10 Bankruptcy FAQ

images (6)1. BANKRUPTCY – WHAT IS IT?

Bankruptcy is a process that takes place in Federal Court. The Bankruptcy Code governs the process and it is designed to provide debt and other relief to consumers and small businesses. Most consumers and small business people file a bankruptcy as a “liquidation” case called a Chapter 7, and some consumers and small business people file a “Reorganization” bankruptcy or Chapter 13.  Very few Consumers or Small Business People file a Chapter 11 Bankruptcy, which is typically used for Corporate Reorganization of Debt.

In a Chapter 7 Bankruptcy you are asking the Court to wipe away as many debts as can be wiped out according to Bankruptcy Code. In a Chapter 13 Bankruptcy you are asking the Court to reorganize your financial life, pay some debts, wipe away others, primarily based on what you can afford and what types of debt you have.When you file a bankruptcy a Court Order automatically goes into affect. This is called the Automatic Stay and it stops most creditors from collecting during the case.

Certain types of debt survive a chapter 7 bankruptcy like child support, spousal maintenance, certain tax debt, most student loan debt and debts incurred fraudulently.

2. HOW DO I KNOW WHICH CHAPTER, CHAPTER 7 OR CHAPTER 13 I SHOULD FILE?

When you file a chapter 7 bankruptcy you are asking the Bankruptcy Court to sever your obligation to pay most of your debt. In exchange for that “discharge” of debt you have to give the Bankruptcy Trustee your assets or at least those that aren’t protected by various asset exemption laws in Arizona. The Trustee will take those non-exempt assets and divide them amongst your creditors.

A Chapter 13 Bankruptcy is not a liquidation case like a chapter 7 case. You don’t have to give up any assets. You do have to pay your creditors on a monthly basis a certain amount of money. The amount of money you pay your creditors depends on several factors. The most important are

a.  Your income levy in the past and in the future.

b.  Your budget

c.  The amount of priority debt i.e. debt the bankruptcy code considers so important that it can’t be “discharged” and it must be paid in a chapter 13 in full.

d. The amount of secured debts you have like car loans

e.  The value of your non-exempt assets: Again, those assets that aren’t protected by the Arizona Exemption Statutes.

With a good breakdown of the above information we can determine how large your plan payment will be in a chapter 13 case, whether that amount will protect your non exempt assets, and how much of your non priority debt will be wiped away after the case is over.

If you qualify to file a chapter 7 bankruptcy there are a number of reasons why you may choose to file a chapter 13 bankruptcy anyway: Some of the more common are:

a.  You have assets that are not exempt that would be lost in a chapter 7 filing and that you consider important enough to keep that you are willing to pay their value to your creditors in a chapter 13 case.

b.  You are about to lose your home to foreclosure and have no other way to bring it current. A chapter 13 case will allow you to spread the amount you are behind over 3-5 years and stop the foreclosure.

c.  You have a car that is worth much less than you owe on it and/or that is about to be repossessed. The chapter 13 will stop the repossession and allow you to pay the market value of the car over 3-5 years at a reduced interest rate (in most cases) if you purchased the car more than 2.5 years ago.

d.  You have non-support related debt obligations as a result of a divorce decree. These obligations are dischargeable in a chapter 7 but are in a chapter 13 Bankruptcy.

e.  You feel the need to pay something back to your creditors and have a steady income.

3. SO I CAN JUST CHOOSE WHICH TYPE OF BANKRUPTCY TO FILE?

If you qualify to file both a chapter 7 Bankruptcy and a chapter 13 Bankruptcy than you can choose which one better suits your needs.

There are a number of ways a person doesn’t “qualify” to file a chapter 7 Bankruptcy or a chapter 13 Bankruptcy, but it is important to understand that even if you qualify for either, the choice you make could be a difficult one. An experienced Arizona Bankruptcy Attorney can help to make sure all of the issues are considered before making such an important decision.

4. WHEN AM I INELIGIBLE TO FILE A CHAPTER 7 OR A CHAPTER 13 BANKRUPTCY?

The most common situations that prevent a person from qualifying to file a chapter 7 Bankruptcy are:

a.  Failed Means Test – Bankruptcy Law requires that each filer is “means tested”. In order to pass the test your disposable income after subtracting certain expenses and debt payments must result in less than a specific amount payable to your creditors over 5 years. This test can be complex in some cases and planning is often involved. If you fail it, you can’t file a chapter 7 bankruptcy UNLESS the majority of your debt is business or tax related.

b.  Filed a Previous Bankruptcy – If you filed a chapter 7 bankruptcy within the last 8 years and received a Discharge you can’t file another. If you filed a Chapter 13 within the last 6 years and received a Discharge you can’t file a Chapter 7 Bankruptcy.

c.  Dismissal – If your Bankruptcy case was dismissed within the last 180 days in certain circumstances.

d.  Fraud – You defrauded your Creditors

The most common situations that prevent a person from qualifying to file a Chapter 13 Bankruptcy are:

a.  Filed a Previous Bankruptcy – If you filed a chapter 7 Bankruptcy and received a discharge within the last 4 years you are ineligible to file a chapter 13 Bankruptcy and receive a discharge.

b.  Too Much Debt – Chapter 13 bankruptcy is limited to those who have less than $1,184,200.00 in secured debt and unsecured debt of $394,725.00.

c.  Business – Business Entities can’t file a chapter 13 Bankruptcy.  (Self employed individuals can)

d. Disposable Income – You must have income that is high enough to pay your basic living expenses and a payment to the Bankruptcy Trustee that will pay car loans, mortgage arrears, priority debt, fees, value of non-exempt assets, and an amount to unsecured creditors required by the means test.

e.  Haven’t Filed Tax Returns – You must file at least the last 4 years and continue to file during the case.

