Posted by Kevin on July 29, 2020 under Bankruptcy Blog | 
In the last blog, we discussed the advantages of paying priority debts through a Chapter 13 “adjustment of debts” case. We referred to recent income taxes as one of the most important kinds of priority debt. Today we show how Chapter 13 can greatly help you take care of recent income tax debts.
Recent Income Taxes Can’t Be Discharged
The law treats some, usually more recent, income tax debts very differently than other, usually older, income tax debts. Generally, new income taxes are “priority” debts and can’t be discharged (written off) in bankruptcy.
There are two major conditions determining whether a tax debt can be discharged. (There are other conditions but they are not very common so we don’t address them here.) Bankruptcy does NOT discharge an income tax debt:
1. if the tax return for that tax debt was legally due less than 3 years before you file your bankruptcy case (after adding the time for any tax return-filing extensions) U.S. Bankruptcy Code Section 507(a)(8)(A)(i).
OR
2. if you actually submitted the tax return to the IRS/state less than 2 years before you file the bankruptcy case. Bankruptcy Code Section 523(a)(1)(B)(ii).
Two Examples
Assume you filed a bankruptcy case on December 10, 2019. You owe income taxes for the 2017 tax year. The tax return for that tax was due on April 17, 2018 (because of a weekend and holiday). (This assumes no tax return filing extension.) That’s much less than 3 years before the December 1, 2019 bankruptcy filing date. So, no discharge of the 2017 tax debt, because of the first 3-year condition above.
As for the second condition above, assume again that you filed your bankruptcy case on December 10, 2019. This time change the facts so that you submitted the tax return late for the 2015 taxes, on October 1, 2018. That’s less than two years before the December 10, 2019 bankruptcy filing date. So because of the second condition above, taxes due for 2015 would not get discharged in bankruptcy
Meeting either of the two conditions makes the tax debt not dischargeable. In the second example immediately above, more than 3 years had passed since the deadline to submit the tax return. (The 2015 tax return was due on or about April 15, 2016.) But less than two years had passed since the actual submission of the tax return. So, no discharge of the tax debt.
With no discharge, you would have to pay that income tax debt after finishing a Chapter 7 case. But there are advantages of paying this priority debt in a Chapter 13 case.
Advantages of Paying Priority Income Tax Debts in Chapter 13
Under Chapter 13:
- You are protected from aggressive collection by the IRS/state not for 3-4 months as in Chapter 7 but rather 3-5 years.
- This includes preventing any new recorded tax liens, and getting out of any installment payment plans.
- The amount you pay monthly to all your creditors, including the priority tax, is based on your actual budget. It’s not based on often arbitrary requirements of the IRS/state.
- The amount your priority tax gets paid each month (if any) among your other debts is flexible. You do have to pay all of the priority tax debt(s) by the time you finish your Chapter 13 case. That’s up to a maximum 5 years. But other more urgent debts (such as catching up on a home mortgage) can often get paid ahead of the taxes.
- Usually you don’t pay any ongoing interest or penalties on the tax during the Chapter 13 case. That takes away the need to pay it quickly. Plus the lack of additional interest and penalties significantly reduces the amount needed to pay off the tax debt.
- If the IRS/state recorded a tax lien against your home or other assets before you filed bankruptcy, Chapter 13 provides a very efficient and favorable forum to value and pay off that secured portion of the priority debt.
Posted by Kevin on July 26, 2020 under Bankruptcy Blog |
Chapter 13 gives you some advantages over Chapter 7 for paying your priority debts.
Priority Debts under No-Asset and Asset Chapter 7
Our last two blog posts dealt with priority debts in a No-Asset Chapter 7 case and in an Asset Chapter 7 case. While there are certain Chapter 7 strategies which may be somewhat helpful in dealing with priority debts, it is far from a panacea. Here are some of its shortcomings.
- You get only brief protection, or none at all, from your priority creditor(s). With income taxes, the IRS/state can resume collections when your Chapter 7 case is over. That’s only 3-4 months after you and you file the case. With child/spousal support, there is no protection at all: collection continues even during your Chapter 7 case.
- Because of this lack of legal protection, you have little or no leverage about the dollar amount of payments you pay on your priority debts. You are largely at the mercy of the IRS/state or the support enforcement agencies.
- In an asset Chapter 7 case, you have no control over the trustee’s sale of your asset(s). Plus you have to pay a significant amount for the trustee’s costs and fee. That reduces what goes to your priority debt(s).
The Benefits of Chapter 13
In contrast, Chapter 13, although not perfect, is better-designed for you to deal favorably with your priority debts. Here are its main benefits and advantages.
1. Ongoing Protection, for Years
The protection from creditors, called the automatic stay, lasts not 3-4 months but rather 3-to-5 years in Chapter 13. You can lose this protection under Chapter 13 if you don’t follow the requirements including making required payments in a timely fashion. But usually this sustained protection can be a powerful tool. It forces otherwise very aggressive creditors like the IRS/state and support enforcement to cooperate, or at least to back off during the course of the bankruptcy. Instead of these tough creditors having the law and the leverage on their side, Chapter 13 puts you much more in charge to formulate a plan that works for you.
2. Pay Monthly What You Can Afford to Pay
The practical leverage Chapter 13 gives you helps where it counts. It enables you to pay your priority debts under sensible and manageable payment terms. Priority debts are ones you have to pay regardless of bankruptcy. You mostly just wish that there was a way that you can spread these payments out. Chapter 13 can, under the right circumstances, provide that opportunity.
Here’s how it works. You and your bankruptcy lawyer propose, and the bankruptcy judge approves a payment plan. (This approval comes after permitted input from the Chapter 13 trustee and your creditors.) This payment plan is mostly based on how much you can actually afford to pay the pool of your creditors. You have to pay all your priority debts in full, but you have 3 to 5 years to do so.
You generally pay nothing on your other unsecured debts until you pay your priority debts in full. Under certain circumstances you may not be required to pay anything to general unsecured creditors. At the end of your case, if all payments are made and you otherwise comply with all the other requirements of Chapter 13, whatever you haven’t paid is discharged or wiped out. At that point you will have paid off your priority debts in full, and usually owe nothing to anybody.
3. Avoid Interest and Penalties
You can also avoid paying any interest or penalties on your priority debt(s) under Chapter 13.
For example, with recent income taxes, interest and penalties continue to accrue after you file your case. But as long as there no prior-recorded tax lien, and you successfully finish your case, you don’t pay these additional interest and penalties. You only pay the initial priority tax debt.
Furthermore, in most situations the penalties that accrued before your Chapter 13 filing are not a priority debt. This portion of your tax due at the time of filing is treated as general unsecured debt. This means it’s treated just like your unsecured credit cards or medical bills. You only pay it to the extent you have money available after paying the priority debts, if at all.
