TAX DEBT AND HIGH INCOME? Bankruptcy may be the solution

johnny unitas-thumb-375x487-61910Tax Debt and High Income?  Bankruptcy may be the solution

More than 1 million people each year file for bankruptcy in the United States. That number always incudes some famous types. Yes famous and “important” people use Bankruptcy. In fact many people are shocked when they see the long list. My list of favorites include:

President Abraham Lincoln
Walt Disney
Henry Ford
President U.S. Grant
Jerry Lewis
Johnny Unitas (yes I know..even Unitas)

 

Dionne Warwick has recently joined the list. You can read more about her bankruptcy filing here.

Ms. Warwick filed her Chapter 7 Bankruptcy case in New Jersey. Some important and interesting disclosures at least for our purposes…include the following:

Assets

Artwork $5000.00
Gowns and Clothes $5000.00
Fur Coats and Diamonds $13000.00
Pension Plan unknown

Income

Wages $5000.00 per month
Social Security Income $2200.00 per month
Pension $14000.00 per month
Royalties $1000.00 per month

Partial Budget

Rent $5000.00 per month
utility costs $2100.00 per month
home maintenance $1000.00 per month
Laundry and Dry Cleaning $750.00 per month
Transportation costs $1000.00 per month
House keeping $5000.00 per month
Personal Assistant $4000.00 per month

Debt

She listed more than $10,000,000.00 in debt, mostly owed to the IRS and the State of California. Much of it more than 15 years old.

The schedules are interesting to a boring attorney who deals with debt problems for a living, but they should also be of great interest to anyone in Arizona who has serious tax debt.

There are a number of reasons why:

1. Income Tax Debt and some other types of tax debt are dischargeable in Bankruptcy

I find myself repeating this on a constant basis. YES…the obligation to pay income tax debt can be discharged or wiped away as a result of a bankruptcy filing depending on the “circumstances”.

The basic circumstances are those related to dates. The tax debt in question has to be based on a tax return that was:

a. due to be filed more than 3 years before the bankruptcy filing
b. actually filed by the person and not the IRS more than 2 years before the bankruptcy
c. assessed or entered into the IRS’ books more than 240 days before the bankruptcy filing

The point…? If the tax debt meets the criteria for discharge, bankruptcy has to be considered. Ms. Warwick considered it.

2. IRS Offers in Compromise Don’t Always Work

Whenever serious tax debt exists, the question immediately becomes… will the IRS settle the tax debt for less than what I owe? For some people yes…for most people no. There are a number of reasons why. The basic explanation as to why many people don’t qualify for an Offer in Compromise is as follows:

Whether you meet the initial criteria to settle tax debt depends on a set of rules. Negotiating an Offer in Compromise isn’t like trading a horse for 3 bags of seed.

The first rule is that your excess income plus your assets cannot be large enough to pay the tax debt over the time remaining in the statute of limitations period for collection of the debt.

The IRS has 10 years from assessment to collect the debt. That 10 years can be extended for any number of reasons. The clock doesn’t start to run until the assessment date which is often delayed because the returns aren’t filed on time. Time in tax court, time in certain appeals, prior offers, prior bankruptcies all extend the 10 year clock as well. Some of this probably explains why Ms. Warwick’s IRS debt is so old and still in existence.

The second rule is that the IRS gets to use a budget to calculate the excess income that is it’s own…and not necessarily Ms. Warwick’s real budget

There are other rules that govern how the actual offer amount is calculated…but these two rules weed lots of people out… all by themselves.

AND…even if the IRS imposed excess income number will leave less than the total debt over the remaining life left in the statute period, the IRS can reject the Offer for other reasons and they do it all the time. You will notice that some articles about her Bankruptcy mention her inability to make a deal with the IRS.

3. What you earn and spend…shouldn’t matter in an Arizona Chapter 7 Bankruptcy if the majority of your debt is tax debt

Bankruptcy law limits your allowable budget in an effort to determine how much you can afford to pay your creditors, much like the IRS does when you file an Offer in Compromise.

