about priorities, honesty, and your love for the other person.

Following these tips can be difficult, but sometimes it needs to be done.

Photo by Billy Halsey.

Student loan borrowers may see a little relief

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Beginning in 2012, about 1.6 million student loan borrowers will be able to make smaller monthly payments and make fewer payments before their balances are forgiven. President Obama announced these changes to the Income-Based Repayment Plan on October 26, 2011.

Here’s a short summary of the changes:

1. Monthly payments:  Under the Income-Based Repayment Plan, payments top out “at an amount intended to be affordable based on your income and family size.” The payment amount has been 15% of disposable income, but it’s going down to 10% only for students who are currently taking out Federal student loans or who have yet to take out new Federal student loans.

2. Repayment term:  The 25-year repayment period under the plan will be shortened to 20 years.

So if your income is low enough, your payments can be very low over the 20-year period.

Unfortunately, these Income-Based Repayment Plan changes only apply to people who 1) Graduate in 2012 or later, 2) Took out their first student loan no earlier than 2008, and 3) Will be taking out at least one new federal student loan in2012 or later. It is designed only for current and future student loan borrowers.

But even if you don’t qualify for new Income-Based Repayment Plan changes, the older version requiring payments of 15% of your income over 25 years can help by saving you money in your budget.

But a major limitation is that the Income-Based Repayment Plan does not apply to private student loans. To discover your options regarding private student loans, you must contact your lender.

And even if you do have a federal student loan, you cannot be in default on the loan to qualify for this Plan. To find out what type of student loans you have and their default status, go to the National Student Loan Data System for this and related information.

Photo by a.mina.

Be sure you file bankruptcy at the right time

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Sometimes the timing of your bankruptcy filing hardly matters, but other times it’s huge. The two examples in this post should convince you that you do not want to be rushed to file because a creditor got a judgment against you is now garnishing your wages. Since the timing of your bankruptcy filing can be a strategic decision, you should preserve the ability to file bankruptcy at a time that’s best for you.

1. Choosing between Chapter 7 and 13:  Being able to file a Chapter 7 generally requires you to pass the means test. This test largely turns on a very special definition of “income.” For many people, means test income can change every month. So you may not qualify to file a Chapter 7 one month but maybe you can the next month. Being able to delay filing means being able to file when you are likelier to pass the means test and not be forced into a Chapter 13. Chapter 7 cases are usually shorter and normally cost less than Chapter 13 cases.

2. Discharging debts:  Getting certain debts discharged can be more difficult if you incurred them within a certain amount of time before your bankruptcy case was filed. Delaying the filing of your case makes it less likely that the dischargeability of one of these debts would be successfully challenged. If a creditor is successful in challenging the dischargeability of a debt, you would still owe the debt, possibly along with the creditor’s costs and attorney fees and your attorney’s fees.

If you get sued, what do you do to avoid getting a judgment against you, so that you’re not rushed into filing bankruptcy at a bad time? See a bankruptcy attorney as soon as possible. The earlier you get advice, the more options you will have.

Photo by: mao_lini.