This combination—no accruing interest and penalties, and no penalties treated as priority—can significantly reduce how much you must pay. The less you have to pay as priority means the less you pay in your Chapter 13 payment plan. In bankruptcy speak, that means you need less money to propose a plan which is feasible. Among other things, you need a feasible plan to be considered for confirmation.
4. Pay Priority (and Secured) Debts Ahead of (and Instead of) Other Debts
If you have secured debts —a vehicle loan or home mortgage arrearage, for example—you often can pay these ahead of the priority debts. Your priority debts generally just have to wait, as long as you are appropriately following the payment plan and pay the priority debts in full by the end of the plan. Once again, in certain circumstances, the payment of secured and priority claims can lead to a discharge even if the general unsecured claims get nothing.
Posted by Kevin on July 22, 2020 under Bankruptcy Blog |
Your Chapter 7 trustee may pay your priority debts—in full or in part—through the proceeds of the sale of your unprotected, non- exempt assets.
Our last blog post was about what happens to priority debts in a no-asset Chapter 7 case. Most consumer “straight bankruptcy” Chapter 7 cases are no-asset cases. This means that the bankruptcy trustee does not take anything from the debtor because everything is protected and “no assets” are distributed to creditors. Hence, the name.
No-Asset Case Even If Some Assets May Not Be Exempt
To understand how this actually works, sometimes from a practical point of view, a Chapter 7 case is a no-asset one even when not all assets are exempt. That’s because the bankruptcy trustee has some discretion about whether to collect and liquidate an otherwise unprotected asset. Here are three reasons why he or she may not pursue an asset:
- The value of the asset, or the amount beyond the exemption, is too small to justify the trustee’s collection efforts. Example: A vehicle worth only a couple hundred dollars more than the vehicle exemption.
- Finding and/or selling the asset may be too expensive compared to its anticipated value. Example: A debt owed to the debtor by somebody who can’t be located and likely has no reliable income.
- The asset could be more of a detriment than a benefit to the trustee. Example: real estate with hazardous waste contamination.
Usually your bankruptcy lawyer will be able to reliably predict whether your Chapter 7 case will be an asset or no-asset case. But not always. Trustees have wide discretion about this. Moreover, before filing, your lawyer doesn’t know which trustee will be assigned to your case. And some trustees are more aggressive than others.
Paying Priority Debt through a Chapter 7 Asset Case
If you know that you will have an asset case, you may be able to pay a priory debt through your case.
In our last blog post our main point was that in a no-asset Chapter 7 case you have to pay any priority debts yourself directly to your creditors after completing the case. But in an asset case, the trustee is required to pay any of your priority debts before any other debts. The trustee collects and liquidates your non-exempt assets (any not protected by exemptions). From the proceeds he or she then pays you your exempt amount, and then pays his or her fee, and then pays debts only to the extent there’s money available. Priority debts get paid before general unsecured debts.
For Example
Assume you owe $4,000 to the IRS for last year’s income tax. That tax is a priority debt. You also owe $75,000 in medical bills and unsecured credit cards. Those are general unsecured debts. If you filed a Chapter 7 case in which everything you owned was protected, that would be a no-asset case. The IRS debt can’t be discharged (legally write off). So you would have to make arrangements to pay it after your Chapter 7 case was over. Most likely the case would discharge the $75,000 in other debts.
But now assume that you have a boat that you no longer want because it costs too much to maintain. There’s usually no exemption for a boat. So the Chapter 7 trustee takes and sells your boat for $5,000. The proceeds of that sale go first to pay the administrative fee of the trustee (since there is no exemption for the boat, the debtor gets nothing). A trustee gets a fee of 25% on the first $5000 of assets that are distributed. So, the trustee gets $1250, the IRS gets $3750 and general, unsecured creditor get nothing. You would be required to pay the IRS $250.
Conclusion
In some circumstances paying a priority debt in a Chapter 7 case is not a bad deal. This is especially true if you have an asset not protected by an exemption that you don’t mind surrendering.
Posted by Kevin on July 19, 2020 under Bankruptcy Blog |
Priority debts are largely unaffected by a Chapter 7 case—it does not discharge them, so you need to pay them after finishing your case.
Most Chapter 7 Cases Are No-Asset Cases
Chapter 7—“straight bankruptcy”—is the most common type of consumer bankruptcy case. They are generally the most straightforward, lasting about 4 months start to finish. Usually everything you own is protected by property exemptions. You discharge, or legally write off all or most of your debts. Secured debts like a home mortgage or vehicle loan are either retained or discharged. You either keep the collateral and pay for it, or surrender it and discharge the underlying debt. Bankruptcy does not discharge certain special debts like child/spousal support and recent income taxes.
A “no-asset” Chapter 7 case is one, as described above, in which everything you own is covered by property exemptions. So you keep everything you own (with the exception of collateral you decide to surrender). It’s called a no-asset case because your Chapter 7 trustee does not get any assets to liquidate and distribute to any of your creditors. A large majority of Chapter 7 cases are no-asset ones.
What Happens to Your Priority Debts in a No-Asset Chapter 7 Case?
Most debts that Chapter 7 does not discharge are what are called priority debts. These are simply categories of debts that Congress has decided should be treated with higher priority than other debts. In consumer cases the most common priority debts are child/spousal support and recent income taxes.
Priority debts generally get paid ahead of other debts in bankruptcy. This is true in an asset Chapter 7 case—where the trustee is liquidating a debtor’s assets. In fact, the trustee must pay a priority debt in full before paying regular (“general unsecured”) debts a penny!
But in a no-asset Chapter 7 case the trustee has no assets to liquidate. So he or she cannot pay any creditors anything, including any priority debts. So, essentially nothing happens to a not-dischargeable priority debt in a no-asset Chapter 7 case.
Dealing with Priority Debts During and After a Chapter 7 Case
However, one benefit you receive with some priority debts is the “automatic stay.” This stops (“stays”) the collection of debts immediately when you file a bankruptcy case. This “stay” generally lasts the approximately 4 months that a no-asset case is usually open. This no-collection period gives you time to make arrangements to pay a debt that is not going to get discharged. So you can start making payments either towards the end of your case or as soon as it’s closed. The hope is that you’ve discharged all or most of your other debts so that you can now afford to pay the not-discharged one(s).
The automatic stay applies to most debts, but there are exceptions. Child/spousal support is a major exception. Filing a Chapter 7 case does not stop the collection of support, either unpaid prior support or monthly ongoing support.
So, with nondischargeable priority debts that the automatic stay applies to, during your case you and/or your bankruptcy lawyer should make arrangements to begin paying that debt. With debts not covered by the automatic stay, you need to be prepared to deal with them immediately.