Many people fail this “Means” test. Ms. Warwick would not have qualified to file a chapter 7 bankruptcy either IF her debt were mostly credit card, mortgage and other consumer debt.

If you look closely at her schedules you will notice something important. Her form B22A which is typically filled out to prove to the Bankruptcy Court that you pass the means test and belong in Chapter 7 Bankruptcy…is mostly blank.

It is blank except for two small squares that are blacked out. The important square for this discussion is the square that “declares” that Ms. Warwick’s debts are primarily “non-consumer” debt.

She darkened this square because her tax debt… far exceeds her non-consumer debt. She knows that as a result, the means test doesn’t apply to her and she gets to file a chapter 7 bankruptcy.

She gets to file for bankruptcy even though she spends $2000.00 per month on utilities and has a driver, a housekeeper and a personal assistant.

The same is true for you in Arizona. No, you don’t get to hire a personal assistant…but you do get to qualify for a chapter 7 bankruptcy If you have tax debt that is the largest portion of all your debt.

At least until the law changes.

 

BANKRUPTCY – 9 COMMON MISCONCEPTIONS

images-thumb-375x534-61823There are lots of misconceptions about bankruptcy. I hear quite a few and I have tried to make a list of the most common.

Misconception Number 1 – TAXES CAN’T BE DISCHARGED IN BANKRUPTCY

Income Tax

Tax on Income can be wiped away in bankruptcy as long as it meets some basic criteria. It is the most common type of tax debt that is dealt with in bankruptcy. I have helped clients discharge millions of dollars in income tax debt.

Other tax debts can be dealt with in bankruptcy as well.

The non-trust fund portion of the payroll tax.

Small businesses have to withhold an employees’ income tax, social security and medicare tax and than they have to match a certain portion of that payroll tax and send it all in. (6.2% social security tax and 1.45% medicare tax) If the entire amount isn’t sent in, the small business owner in a sole proprietorship or single member LLC will owe the entire amount personally.

The portion that is withheld from the employee’s check is called a “trust fund tax” and isn’t ever dischargeable in bankruptcy.

The employer portion can be discharged in bankruptcy assuming no “tolling” events have occurred when:

More than 3 years from the date the employment tax return was due and the date the bankruptcy is filed have elapsed

More than two years have gone by between the date the returns were actually filed and the date of the bankruptcy filing and;

No “willful evasion” or purposeful attempt to avoid the obligation to pay took place.

Arizona Transaction Privilege Tax

The Arizona Transaction Privilege Tax is a sales tax but it isn’t collected from the customer. It is tax on the privilege of doing business paid based on a percentage of sales. It is not “trust fund”. If it meets criteria similar to the criteria mentioned above under Non Trust Portion of Payroll Tax, it may also be discharged in Bankruptcy.

Tax Penalty

The IRS issues various penalties related to income tax debt. The big ones are the “failure to file a tax return on time” penalty and “failure to pay” the debt penalty.

These penalties add up fast and with interest will often double the debt.

In a chapter 7 bankruptcy these penalties are dischargeable if they meet the three basic date rules…the same rules that are required for the discharge of the underlying income tax debt.

3 years between due date of return and filing date of bankruptcy
2 years between actual filing date and filing date of bankruptcy
240 days between assessment date and bankruptcy filing date

What if the underlying debt hasn’t met meet one of these rules. In a chapter 7 case, the debt and the penalty survive the bankruptcy.

In a chapter 13 bankruptcy however, the penalty and the interest on the penalty is treated as non priority dischargeable debt no matter it’s age.

The chapter 13 bankruptcy is an important tool in dealing with debt as a result. Especially for those people who have income tax debt with lots of penalty and none of it has met the date requirements for discharge, but there are other creditors forcing the person into bankruptcy.

Misconception Number 2 – YOU WILL LOSE YOUR HOME

In Arizona, $150,000.00 equity in a personal residence is safe from creditors. This same rule applies in a bankruptcy case.

The simple example:

You live in a home valued at $300,000.00, and the mortgage is $200,000.00.
Equity is $100,000.00 and the equity is safe.

