There 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
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.
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.