If neither of these make sense in your situation, consider filing a Chapter 13 case instead. TChapter 13 takes a lot longer—from 3 to 5 years usually. But if you have a lot of priority debt, it can help.
Posted by Kevin on under Bankruptcy Blog |
One of the most important aspects of bankruptcy is that all debts are not equal. “Priority” debts are treated special in a number of ways.
Debts Are Different So the Law Recognizes Some Differences
The law does not treat all debts the same. That’s because you have different kinds of creditors that you owe for very different reasons. The law tries to be practical and so to some extent it respects these differences.
Your debts all fall into three categories:
- Secured
- General unsecured
- Priority
Today we will start with priority debts.
Priority Debts
Priority debts are specific categories of debts that the law has decided should be treated as more important. Bankruptcy gives them higher priority, especially over “general unsecured” debts. Priority debts have power over you and over other debts in various ways.
Secured debts are debts with liens on something you own. Secured debts are special in that the creditor usually has a stronger position because of its lien. The lien gives the creditor power over you if you want to keep whatever secures the debt.
Most priority debts are unsecured, but some may have a lien and so are secured. Secured priority debts have that much more power over you and over other creditors.
Reasons for Priority
Each of the priority debt categories have their own different reason to be treated as special.
For example, the two most common categories of priority debts in consumer bankruptcy cases are:
- Child and spousal support
- Income taxes—certain income taxes that meet certain conditions. See Section 507(a)(8).
Support payments are special essentially because society very strongly believes that children and ex-spouses should receive the financial support ordered by divorce courts. Federal bankruptcy law incorporates this social attitude. So support debt has the highest priority in the list of priority debts.
Income tax debts are special because taxes are a debt to the public at large. It’s not a debt to a private person or business. In effect it’s a debt to us all. So it deserves a higher priority than regular private debt. However, unlike support debt which is always a priority debt, an income tax is a priority debt only if it meets certain conditions. Those conditions mostly relate to how old the taxes are. The newer the tax is the more likely it is to be priority. Income taxes that do not meet the required legal conditions are mere general unsecured debts.
Priority Debts in Bankruptcy
In most bankruptcy cases there isn’t enough money to pay all debts. So the laws that determine the order that creditors get paid often determine which debts receive full or partial payment and which receive nothing. Priority debts often receive full payment while general unsecured debts receive less or, often, nothing.
This works very differently under Chapter 7 “straight bankruptcy” vs. Chapter 13 “adjustment of debts.” Our next blog posts will show how.
Posted by Kevin on February 17, 2019 under Bankruptcy Blog |
“Adjustment of Debts of an Individual with Regular Income”
That is the formal name given to Chapter 13 of Title 11—the U. S. Bankruptcy Code.
As the word “Individual” indicates, you must be a person to file a Chapter 13 case—a corporation cannot file one. This also applies to a limited liability company (LLC) and other similar types of legal business entities.
But if you have a business which you operate as a sole proprietorship, you and your business can file a Chapter 13 case together.
The assets of your sole proprietor business are simply considered your personal assets. The debts of your business are simply your debts.
This is true even if your business is operated under an assumed business name or d/b/a.
Chapter 13 Helps Your Sole Proprietorship Business in 6 Major Ways
1) Chapter 13 addresses both your business and personal financial problems in one legal and practical package. You are personally liable on all debts of your sole proprietorship business, as well as, of course, your individual debts. So as long as you qualify for Chapter 13 otherwise, you can simultaneously resolve both your business and personal debts.
2) Chapter 13 stops both business and personal creditors from suing you, placing liens on your assets, and shutting down your business. The “automatic stay” imposed by the filing of your Chapter 13 case stops ALL your creditors from pursuing you, including both business and personal ones. Your personal creditors are prevented from hurting your business, and your business creditors are prevented from taking your personal assets.
3) Chapter 13 enables you to keep whatever business assets you need to keep operating. If you do not file a bankruptcy, and one of either your business or personal creditors gets a judgment against you, it could try to seize your business assets. Also, if you filed a Chapter 7 “straight bankruptcy,” under most circumstances you could not continue operating your business. However, Chapter 13 is specifically designed to allow you to keep what you need and continue operating your business.
4) Chapter 13 gives you the power to retain business and personal collateral which secure a business debt even if you are behind on payments. Chapter 13 will allow you to pay those arrearages over the term of the Chapter 13 plan which could be between 36-60 months usually with no interest.
5) If you have second or third mortgages of your personal residence which are completely underwater (e.g. residence worth $200,000 subject to a $225,000 first mortgage and a $60,000 home equity loan), Chapter 13 allows you to strip off the second mortgage and treat it like an unsecured date. That means that the $60,000 second gets paid for pennies on the dollar from your monthly payments to the Chapter 13 trustee. And if you successfully complete the Plan, the second mortgage must be cancelled of record.
6. Business owners in financial trouble are generally also in tax trouble. Chapter 13 gives business owners time to pay tax debts that cannot be discharged (permanently written off), all the while keeping the IRS and other tax agencies at bay. Chapter 13 usually stops the accruing of additional penalties and interest, enabling the tax to be paid off much more quickly. Tax liens can be handled especially well. At the end of a successful Chapter 13 case you will have either discharged or paid off all your tax debts, and will be tax-free.
Posted by Kevin on January 21, 2019 under Bankruptcy Blog |
Say you owe $8000 on your 2018 federal taxes and have $18000 of credit card debt. If you file under Chapter 7, you should discharge the $18,000 credit card debt, but you will owe the IRS $8000- and they will come after you.
Chapter 13 can help.
Payment of 2018 Income Taxes in Chapter 13 Case
Chapter 13 is a very flexible procedure, especially appropriate for taking care of income tax debt. If you file in 2019, your plan will include taxes owed in 2018. In fact, that 2018 taxes (and any other years) income tax MUST be paid in full under the terms of your Chapter 13 plan. But the requirement that you pay that tax in full can be used to your advantage in a Chapter 13.
Basic Benefits
No matter what else is going on in your Chapter 13 case, you get three major benefits for paying your 2018 taxes through it.
1. The IRS (and any applicable state income tax agency) cannot harass you during the repayment process.
2. You have much more flexibility on the terms for paying the 2018 tax, including the ability to delay paying anything while focusing on even higher priorities (such as a home/vehicle/child support arrearage).
3. No additional interest or penalties are added while you are in the Chapter 13 case, so you will pay less while paying off the 2018 tax debt.
Paying Off Your 2018 Tax For Free
Sometimes the fact that you owe some recent income taxes can cost you absolutely nothing beyond what you would have had to pay anyway through your Chapter 13 case. How could this be?
The justification for this comes from the Chapter 13 requirement that you must pay all your “disposable income” into your plan each month during the required period of time. Usually that means that all your creditors are scheduled to receive a certain percent of the debt you owe them. However, priority creditors (including taxes) and secured creditors are paid first, and then whatever is left over is divided among the “general unsecured” creditors (credit cards).