But what if you aren’t making your mortgage payment? The Bank that owns the mortgage will foreclose on the home but not the Bankruptcy Court.

Misconception Number 3 – YOU GET TO CHOOSE WHICH CREDITORS TO “INCLUDE”

A common misunderstanding and a potentially dangerous one. All info has to be disclosed to the Bankruptcy Court. Your assets, debts, income and budget. Failure to disclose can be considered a crime.

The Bankruptcy Code determines how a creditor is treated whether it is disclosed or not and that treatment depends on a number of things like when the money was borrowed, type of debt, secured vs unsecured, priority vs. non-priority.

When you file bankruptcy make sure and tell the attorney every debt you have.

Misconception Number 4 – YOU CAN LOSE YOUR JOB IF YOU FILE FOR BANKRUPTCY

The employer is barred from firing because you filed for bankruptcy. The employer can decide not to hire based on a bankruptcy filing though.

Misconception Number 5. YOU HAVE TO BE “DESTITUTE” TO FILE FOR BANKRUPTCY

The bankruptcy code doesn’t contain a “really broke” provision. Many people file that have an income and who are able to pay their basic bills. Some are even able to file who make a better than decent income. Many assets are protected as well up to certain values like:

Home – Equity to 150,000.00
Tax Qualified Retirement Accounts and pensions
Certain Whole Life Insurance Policy Cash Value Amounts
1 Car per person up to $5000.00 in equity
Most household Furniture
Clothing, Wedding Rings, Gun
Six Months of Food Fuel and Provisions

Misconception Number 6 – EMPLOYER IS NOTIFIED OF THE BANKRUPTCY FILING

The employer doesn’t receive a notice of the bankruptcy unless you owe him or her some money. However, filings are in the public record.

Misconception Number 7 – MY CREDIT WILL BE BAD FOR TEN YEARS

Most bankruptcy filers see some improvement after a relatively short period of time 1 to 2 years, especially if they apply some effort after the case is over to rebuild the credit score.
Bankruptcy often improves the credit score of many with already bad credit.

Misconception Number 8 – I CAN GIVE MY STUFF AWAY AND PROTECT IT FROM BEING TAKEN IN THE BANKRUPTCY CASE

If you give away an asset to anyone within a few years of filing the bankruptcy case you have to disclose it to the Court when you file and the trustee can sue the transferee for a return of the asset or it’s value. You must sell the asset for market value.

Don’t move assets around until you have spoken with an experienced attorney.

Misconception Number 9 – I HAVE TO FILE BANKRUPTCY JOINTLY

You may be able to file alone and in Arizona still give your spouse the benefit of the bankruptcy discharge i.e. protection from creditors. It is called the “community discharge”. Speak with an experienced attorney about this.

BANKRUPTCY AND THE IRS COLLECTION DUE PROCESS APPEAL – The relationship is important

crossing paths - snow-thumb-375x249-61715Bankruptcy and the IRS Collection Due Process Appeal – The relationship is important

The Bankruptcy Code and the Tax Code cross paths on a regular basis. One example of this is when a taxpayer has filed a “Collection Due Process” Appeal with the IRS and used it to eventually negotiate a payment plan.

While the Collection Due Process appeal has it’s advantages…it stops IRS collections, buys time, and allows you to discuss your legal proposal with an IRS appeals officer rather than a revenue officer or IRS automated collections… it has a downside when it comes to filing bankruptcy.

When the appeal is filed, the clock that determines when tax debt can be discharged in bankruptcy is “tolled” or stopped.

A few basic tax discharge rules:

1. The bankruptcy must be filed at least 3 years after the tax return was due to be filed including extensions.

2. The bankruptcy must be filed at least 240 days after the IRS places the amount you owe in it’s records. (known as the “assessment” date)

These time periods are tolled while the collection due process appeal is in place plus an extra 90 days. You can see the bankruptcy code section at 507(a)(8)(G).

