Debt Collection Protection Using Chapter 13 Bankruptcy Co-Debtor Stay

In most bankruptcy cases, a powerful tool called the “automatic stay” comes into existence the moment the case is filed. This “stay” prevents almost every type of debt collection from continuing.  A home foreclosure, car repossession, and garnishments all end by operation of law.  The automatic stay applies to the “debtor” or “debtors” who actually file the bankruptcy case.

But sometimes the debtor filing the bankruptcy has a co-debtor (someone who owes the debt jointly) who can’t or won’t file bankruptcy.  In those cases, the question becomes whether the automatic stay will stop debt collection activity for them as well.  In certain situations, it will via the “co-debtor stay”.

The Co-Debtor Stay and How it Works

Imagine a husband and wife who have jointly financed the purchase of some nice furniture for the family room.  They are both on the hook to pay the loan for the furniture either or both of them sign the loan documents.  (Arizona is a community state so what binds one spouse binds the other).

The couple later has financial problems and the wife decides to use chapter 13 bankruptcy to deal with the debt.  The husband doesn’t file the case with her. The wife is protected by the bankruptcy filing’s automatic stay…but is the husband as well?  Can the bank that lent the money on the furniture sue the non-filing husband who is outside the bankruptcy case?  No, the creditor can’t sue the Husband.

In a chapter 13 case, the automatic stay applies twice.  Once for the filer of the case and once to the co-debtor on a specific debt.

Even though we used a husband and wife example, the co-debtor stay applies to non-spouses as well in a chapter 13 bankruptcy.  It will protect anyone jointly responsible.

The Co-Debtor Stay has Some Limits

Not in Chapter 7 Bankruptcy

The first limitation on the co-debtor stay is that it never applies in a chapter 7 case.  Some people use chapter 13 bankruptcy just for the purpose of protecting a co-debtor even when chapter 7 makes more sense for other reasons.

Only Consumer Debt

The second limitation is that the co-debtor stay only applies to consumer debts.  A consumer debt according to the bankruptcy code is a debt incurred primarily for a personal, family or household benefit.  The co-debtor stay doesn’t apply to tax or business related debt.

Court Ruling

Under section 1301(c) of the bankruptcy code the Bankruptcy Judge can lift the co-debtor stay and allow the creditor to continue collection if the creditor files a motion and one of three circumstances are true.  First, if the co-debtor was the party that actually received the benefit of the loan as opposed the bankruptcy filer.  Second, if the chapter 13 filer’s plan doesn’t propose 100% payment on the creditor’s claim.  Third,  if the creditor would be irreparably harmed by the co-debtor stay.

Once a motion to lift or remove the co-debtor stay is filed, a hearing is held.  If the creditor is alleging that 100% of the debt won’t be paid, the stay is lifted automatically after 20 days if no objection is filed by the debtor or co-debtor.





Received a 1099 for canceled debt? Make sure it’s right

fix the 1099 form if incorrectly issuedCreditors like to issue 1099-c documents if they’ve worked out a settlement and decided to forgive the debt entirely.  Creditors also issue 1099 forms when bankruptcy is filed and it discharges the obligation to pay the debt.  These forms also show the IRS that the debt forgiven matches the amount written off in their own tax return.

Avoiding tax on forgiven debt

If the debt obligation is discharged in bankruptcy and the creditor issues a 1099 form, the law requires the bankruptcy filer to show the amount forgiven on the tax return. However, debt forgiven as a result of a bankruptcy discharge doesn’t cause “cancellation” of debt income and on IRS Form 982 the bankruptcy filer can make clear to the IRS that the forgiven debt isn’t taxable, by simply marking the box.

If the debt was forgiven outside of bankruptcy, then the amount of the debt that counts as income depends on how “insolvent” you were on the day before the forgiveness took place.  Form 982 is used again to show the IRS that the included debt forgiveness amount should be reduced as income based on the insolvency amount.  Talk to your Accountant about this.

If the debt was forgiven outside of bankruptcy, then the amount of the debt that counts as income depends on how “insolvent” the person was on the day before the forgiveness took place.  Form 982 is used again to show the IRS that the included debt forgiveness amount should be reduced as income based on the insolvency amount. Talk to your Accountant about this.