An Example
Say you have disposable income of $300 per month, a 3 year plan and general unsecured debts of $18,000. You have to pay into the plan (assuming no trustee or attorney fees for the sake of simplicity), $10,800 (36 months times $300 per month) which would go to “general unsecured” debts.
But now assume that you have a 2018 income tax debt of $8,000. You would still pay $300 per month for 36 months, but now the $8,000 income tax would be paid out first, reducing the amount paid out to the “general unsecured” creditors. Those creditors would receive only $2,800 ($10,800 minus $8,000) out of the $18,000 owed to them, and you still get a discharge.
Since those 2018 taxes are not dischargeable, you, are, in effect, paying your taxes off the backs of your unsecured creditors. And you not only discharge your credit card debt but you paid your taxes in full. Not bad.
Posted by Andy Toth-Fejel on November 11, 2018 under Bankruptcy Blog |
Chapter 7 vs. 13 for Income Taxes
Thinking that the only way to handle your income tax debts in bankruptcy is through Chapter 13 is a misunderstanding of the law. It’s an offshoot on the broader error that you can’t write off taxes in a bankruptcy.
Both are understandable mistakes.
It is true that some taxes cannot be discharged (legally written off) in bankruptcy. But some can.
And it is true that Chapter 13 can be the best way to solve many income tax problems. But that does not necessarily mean it is the best for you. Chapter 7 might be better.
When Chapter 13 Is Better
Chapter 13 tends to be the better option if you owe a string of income tax debts, and especially if some are relatively recent ones. That’s because in these situations Chapter 13 solves two huge problems in one package.
First, if you owe recent income taxes which cannot be discharged, you are allowed to pay those taxes over the term of your Chapter 13 plan (up to 60 months) usually avoiding most penalties and interest that would have accrued during the term of the plan. That can be a huge savings. Moreover, you can often hold off on paying anything towards the back taxes while you first pay even more important debts—such as back child support.
Second, if you have older back taxes, under Chapter 13, you pay these taxes as general unsecured debt under your plan. If you complete all payments under your plan and otherwise satisfy the requirements of Chapter 13 any remaining older taxes are discharged; i.e., wiped out.
When Chapter 7 is Better
But you don’t need the Chapter 13 package if all or most of your income tax debts are dischargeable. In that situation, the generally much simpler Chapter 7 could be enough.
So, what makes an income tax debt dischargeable under Chapter 7?
The Conditions for Discharging Income Taxes
To discharge an income tax debt in a Chapter 7 case, it must meet these conditions:
1) 3 years since tax return due: The tax return for the pertinent tax must have been due more than three years before you file your Chapter 7 case. Also, if you requested any extensions for filing the applicable tax returns, add that extra time to this three-year period.
2) 2 years since tax return actually filed: Regardless when the tax return was due, you must have filed at least two years before your bankruptcy is filed in court.
3) 240 days since “assessment”: The taxing authority must have assessed the tax more than 240 days before the bankruptcy filing.
4) Fraudulent tax returns and tax evasion: You cannot file a “fraudulent return” or “willfully attempt in any manner to evade or defeat such tax.”
These four conditions and the procedure for utilizing them are a bit complicated. Therefore, we advise that you retain an experienced bankruptcy attorney to assist you.
Posted by Kevin on October 21, 2018 under Bankruptcy Blog |
Debts in Bankruptcy
If you are thinking about bankruptcy there’s no more basic question than what it will do to each of your debts. Will it wipe away all your debts or will you still owe anybody? What about debts you would like to keep like your car or truck loan or your home mortgage? What help does bankruptcy give for unusual debts like taxes, or child and spousal support?
The Three Categories of Debts
At the heart of bankruptcy is the basic rule of treating all creditors within the same legal category the same. So we need to understand the three main categories of debts. You may not have debts in all three of these categories, but lots of people do. A basic understanding of these three categories will help make sense of bankruptcy, and make sense of how it treats each of your creditors.
The three categories of debts are “secured,” “general unsecured,” and “priority.”
Secured Debts
Every single debt is either “secured” by something you own or it is not. A secured debt is secured by a lien—a legal right against that property.
Most of the time you know whether or not a debt is secured because you voluntarily gave collateral to secure the debt. When you buy a car, you know that you are signing on to a vehicle loan in which the lender is put onto your car’s title as its lienholder. That lien on the title gives that lender certain rights, such as to repossess it if you don’t make the agreed payments.
But debts can also be secured as a matter of law without you voluntarily agreeing to it. For example, if you own a home and an unsecured creditor sues you and gets a judgment against you that usually creates a judgment lien against the title of your home. Or if you don’t pay federal income taxes you owe, the IRS may put a tax lien on all your personal property.
For a debt to become effectively secured, for purposes of bankruptcy, certain steps have to be taken to accomplish that. Otherwise the debt is not secured, and the creditor does not have rights against the property or possession that was supposed to secure the debt.
In the case of a vehicle loan, the lender and you have to go through certain paperwork for the lender to become a lienholder on the vehicle’s title. If those aren’t done right, the vehicle will not attach as collateral to the loan. That could totally change how that debt is treated in bankruptcy.
Finally, it’s important to see that debts can be fully secured or only partly secured. This depends on the amount of the debt compared to the value of the collateral securing it. If you owe $15,000 on a vehicle worth only $10,000, the debt is only partly secured—secured as to $10,000, and unsecured as to the remaining $5,000 of the debt. A partly secured debt may be treated differently in bankruptcy than a fully secured one.
In the next blog we will be reviewing general unsecured debts and priority debts.
Posted by Kevin on May 14, 2018 under Bankruptcy Blog |
Most people who close down a failed small business owe income taxes. Chapter 7 and Chapter 13 provide two very different solutions.
Here are the two options:
Chapter 7 “Straight Bankruptcy”
File a Chapter 7 case to discharge (permanently write off) most of your debts. This can include some or even all of your income taxes. If you cannot discharge all of your taxes, right after your Chapter 7 is completed, you (or your attorney or accountant) would arrange a payout plan (either lump sum or over time) with the IRS or other taxing authorities.
Chapter 13 “Adjustment of Debts”
File a Chapter 13 case to discharge all the other debts that you can, and sometimes some or even all the taxes. If you cannot discharge a significant amount of your taxes, you then pay the remaining taxes through your Chapter 13 plan, while under continuous protection of the automatic stay against the IRS’s or state’s collection efforts.