An example of how this works:

If your 2009 tax return was filed on May 28th of 2010, and assessed on May 28th of 2010 and no extension to file was used:

The 3 year rule would require that the bankruptcy be filed on or after April 15th 2013, 3 years+ from the date the return was due to be filed, (not the date actually filed has to do with a separate rule – the two year rule not discussed here)

The 240 day rule would have easily been met by the time the 3 year rule was met.

The tax debt would meet the date requirements for bankruptcy discharge on the latest required date or the 3 year date requirement here.

However…if you filed a collection due process appeal at any time between your assessment date and the 3 year date above…both the 3 year date and the 240 day date would be tolled by whatever time period you were in the appeal process plus ninety days.

If the appeal process were 6 months long or 180 days, than the 3 year rule wouldn’t be met until 270 days + days after the original 3 year rule was met or April 15th, 2013 + 270 days.

Conclusion

You may be surprised at how often the time spent in an appeal isn’t reviewed prior to filing a bankruptcy case. Many bankruptcy filers think that their tax debt is going to be removed and find out after the bankruptcy case is over that a step in the analysis was missed.

If you have a large tax debt…and are considering bankruptcy, be certain that the history of your account with the IRS is closely reviewed and that all the events that toll the time periods are taken into account. It may be necessary to stay in the IRS payment plan for a longer period than you had hoped in order to make the bankruptcy code work for you.

Sidenote

Only timely filed collection due process appeal requests toll the 3 year and the 240 day rules. Timely filing is 30 days from the date the IRS mails the Final Notice of Intent to Levy.

Late filed collection due process appeal requests shouldn’t toll these periods. Sometimes it makes sense to file the collection due process appeal late.

CREDIT CARDS AND 1099 FORMS – When the debt is forgiven how to avoid the tax

Antique_Mailbox-thumb-375x341-49286CREDIT CARDS AND 1099 FORMS – When the debt is forgiven how to avoid the tax

Many of our Clients receive or are expecting to receive
a 1099 form in the mailbox from Creditors that have or will be forgiving credit card debt.

The Creditor may have forgiven the debt as part of a settlement or just forgave it because it made sense.

The 1099 form the creditor issues to you isn’t a good thing. It tells the IRS that the credit card debt was forgiven and that the forgiven portion is now taxable income. If you fail to list it on your tax return as income the IRS will change your return and add it. It will then send you a bill.

If you have negotiated a settlement with a credit card lender, or one just forgave a debt without your input…you should be concerned about the potential tax liability.

Here are 3 ways to avoid the liability:

1. Bankruptcy

If the debt obligation was discharged in a bankruptcy case, it can’t be counted as taxable income. My Arizona clients often weigh out whether it makes more sense to try and settle credit card debt or whether it makes more sense to file for bankruptcy.

In making that decision, the ability to treat the debt as non-taxable as a result of the bankruptcy filing has to be taken into account.

If you are sent a 1099 for a debt that was discharged in bankruptcy and the 1099 was issued after the filing of the bankruptcy, talk to your accountant about a form 982 to use with your tax return. This form tells the IRS that the discharged debt isn’t taxable.

2. Insolvency

If you were “insolvent” just before the debt was forgiven, the debt is tax free to the extent of the insolvency. If the debt was greater than your assets by $50,000.00 at the moment before the forgiveness occurred, you would be able to have $50,000.00 of the debt forgiven and avoid tax on it.

The form 982 is key here again. If you don’t file it with the return, the IRS will treat the debt as income.

3. Principal Only

Only the forgiveness of the principal portion of the debt is taxable…. not the interest.

IRS LEVY A CONCERN? Four steps you should always take

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IRS LEVY A CONCERN? Four steps you should always take

Stephen J. Dunn at Forbes has written a short article that caught my eye about “Dealing with IRS Collection Action“.

His article provides some “big picture” and makes the following suggestions that I agree with:

1. Always Open Mail From the IRS

Mr. Dunn makes the point that correspondence from the IRS has a purpose. Failing to open is usually the first step toward a bad outcome. A good example of this is when a taxpayer fails to open a letter called a  “Final Notice of Intent to Levy”.