But what happens if the 1099-C is incorrectly issued

Sometimes a creditor will issue a 1099-C to someone who hasn’t actually filed for bankruptcy or settled the debt.  This tends to happen to a joint debtor whose partner on the debt has negotiated a settlement or filed for bankruptcy.  Usually, the partner is an ex-spouse but it can be a business partner or other family member.

Post-bankruptcy, the partner shouldn’t be receiving the 1099-c as the bankruptcy discharge doesn’t apply to the personal liability of that spouse, ex-spouse or other.

If this happens, the first step is to contact the creditor and ask them to correct the 1099 form.  The creditor issues the form to the individual several weeks before it sends the form to the IRS.  This provides enough time to make the contact and try to get the problem fixed.

If the form has already reached the IRS, a form 982 may need to be filed with the 1040 and an explanation attached containing the reason why the debt wasn’t actually forgiven, i.e. didn’t file for bankruptcy and no personal liability discharge occurred as a result.

Debt Settlement Versus Bankruptcy

For someone struggling with credit card debt, settling for less than the amount owed can be a real blessing until the 1099 form is received.  If money is being saved for the purpose of settling a debt, forgiven debt as income should be taken into account before a settlement is reached.  An advisor should be mapping out whether insolvency will be a way to avoid tax on the forgiven amount or not.

Bankruptcy avoids the issue entirely as debts discharged in bankruptcy aren’t treated as taxable income and the IRS won’t try to treat them this way as long as the 1040 form is accompanied by the 982 form and the correct box is checked.



IRS to begin using private collection within months

dl4In September of last year, the IRS issued a notice indicating an intent to use private debt collection services.  This is going to become reality when the collectors begin handling old accounts within a few months.

The IRS will send a notice explaining the details and the private debt collection agencies will also send a notice out explaining that it will not be enforcing debt collection.

These debt collectors will be subject to the Federal Fair Debt Collection Practices Act that imposes a penalty on collectors that don’t follow specific noticing rules, “abuse” the debtor, call the debtor’s friends and family etc.  The IRS isn’t subject to this act of course.  These collectors will have to identify themselves as contractors for the IRS and not as the IRS itself.  They also won’t be able to issue levies or take any time of affirmative action to collect the money other than to make contact.

Nonetheless, I anticipate a great deal of confusion as a result of the legitimate fears we all have of identity theft and other related problems.  Tax debtors will not be sure who to trust when receiving a call or a letter and criminals will likely find a way to take advantage of this.

If you receive a call or letter from a collection agency for the IRS, be careful about the information you provide.


Income Producing Assets in an IRS Offer in Compromise

imagesIf you own a business and that business has value, many people would assume that it should be included as an asset in calculating the amount of settlement.  As a result, many offers are calculated much higher than they should be.

Income producing assets in an IRS Offer in Compromise shouldn’t always be fully included in the calculation of “reasonable collection potential”.

When an Offer in Compromise is submitted to the IRS and that taxpayer owns business assets that produce income, it’s correct to adjust the income or the expense calculation to account for any loss of income if the asset were liquidated or used as collateral to secure a loan for purposes of funding the offer.

This analysis may even include a rental property.

The Internal Revenue Code defines rental property as a real estate trade or business.  Rental property is important to the production of income where it is actually being rented.  If the IRS were to treat the equity in the rental property as an asset for Offer in Compromise calculation purposes, it would then need to reduce the income from that rental property as well.

The reason so many people get this calculation incorrect is because the IRS forms 433A and 656 don’t specifically ask if any business assets are essential to the production of income.  Most offer in compromise “filers” simply add both the asset value and the income stream from the asset to the disclosures in 433A and to the calculation in the 656 form as a result.

When they do this, the IRS gladly accepts.  It won’t catch the mistake and fix it.  It definitely won’t make the argument for the taxpayer either.

If you own rental property or a business and have significant tax debt, keep in mind that the Offer in Compromise must take the above into account. The documents should contain and the argument must be made that either the equity should be excluded or the stream of income should be excluded from the income producing business asset when calculating a settlement amount in an Offer in Compromise.