The Income Tax Factor in Deciding Between Chapter 7 and 13
In real life, especially after a complicated process like closing a business, often many factors come into play in deciding between Chapter 7 and Chapter 13. But focusing here only on the income taxes you owe, the choice could be summarize with this key question: Would the amount of tax that you would still owe after completing a Chapter 7 case (if any) be small enough so that you could reliably make workable arrangements with the IRS/state to pay off or settle that obligation within a reasonable time? If so, consider Chapter 7. If not, then consider Chapter 13 which provides the automatic stay during the 5 year period allowed to pay taxes.
How Do You Know?
To find out whether you need Chapter 13 protection, you need to find out from your attorney the answers to two questions:
1) What tax debts will not be discharged in a Chapter 7 case?
2) What payment or settlement arrangements will you likely be able to make with the taxing authority to take care of those remaining taxes?
The IRS has some rather straightforward policies about how long an installment plan can last and how much has to be paid. In contrast, predicting whether or not the IRS/state will accept a particular “offer-in-compromise” to settle a debt can be much more difficult to predict. Generally, it takes more attorney or accountant time to negotiate an offer in compromise, so the cost factor to the debtor should be considered.
When in doubt about whether you would be able to pay what the taxing authorities would require after a Chapter 7 case (either by installment plan or offer in compromise), or in doubt about some other way of resolving the tax debt, you may well be better off under the protections of Chapter 13.
Posted by Kevin on March 28, 2018 under Bankruptcy Blog |
Whether to file under Chapter 7 or Chapter 13 depends largely on your business assets, taxes, and other nondischargeable debts.
You have closed down your business and are considering bankruptcy. What are your options?
If you operated as a sole proprietor (DBA), then all the debts of the business are your personal debts. If you operated as a corporation or LLC, then the business was a separate entity. So, the business entity is liable for its debts, then, absent fraud, you are liable only for those debts which you personally guaranteed. In addition, you personally may be liable to taxing authorities for certain taxes.
Then, you have to consider remaining assets of the business. If a DBA, then you own the assets which become part of your bankruptcy estate upon filing. If it a corporation or LLC, then the entity owns the assets. But if you are the 100% owner of the business, then the stock or other ownership interest is an asset of the bankruptcy estate. So, the trustee can get to the assets through your ownership interest.
Your options would be to file under Chapter 7 or Chapter 13. A Chapter 7 is generally over in 4-5 months and requires no payments. A Chapter 13 lasts from 36-60 months and requires payments each month. It would be understandable if you preferred to file under Chapter 7.
Likely Can File Under Chapter 7 Under the “Means Test”
The “means test” determines whether, with your income and expenses, you can file a Chapter 7 case. The “means test” will still not likely be a problem if you closed down your business recently. That’s because the period of income that counts for the “means test” is the six full calendar months before your bankruptcy case is filed. An about-to-fail business usually isn’t generating much income. So, there is a very good chance that your income for “means test” purposes is less than the published median income amount for your family size, in your state. If your prior 6-month income is less than the median amount, by that fact alone you’ve passed the means test and qualified for Chapter 7.
Three Factors about Filing Chapter 7 vs. 13—Business Assets, Taxes, and Other Non-Discharged Debt
The following three factors seem to come up all the time when deciding between filing Chapter 7 or 13:
1. Business assets: A Chapter 7 case is either “asset” or “no asset.” In a “no asset” case, the Chapter 7 trustee decides—usually quite quickly—that all of your assets are exempt (protected by exemptions) and so cannot be taken from you to pay creditors.
If you had a recently closed business, there more likely are assets that are not exempt and are worth the trustee’s effort to collect and liquidate. If you have such collectable business assets, discuss with your attorney where the money from the proceeds of the Chapter 7 trustee’s sale of those assets would likely go, and whether that result is in your best interest compared to what would happen to those assets in a Chapter 13 case.
2. Taxes: It seems like every person who has recently closed a business and is considering bankruptcy has tax debts. Although some taxes can be discharged in a Chapter 7 case, many cannot. Especially in situations in which a lot of taxes would not be discharged, Chapter 13 is often a better way to deal with them.
3. Other nondischargeable debts: Bankruptcies involving former businesses get more than the usual amount of challenges by creditors. These challenges are usually by creditors trying to avoid the discharge (legal write-off) of its debts based on allegations of fraud or misrepresentation. The business owner may be accused of acting in some fraudulent fashion against a former business partner, his or her business landlord, or some other major creditor. These kinds of disputes can greatly complicate a bankruptcy case, regardless whether occurring under Chapter 7 or 13. But in some situations Chapter 13 could give you certain legal and tactical advantages over Chapter 7.
Posted by Kevin on April 3, 2017 under Bankruptcy Blog |
Same facts as previous blog.
- Without a bankruptcy, a couple would have to pay about $30,000 to the IRS for back taxes, plus about another $45,000 in medical bills and credit cards, a total of about $75,000.
- Under Chapter 13, this same couple would pay only about $18,000—36 months of $500 payments.
How Does Chapter 13 Work to Save So Much on Taxes and Other Debts?
- Tax debts that are old enough are grouped with the “general unsecured” debts—such as medical bills and credit cards. These are paid usually based on how much money there is left over after paying other more important debts. This means that often these older taxes are paid either nothing or only a few pennies on the dollar.
- The more recent “priority” taxes DO have to be paid in full in a Chapter 13 case, along with interest accrued until the filing of the case. However: 1) penalties—which can be a significant portion of the debt—are treated like “general unsecured” debts and thus paid little or nothing, and 2) usually interest or penalties stop when the Chapter 13 is filed.
- “Priority” taxes—those more recent ones that do have to be paid in full—are all paid before anything is paid to the “general unsecured” debts—the medical bills, credit cards, older income taxes and such. In many cases this means that having these “priority” taxes to pay simply reduces the amount of money which would otherwise have been paid to those “general unsecured” creditors. As a result, in these situations having tax debt does not increase the amount that would have to be paid in a Chapter 13 case, which is after all based on what the debtors can afford. In our example, the couple pays $500 per month because that is what their budget allows.
- The bankruptcy law that stops creditors from trying to collect their debts while a bankruptcy case is active—the “automatic stay”—is as effective stopping the IRS as any other creditor. The IRS can continue to do some very limited and sensible things like demand the filing of a tax return or conduct an audit, but it can’t use the aggressive collection tools that the law otherwise grants to it.
Deciding Between Chapter 7 and 13 for Income Taxes
If, unlike the example, all of the taxes were old enough to meet the conditions for discharging them under Chapter 7, there would be no need for a Chapter 13 case (but may require additional work in a Chapter 7). On the other hand if more “priority” tax debts had to be paid than in the example, the debtors would have to pay more into their Chapter 13 plan, either through larger monthly payments or for a longer period of time.
There are definitely situations where it is a close call choosing between Chapter 7 or Chapter 13. And sometimes preparing an offer in compromise with the IRS—either instead of or together with a bankruptcy filing—is the best route. To decide which of these is best for you, you need the advice of an experienced bankruptcy attorney to help you make an informed decision and then to execute on it.