The IRS is required to send this letter to the taxpayer before it can levy a paycheck or freeze an account.  If the taxpayer opens this letter instead of dropping it a box, he or she would have seen an opportunity to file a collection due process appeal.  This appeal would have bought the taxpayer more time to get finances in order and avoid enforced collection by the IRS.

Another letter that is consistently left unopened is the IRS letter indicating an Audit or the completion of a substitute tax return. Failure to open those letters and respond often end up in the creation of thousands of dollars of incorrectly assessed debt.

No matter how scary the letter looks, open it. Share it with an experienced tax resolution attorney who will be able to advise you and then commit to do something about it.

Otherwise it usually gets worse.

Video: How To Prevent An IRS Levy by Tax Debt Lawyer In Mesa AZ

There is one thing that people often ask a Mesa tax lawyer, and that is how to prevent a levy or a collection
generally by the IRS when they know they owe, and they know the IRS is on the way.

2. Convince the IRS to Hold Collection Activity

The IRS doesn’t have to stop levy activity just because you ask it to. Read more about when it has to stop collection activity here – “IRS Levy – 13 Common Situations When the IRS Can’t or Won’t Levy your Assets or Garnish your Paycheck“.

If the IRS hasn’t started to levy an account or garnish a paycheck, the IRS collection personnel will often agree to hold collections activity for a few weeks to give your attorney time to: review your finances, the history of the account, which returns need to be filed, statute of limitations periods, bankruptcy dates and to determine which legal option may be the best to propose.

If this step isn’t taken i.e. if at least some time isn’t obtained to determine the issues above, you will face a difficult situation: IRS Levy and no time to figure out how best to deal with it.

3. Investigate – Analysis can be everything

We need to know a number of facts in order to determine the legal option or options that make the most sense to pursue. In order to do this, we look at IRS account transcripts to help determine:

Statute of Limitations on Collection
Bankruptcy Discharge Dates
Which returns need to be completed
Which ones need to be challenged
Incorrect Income Reporting by 3rd parties
Incorrect Debt Calculation by the IRS
Whether penalties have been correctly assessed

We also look at our client’s income, budget, and asset history to help calculate whether an offer in compromise may make sense and what changes can be made to help it work.

We find that many people skip the analysis step and don’t apply the law to their set of facts. They end up in a payment plan that doesn’t work or filing an offer in compromise that isn’t going to happen.

4. Propose a Solution to the IRS that will work

The solution may be one or more of the following:

Offering to settle for less than what is owed – IRS Offer in Compromise
Negotiating a payment plan based on actual income and expenses
Negotiating a streamlined plan
Creating tax returns that are missing
Creating tax returns and using them to challenge the IRS debt incorrectly created by its tax return
Bankruptcy
Penalty Abatement
Innocent Spouse Negotiation

Until you know the history of the case, the income, budget, asset situation and the law, you won’t necessarily know what the best option or group of options will make the most sense.

photo credit: wordofgodmission.com

Michael Anderson, Tax Lawyer In ArizonaWritten By:

Anderson Tax Law
2158 N. Gilbert Rd. Ste 101
Mesa, Arizona 85203

Phone: (480) 507-5985
Fax: (480) 507-5988
Email: [email protected]
Website: https://taxlawyeraz.com

IRS LEVY – Two reasons to file the IRS Collection Due Process Appeal late

jim brown si-thumb-375x498-60919IRS LEVY? Two reasons to file the IRS Collection Due Process Appeal late

The IRS is a debt collection machine. If there were an NFL Draft for debt collection outfits, the IRS would be the first player drafted every year.

Part of the reason why the IRS is so good at its job is because it has it’s hands “untied”. Unlike normal creditors the IRS doesn’t have to file a lawsuit and obtain a Judgment to begin the collection process. It just has to “assess” or place the debt into its books as an amount owed and issue some notices to the taxpayer by mail.

There are just a few ways to slow it down. One of the most important is the ability of the taxpayer to file a Collection Due Process Appeal.

