Tax 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
President U.S. Grant
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:
Gowns and Clothes $5000.00
Fur Coats and Diamonds $13000.00
Pension Plan unknown
Wages $5000.00 per month
Social Security Income $2200.00 per month
Pension $14000.00 per month
Royalties $1000.00 per month
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
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.