Posted by on March 30, 2017 under Bankruptcy Blog |
If you owe recent income taxes, or multiple years of taxes, Chapter 13 can provide huge advantages over Chapter 7, and over other options.
The Example
Consider a husband and wife with the following scenario:
- Husband lost his job in 2008, so he started a business, which, after a few promising years in which it generated some income, failed in late 2012.
- The wife was consistently employed throughout this time, with pay raises only enough to keep up with inflation.
- They did not have the money to pay the quarterly estimated taxes while husband’s business was in operation, and also could not pay the amount due when they filed their joint tax returns for 2008, 2009, 2010, 2011 and 2012. To simplify the facts, for each of those five years they owe the IRS $4,000 in taxes, $750 in penalties, and $250 in interest. So their total IRS debt for those years is $25,000—including $20,000 in the tax itself, $3,750 in penalties, and $1,250 in interest.
- Husband found a reliable job six months ago, although earning 20% less than he did at the one he lost before he started his business.
- They filed every one of their joint tax returns in mid-April when they were due, and have been making modest payments on their tax balance when they have been able to.
- They have no debts with collateral—no mortgage, no vehicle loans.
- They owe $35,000 in medical bills and credit cards.
- They can currently afford to pay about $500 a month to all of their creditors, which is not nearly enough to pay their regular creditors, and that’s before paying a dime to the IRS.
- They are in big financial trouble.
Without Any Kind of Bankruptcy
- If they tried to enter into an installment payment plan with the IRS, they would be required to pay the entire tax obligation, with interest and penalties continuing to accrue until all was paid in full.
- The IRS monthly payment amount would be imposed likely without regard to the other debts they owe.
- If the couple failed to make their payments, the IRS would try to collect through garnishments and tax liens.
- Depending how long paying all these taxes would take, the couple could easily end up paying $30,000 to $35,000 with the additional interest and penalties.
- This would be in addition to their $35,000 medical and credit card debts, which could easily increase to $45,000 or more when debts went to collections or lawsuits.
- So the couple would eventually end up being forced to pay at least $75,000 to their creditors.
Under Chapter 13
- The 2008 and 2009 taxes, interest and penalties would very likely be paid nothing and discharged at the end of the case. Same with the penalties for 2010, 2011, and 2012. That covers $11,500 of the $25,000 present tax debt.
- The remaining $13,500 of taxes and interest for 2010, 2011, and 2012 would have to be paid as a “priority” debt, although without any additional interest or penalties once the Chapter 13 case is filed.
- Assuming that their income qualified them for a three-year Chapter 13 plan, this couple would likely be allowed to pay about $500 per month for 36 months, or about $18,000, even though they owe many times that to all their creditors.
- This would be enough to pay the $13,500 “priority” portion of the taxes and interest, plus the “administrative expenses” (the Chapter 13 trustee fees and your attorney fees).
- Then after three years of payments, they’d be completely done. The “priority” portion of the IRS debt would have been paid in full, but the older IRS debt and all the penalties would be discharged (written off), likely without being paid anything. So would the credit card and medical debts.
After the three years, under Chapter 13 the couple would have paid a total of around $18,000, instead of eventually paying at least $75,000 without the Chapter 13 case. They’d be done—debt-free—instead of just barely starting to pay their mountain of debt. And they would have not spent the last three years worrying about IRS garnishments and tax liens, lawsuits and harassing phone calls, and the constant lack of money for necessary living expenses.
The next blog post will follow up on this theme.
Posted by Kevin on March 29, 2017 under Bankruptcy Blog |
Many people believe that bankruptcy can’t write off any income taxes. In fact, it is not uncommon for non-bankruptcy attorneys to lump taxes in with other priority debts like alimony and child support payments (which are not dischargeable) and student loans (which are dischargeable in bankruptcy upon a showing of undue hardship).
Through the next few blog posts, you’ll learn what taxes can be discharged and what can’t. 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, which I will explain carefully in those blogs.
Besides the possibility that you may be able to discharge some or all of your taxes, bankruptcy can also:
1. Stop tax authorities from garnishing your wages and bank accounts, and levying on (seizing) your personal and business assets.
2. Prevent post petition accrual of interest and penalties in certain situations.
3. If paid through a plan, limits your payments to what is affordable as opposed to what the taxing authority demands.
4. Eliminate other debts so that money is available to pay the taxing authority.
Overall, bankruptcy gives you unique leverage against the IRS and/or your state or local tax authority. It gives you a lot more control over a very powerful class of creditors. Your tax problems are resolved not piecemeal but rather as part of your entire financial package. So you don’t find yourself focusing on your taxes while worrying about the rest of your creditors.
The laws relating to taxes and bankruptcy are somewhat complex and not easily handled by “do it your selfers”. It is recommended that a prospective debtor seek out an attorney with experience in taxes and bankruptcy.
Note I mentioned students loans above. If that is your issue, you can contact me on this website or on http://studentdebtnj.com
Posted by on July 22, 2016 under Bankruptcy Blog |
Many of the laws about bankruptcy are time-sensitive. When your case is filed can have significant consequences. This blog will address how timing of a bankruptcy filing can effect what debts can be discharged.
Income Taxes Can Be Discharged, with the Right Timing
Federal and state income taxes are forever discharged if you meet a number of conditions. Two of the most important of these conditions are met by just waiting long enough before filing your bankruptcy case:
- Three years must have passed since the time that the tax return for that tax was due (plus any extension if you asked for one).
- Two years must have passed since you actually filed the pertinent tax return.
For example, assume a taxpayer owes $10,000 to the IRS for the 2009 tax year. She had asked for an extension to file that year to October 15, 2010, but then did not actually file that tax return until October 31, 2011. The above 3-year condition is met after October 15, 2013, because that is three years after the tax return was due. But the 2-year condition has to be met as well, which would not occur until after October 31, 2013, two years after the actual tax return filing date. So filing a bankruptcy case on or before October 31, 2013 would leave that $10,000 tax debt still owing; filing on November 1, 2013 or after would result in it being discharged forever. Simply waiting this one day makes a difference of $10,000.
Now, there are other conditions involved in getting taxes discharged. So, it would be wise to seek professional help.
Posted by on August 15, 2015 under Bankruptcy Blog |
If you had struggled to keep a business open, but have decided to throw in the towel, there’s a good chance you owe taxes. Here’s how to deal with them.
The Basic Choice
Let’s assume that you are seriously considering filing bankruptcy, but want to know your options.