3 Problems IRS Liens create if a bankruptcy is filed

elephant leaning on mom-thumb-375x282-55228When the IRS is owed more than $10,000.00, it will record a notice of federal tax lien in the County in which you or your real property are situated.  It will do this unless you’ve arranged a streamlined installment agreement, or you file a bankruptcy case before the recording occurs.

The recorded document puts the world on notice that the IRS has a lien on your stuff and makes it impossible to sell your home without obtaining the Government’s “permission”.

We’ve reviewed IRS liens and the options that exist to deal with them several times inside this blog.  Start here to read more about how liens are dealt with outside of bankruptcy.

When a bankruptcy case is filed, and the Filer has equity in a home and/or other substantial assets, another layer of complexity is added to the mix. There are 3 problems IRS liens create if a bankruptcy case is filed after the lien notice has been recorded


If the IRS has recorded it’s lien prior to filing the chapter 7 bankruptcy case,  and the underlying obligation to pay the debt is removed, the lien itself isn’t removed. Bankruptcy exemption laws don’t apply to IRS Liens.

If the bankruptcy filer has equity in a home or other assets that were subject to the lien prior to the bankruptcy filing, those same assets will be subject to the lien after the bankruptcy case is over.

In certain situations this isn’t a terrible thing.  Where the equity value in the assets is low, the IRS will sometimes just release the lien or agree to release the lien just because you asked.  Sometimes an amount offered that is less than the value of the asset(s) is paid in exchange for a release.

Even when the equity is large, it will make sense in certain situations to file the chapter 7.  As an example:

Mr. F owed the IRS $250,000.00 and his home had an equity value of $75,000.00 at the time of filing.  That equity was exempt in bankruptcy and safe from creditors, but not the IRS’ lien. He also owed other creditors $50,000.00.  He wasn’t a great candidate for an offer in compromise but he did qualify to file a chapter 7 and was able to discharge his tax obligation and credit card debt.  Post bankruptcy, the equity in the home had climbed to $85,000.00 making the lien more valuable. The IRS approached him and he agreed to pay them $50,000.00 in exchange for a release of the lien.


I mentioned above that the exemption law that might protect home equity during a bankruptcy, doesn’t protect that home’s equity from a tax lien. This problem shows up post bankruptcy when the IRS tries to collect on the assets as described above.

That same lien however does something that would surprise most bankruptcy filers.  It gives the Bankruptcy Trustee the ability to snatch the equity in the home under Bankruptcy Code Section 724(b).

The Bankruptcy Trustee rarely uses this power because it tends only to benefit the IRS and the IRS can collect it’s own equity post bankruptcy.

What needs to be understood though, is that many people file bankruptcy to discharge IRS debt and they understand that the lien will survive.  They’re taking the calculated risk that the IRS won’t try to collect the assets subject to the lien before the 10 year statute runs on collection post bankruptcy discharge.

Section 724(b) adds another layer of complexity to that decision, because the Trustee can use the lien to take the home, the filer has to assume the additional risk that the home equity may be grabbed before the bankruptcy case ever ends.


A chapter 13 bankruptcy isn’t a “liquidation” case like a chapter 7 bankruptcy.  Nobody is taking anything in a chapter 13 unless you ask them to.  The trade-off is that certain debts have to be paid over time to the Trustee for distribution to creditors in order to obtain a confirmed plan and an eventual discharge. Most secured debts have to paid to the Trustee through the plan.

If the IRS has recorded it’s lien and you have equity in assets, the IRS is a secured creditor as well.  In order to receive a confirmed plan and eventual discharge in the bankruptcy case, that lien’s value as of the filing date, has to be paid to the IRS with interest during the plan period.

Despite the fact that this sounds awful, it’s often the case that the overall situation lends itself to a chapter 13 filing. Chapter 13 Bankruptcy and it’s potential value has to be viewed with the big picture in mind.


If you have a large IRS debt and assets that would normally be exempt or safe in bankruptcy AND the IRS debt would potentially be discharged in bankruptcy, you will want to file a bankruptcy before the IRS records it’s lien notice if you were going to file a bankruptcy at all.  This would remove all 3 of the above problems.

Talking to an attorney who is experienced in bankruptcy and IRS debt sooner rather than later is absolutely necessary.