If the IRS levy machine is the equivalent of Hall of Fame Running Back Jim Brown, the Collection Due Process Appeal is the equivalent of Dick Butkus.

The Collection Due Process Appeal, properly and timely filed, will stop the IRS collection activity cold, until a referee steps in to determine whether there is a better alternative than levy or garnishment. That referee is initially an Appeals Officer with the IRS, but it can be the US Tax Court. This type of Appeal levels the playing field.

So if the Collection Due Process Appeal is so great…why in the world would I tell you that there may be two occasions when you should file it late i.e. not on time.

Let me explain:

Filing the Collection Due Process Appeal late is called an “Equivalent Hearing” request. “Equivalent” to a Collection Due Process Hearing….

It isn’t really equivalent though because when you file the appeal late, you will lose a few rights:

1. The right to have your case heard by the appeals officer

The IRS doesn’t have to stop the levy activity and give you a chance to be heard by the appeals officer. These equivalent hearings are granted on a case-by-case basis and aren’t absolute.

However, the Internal Revenue Manual guides tells the IRS to process the late appeal and give the taxpayer a hearing while placing a hold on collections. In most cases the IRS does this…even if the request if filed a year late (1 year is the deadline to file the late request)

2. You lose your ticket to US Tax Court

You will not be able to ask the Tax Court to rule on the reasonableness of the IRS collection activity. Most people don’t anyway.

So again…why not just file the appeal on time?

Two reasons:

1. When you don’t want to stop the Statute of Limitations clock from ticking

As you probably know, the IRS has 10 years to collect the debt. The timely filed Collection Due Process Appeal stops this clock form running. If you are close to the 10 year period, and in your situation it would make sense overall, the equivalent hearing request will typically allow you to get your hearing and the benefit of a shorter collection clock.

2. When you don’t want to stop the clock from running on the discharge of tax debt in bankruptcy

The Collection Due Process Appeal will stop 2 of the 3 time periods that must be met in order to treat income tax as dischargeable in a bankruptcy case.

a. The 3 year rule – the bankruptcy must be filed more than 3 years after the return was due to be filed

b. The 240 day rule – the bankruptcy must be filed more than 240 days after the debt is assessed or placed in the books by the IRS

Equivalent hearing requests don’t stop either clock. If you are otherwise a good candidate for bankruptcy, and the timeframes to get you there are what is holding you back, you will not want to stop those time frames from running by requesting the wrong type of hearing.

image credit – si

BANKRUPTCY WILL STOP THE IRS LEVY

chess-thumb-375x374-60916BANKRUPTCY WILL STOP THE IRS LEVY

The IRS likes to garnish paychecks and levy bank accounts and other property. This is the primary way that it pushes people into payment plans that haven’t already negotiated one or filed an offer in compromise. There are several ways to stop a levy or other collection action by the IRS (read this) but often the best way to stop it is to file a bankruptcy case.

A bankruptcy filing creates an automatic stay. This means that the moment the bankruptcy is filed; creditors…including the IRS have to stop collection efforts. If a paycheck is being garnished, it has to stop. The Bankruptcy Code trumps the tax code and removes any IRS discretion in this area of the law. Specifically, Section 362(a) of the Bankruptcy code requires that the stay occur.

Stopping IRS collection activity is just the beginning though of what the bankruptcy may do.

The taxpayer may be able to:

1. Stop future IRS lien filings
2. Discharge the obligation to pay tax debt
3. Stop the IRS from adding additional interest and penalty to the debt (Chapter 13 Bankruptcy)
4. Create a payment plan on the non-dischargeable debt tax debt that may be far less than an IRS Installment Agreement would be (Chapter 13 Bankruptcy)
5. Reduce or eliminate other debt, like credit card debt, debt related to repossession, personal loans etc.

If you are having a problem negotiating an offer in compromise with the IRS, or if your IRS plan payment is too high, or if you have tax debt and other debt problems, bankruptcy may be the answer…not just to stop IRS collection activity but also to find a fresh start.