You have two choices within bankruptcy for addressing tax debts after closing down a small business:
1. File a Chapter 7 case to discharge (legally write-off) all the debt that you can, which may include some of your tax debt, and then deal directly with the IRS and any other tax authorities to either pay the rest of the taxes in monthly installment payments or to negotiate a settlement (called an Offer in Compromise in the case of the IRS).
2. File a Chapter 13 case to deal with all your debts, which again may include the discharge of some of your tax debt, while you pay the rest of the taxes through a court-approved Chapter 13 plan, and being protected throughout the process from collection actions by the IRS and any other tax authorities.
Putting aside the many factors distinct from taxes, choosing between Chapter 7 or 13 comes down to this key question: Would the amount of tax that you would still owe after completing a Chapter 7 case be small enough so that you could reliably make reasonable payments to the Internal Revenue Service (or other tax authority) which would satisfy that obligation within a sensible time period?
Answering that Question
The idea is that Chapter 7 is likely the way to go if you don’t need the long-term protection that comes with Chapter 13. In a Chapter 7 case, once that case is completed—usually only about three to four months after it is filed—the IRS/state can resume collection activity on the taxes that were not discharged in bankruptcy. You clearly want to avoid that. So a Chapter 7 makes sense ONLY IF before any collection activity begins you have arranged with the IRS/state to make payments, and 1) those payments are reasonable in amount, 2) your circumstances are stable enough so that you are confident that you will be able to pay them consistently, and 3) the length of time you would be making payments does not stretch out so long that the interest and penalties get too high.
Your attorney will be able to tell you—usually with high reliability—which tax debts will and will not be discharged in a Chapter 7 case, and thus how much in taxes you still owe. Then the next step is determining what the IRS/state would require you to pay in monthly payments, or possibly would accept in settlement. Your bankruptcy attorney may be able to give you guidance about this, or may need to refer you to a tax specialist (usually an accountant). Once you know the likely monthly installment payment amount—assuming you go that route—then you need to seriously consider whether that would be an amount you could reliably, reasonably pay, without incurring too much in interest and penalties before you paid it off.
If so, Chapter 7 likely is more appropriate. If not, then Chapter 13 is likely better because it gives you much more protection.
Posted by on August 11, 2015 under Bankruptcy Blog |
The IRS is just another creditor that you can get immediate protection from by filing bankruptcy. With some exceptions.
The “Automatic Stay”
The filing of a bankruptcy case—either Chapter 7 or 13—triggers one of the most powerful tools of bankruptcy—the “automatic stay.” That’s the aggressively protective law that goes into effect 1) automatically the instant your bankruptcy case is filed at court 2) to stay—which means stop—all collection activity against you and against any of your assets.
The Bankruptcy Code includes a list of what creditors cannot do because of the “automatic stay.” Here are some of them (focusing on those readily applicable to the IRS):
- start or continue a lawsuit or administrative proceeding to recover a debt you owe
- take possession or exercise control over property you own as of the time your bankruptcy is filed
- create or enforce a lien against such property
- collect by any means any debt that existed before the bankruptcy filing
Applied to the IRS
The IRS and similar state agencies are certainly not treated like your conventional creditors when it comes to the discharge (legal write-off) of your debts. But in most respects they ARE treated the same for purposes of the “automatic stay.”
The Bankruptcy Code says that the “automatic stay” “operates as a stay, applicable to all entities.” (11 U.S.C. Section 362 (a).) Is the IRS an “entity”? The Code explicitly defines that term to include “governmental unit.” (Section 101(15).) So the IRS and all tax collecting “governmental units” are governed by the “automatic stay.”
What If the IRS Still Tries to Collect
Just like any other creditor, the IRS can get slapped pretty hard if it violates the “automatic stay” by continuing to collect on a debt or taking any other of the forbidden actions. If you are
“injured by any willful violation of [the automatic] stay… [you] shall recover actual damages, including costs and attorneys’ fees, and, in appropriate circumstances, may recover punitive damages” against the IRS. (Section 362(k).) Indeed on occasion the IRS HAS been slapped hard. It now tends to follow the law and respect the “automatic stay” quite faithfully.
Special Exceptions to the “Automatic Stay” for “Governmental Units”
The IRS and state tax agencies do have some specialized exceptions—things they can continue doing in spite of your bankruptcy filing. (Section 362(b)(9).) But these are sensible exceptions that apply more to the determination of amount of a tax debt than to its actual collection. These tax agencies can demand that you file your tax returns, can make an assessment of the tax and tell you how much you owe, and can do an audit to figure out the amount you owe. They cannot create a tax lien or take any other collection action.
Posted by on June 11, 2015 under Bankruptcy Blog |
Did You Know…
- The first income tax was enacted during the Civil War, but it expired a few years after the war ended.
- The first peacetime income tax was passed in 1894, an effort of the Populists to get the wealthy to pay a greater share of the cost of the national government. It was a two percent tax on incomes over $4,000 (worth about $108,000 in today’s dollars), which at the time affected only about the top two percent of wage earners.
- The next year the U.S. Supreme Court overturned this law as unconstitutional, in a 5-4 decision. Pollock v. Farmers’ Loan & Trust Co., 158 U.S. 161 (1895).
- A constitutional amendment to allow an income tax was proposed by the Republican President William Howard Taft, and the resolution for that amendment was passed by Congress with the Republicans in control of both the Senate and the House of Representatives.
- The entire Sixteenth Amendment states: “The Congress shall have power to lay and collect taxes on incomes, from whatever source derived, without apportionment among the several states, and without regard to any census or enumeration.”
- After the required 3/4ths of state legislatures (36 of the 48 then-existing states) ratified it, on February 25, 1913 the Sixteenth Amendment was proclaimed ratified and became part of the Constitution.
So February 25, 2013 was the 100 year anniversary of the income tax becoming constitutional. Funny, I don’t remember any anniversary celebrations!
The MOST Interesting Facts
As the blogs in this series on taxes have been describing, bankruptcy can help you with income tax debts in a variety of ways. If it’s true that in life the facts that are most interesting to you are those that are going to help your pocketbook, then check out the following facts:
- Some income taxes CAN be forever discharged (legally written off).
- Taxes can be discharged under either Chapter 7 or Chapter 13, depending on which is right for you based on your other circumstances.
- The protection from creditors you receive by filing bankruptcy—the “automatic stay”—protects you from the IRS (and other tax creditors) like any other creditor.
- In a Chapter 13 payment plan, that protection can last for 3 to 5 years, giving you that much time to pay taxes that can’t be discharged.
- Even if you owe a tax that can’t be discharged, a Chapter 7 bankruptcy can put you in a much better position afterwards either to enter into a payment plan or negotiate a settlement.
- Chapter 13 usually stops accruing interest and penalties on tax debts that can’t be discharged, reducing the overall amount you have to pay.
- If you owe a number of years of income taxes, Chapter 13 is often an excellent tool because all your taxes—as well as all your other debts—are handled in one tidy package.
Taxes and bankruptcy DO mix, often greatly in your favor.
Posted by on May 30, 2015 under Bankruptcy Blog |
If you can’t discharge your income tax debt through Chapter 7, or make workable payment arrangements on the remaining tax debt, then Chapter 13 can be a good solution.
The Previous Chapter 7 Options
A consistent theme through these past blogs has been that in many situations you do not need to incur the extra expense and time of going through a three-to-five-year Chapter 13 case when other solutions will work. But Chapter 13 IS often an excellent mechanism for resolving all your income tax debts (and usually all your other debts, too).
Chapter 13 Can Be the Easiest Way to Address Your Income Tax Debts
A Chapter 13 payment plan is often a significantly easier way to deal with income tax debts than the other alternatives because:
1. The payment amount going to the taxes are often more reasonable than the IRS/state would require. That’s because they are based on what you can actually afford, by allowing you more reasonable amounts for your expenses.
2. Your Chapter 13 case incorporates ALL your debts in one package, so that you are not forced to satisfy the IRS/state to the exclusion of other important creditors (such as your mortgage, vehicle payments, and child/spousal support). The taxes may have to wait their turn to be paid after debts that are a higher priority for you, instead of just getting paid first.
3. Putting all your debts into one Chapter 13 package also includes all categories of your income taxes—particularly those that are being discharged and those that aren’t. This avoids the situation under Chapter 7 in which you discharge some of the taxes but then have to deal directly with the IRS/state for the taxes that were not discharged.
4. The payments going to the IRS/state can be adjusted during the course of the Chapter 13 if your circumstances change, usually without much room for their objection.
Chapter 13 Can Be a Cheaper Way to Pay Non-Discharged Taxes
It can be cheaper because:
1. In contrast to the other scenarios, under Chapter 13 usually no more interest and penalties can be added after the case is filed.
2. Often you don’t have to pay even the previously accrued penalties.
3. If you have a tax lien attached to any of your tax debts, the lien can sometimes be paid off more cheaply by paying the secured value of the lien instead of the full tax.
If your tax debt is high, and you are paying into your plan for the full five years, these savings can amount to many thousands of dollars.
Chapter 13 Is a Safer Way to Pay Non-Discharged Taxes
It’s safer because:
1. Instead of being at the mercy of the IRS/state if you are not able to make a payment, under Chapter 13 your “automatic stay” protection from all your creditors—including tax creditors—persists throughout your case. So you are not a hair-trigger away from being hit with tax liens, or levies on your wage and bank accounts.
2. You CAN lose this protection, but if you and your attorney deal with your situation proactively you can usually preserve it.
3. This protection is particularly important when your circumstances change—instead of being at the mercy of the IRS/state, your attorney can make adjustments to your Chapter 13 plan. Or if necessary, even more aggressive or creative steps may be appropriate, such as changing to a new bankruptcy case. The point is that you usually have much more control over the situation.
Posted by on May 24, 2015 under Bankruptcy Blog |
Give gladly to your Chapter 7 trustee assets that you don’t need, if most of the proceeds from sale of those assets are going to pay your taxes.
We are in a midst of a series of blogs about bankruptcy and income taxes. Today we describe a procedure that doesn’t happen very often, but in the right circumstances can work very nicely.
Turning Two “Bad” Events into Your Favor
Most of the time when you file a Chapter 7 “straight bankruptcy,” one of your main goals is to keep everything that you own, and not surrender anything to the Chapter 7 trustee. To that end, your attorney will usually protect everything you own with appropriate property “exemptions.”
If instead something you own can’t be protected, and so must be surrendered to the Chapter 7 trustee, that’s often considered a “bad” thing because you’re losing something.
And that leads to a second “bad” thing—the trustee selling that “non-exempt” property and using the proceeds to pay your creditors. That usually does you no good because those creditors which receive payment from the trustee usually are ones that are being written off (“discharged”) in your Chapter 7 case, so you’d have no legal obligation to pay anyway.
But it may well be worth giving up something you own—particularly if it is something not valuable to you in your present circumstances—if doing so would have the consequence of paying some or all of your income tax debt that isn’t being written off in your Chapter 7 case.
Circumstances in which the Trustee would Pay Your Income Taxes
Consider the combination of the following two circumstances:
1) You own something not protected by the applicable property “exemptions,” which you either don’t need or is worth giving up considering the other alternatives.
2) The proceeds from the trustee’s sale of your “non-exempt” asset are mostly going to be paid towards taxes which otherwise you would have to pay out of your own pocket.
Let’s look at these two a little more closely.
“Non-Exempt” Assets You Don’t Need or Are Worth Giving Up
Although most people filing bankruptcy do NOT own any “non-exempt”—unprotected—assets, there are many scenarios in which they do. In some of those scenarios, those assets are genuinely not needed or wanted, so giving them to the trustee is easy. For example, a person who used to run a now-closed business, and still owns some of its assets, may have absolutely no use for those business assets. Or a person may own a boat, or an off-road vehicle, or some other recreational vehicle, but because of health reasons can no longer use them.
More commonly, a person may own a “non-exempt” asset which he or she would prefer to keep, but surrendering it to the trustee is much better than the alternative. That alternative is often filing Chapter 13—the three-to-five year payment plan. In the above example of a boat owned by somebody who can no longer use it, he or she may have a son-in-law who would love to use that boat. But that would probably not be worth the huge extra time and likely expense of going through a Chapter 13 case.
Allowing Your Trustee to Pay Your Non-Discharged Income Taxes
Letting go of your unnecessary or non-vital assets makes sense if most of the proceeds of the trustee’s sale of those assets would go to pay your non-dischargeable income taxes. Under what circumstances would that happen?
The Chapter 7 trustee is required by law to pay out the proceeds of sale of the “non-exempt” assets to the creditors in a very specific order. If you don’t owe any debts which have a higher “priority” than your income taxes, then the taxes will be paid in full, or as much money as is available, ahead of other creditors lower in order on the list.
The kinds of debts which are AHEAD of income taxes on this priority list include:
- Child and spousal support arrearage
- Wages, salaries, commissions, and employee benefits earned by your employees (if any) during the 180 days before filing or before the end of the business, up to $10,000
- Contributions to employee benefit plans, with certain limitations
If you know that you do not owe any of these higher “priority” debts, then the trustee will pay your taxes (after paying the trustee’s own fees), to the extent funds are available, assuming the tax creditor files a “proof of claim” on time specifying the tax debt.
As you can imagine, each step of this process must be carefully analyzed by your attorney to see if it is feasible, and if so then it must be planned and implemented by your attorney. Again, it will only work in very specific circumstances. But when the stars are aligned appropriately, this can be a great way to get your taxes paid.