5. WHAT CAN BANKRUPTCY DO FOR ME?

Bankruptcy can do a number of things for you if you are having serious debt problems. The most common are:

a.  Eliminate your obligation to pay most of your debt.

b.  Eliminate the obligation to pay tax on the eliminated debt as you may have to if it were forgiven outside of bankruptcy

c.  Stop a foreclosure on a home and allow you to pay the arrears over time

d.  Stop the repossession of your car and even force the return of it in certain circumstances.

e.  Stop wage garnishment, debt collection calls.

f.  Restore or prevent termination of utility service.

g.  Allow you to challenge creditor claims

h.  Allow you to pay less per month on your debt obligation than you may have had to pay the IRS directly.

6. BANKRUPTCY CAN DISCHARGE DEBT, SAVE MY HOME FROM FORECLOSURE, PROTECT CERTAIN ASSETS AND SOME OTHER GREAT THINGS, BUT, WHAT CAN’T IT DO

a.  It can’t eliminate certain debt obligations

Certain debt obligations aren’t discharged in Bankruptcy.  The most common are: Child Support/Spousal Maintenance, Property Settlement Debt related to divorce (chapter 7 only), Certain taxes, Most student loan debt, debt you forget to list (there are exceptions in a chapter 7 bankruptcy), debts related to drunk driving or criminal activity and fraudulently incurred debt

b.  It can’t prevent a creditor whose debt is secured with property from taking the property.  Bankruptcy can eliminate the obligation to pay the debt, but it doesn’t eliminate most liens. So if you don’t continue to pay for your car, you won’t be obligated to pay for it but the bank can take it.

c.  It can’t protect co-signers.  When a relative or friend has co-signed a loan, and you discharge the loan obligation in your bankruptcy, the co-signer may still be on the hook. (This may not be true in Arizona re: your spouse)

d.  Discharge debts that you incur after Bankruptcy

7. CAN BANKRUPTCY ELIMINATE MY TAX OBLIGATION?

The most common type of tax debt obligation eliminated in bankruptcy is income tax. There are some basic requirements for this type of debt obligation to be eliminated in Bankruptcy.

a.  The Tax Return must have been due more than three years before you file the bankruptcy.

b.  The Tax Return must have been filed by you more than two years before you file the bankruptcy

c.  The Tax Debt must have been assessed by the IRS more than 240 day before you file the bankruptcy case

d.  You cannot have filed a fraudulent tax return or otherwise willfully tried to evade paying tax.

We have helped hundreds of clients discharge millions of dollars in income tax debt using bankruptcy and the rules although simple on their face can get confusing and an experienced tax and bankruptcy attorney is often necessary to sort them out.

There are other benefits that bankruptcy can provide in relation to tax debt as well like:

a.  A chapter 7 bankruptcy will discharge the obligation on most income tax penalties and interest on the penalty older than 3 years

b.  A chapter 13 bankruptcy will allow you to treat most income tax penalty and interest on the penalty as dischargeable debt no matter how old the tax debt is

c.  The non trust fund portion of employment tax if owed by the individual business owner is dischargeable in bankruptcy if it meets the date requirements.

d.  Arizona Sales Tax (Transaction Privilege Tax) is dischargeable in bankruptcy if it meets the date requirements, as it is not a trust fund tax.

8. WILL BANKRUPTCY ALLOW ME TO GET RID OF MY SECOND MORTGAGE?

In Arizona, a Bankruptcy can be used to “get rid” of your obligation on the second mortgage if:

a.  The home is worth less than the 1st mortgage is owed making the second mortgage fully unsecured

b.  You file a chapter 13 Bankruptcy and follow the local rules in filing certain documents and following certain procedures

c.  You complete the chapter 13 Bankruptcy and obtain a discharge.

9. CAN I FILE THE BANKRUPTCY WITHOUT MY SPOUSE?

In Arizona you may be entitled to what is called a “community discharge” of your debt. This means that even if your spouse doesn’t file with you he or she may protect community assets and income from creditors as long as you are married.

10. HOW WILL BANKRUPTCY AFFECT MY CREDIT?

The affect on your credit score as a result of bankruptcy is difficult to determine. Generally, if you have bad credit now and bankruptcy will wipe out the obligation on a number of debts listed on your credit report, your credit should improve. Bankruptcy should be considered a last resort and if the decision between filing and not filing is being made based solely on the effect the bankruptcy will have on the credit report, you may not be a good bankruptcy candidate.

10 Bankruptcy Misunderstandings

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1. YOU WILL LOSE YOUR HOME

In Arizona, a person or married couple is allowed to protect the first $150,000.00 equity in their personal residence from creditors. This rule applies in bankruptcy as well.For example, if you own a home, you live in it, and it is worth $200,000.00 and your only mortgage is $50,000.00, you have $150,000.00 in equity. That equity is safe.

What if you don’t make your mortgage payment? That’s a different story.

2. TAXES CAN’T BE DISCHARGED IN BANKRUPTCY

Income tax debt is dischargeable in bankruptcy if it meets certain criteria.  It is the most common type of tax debt dealt with in bankruptcy. Certain other tax debts are as well like:

a.  The non-trust fund portion of the self employed payroll tax. If you own a small business and run it as a sole proprietor using your social security  number and you have employees… you must withhold their income taxes, their portion of social security and medicare taxes, and you must  match a certain portion of that payroll tax and send it all in. (6.2% social security tax and 1.45% medicare tax) If you don’t, you will owe the  entire amount. The employee portion is trust fund i.e. it is never dischargeable in bankruptcy, but the employer portion may be dischargeable in  bankruptcy if:

–  More than 3 years between the date the 941 return was due and the date the bankruptcy is filed

–  More than two years have elapsed between the date the returns were filed and the bankruptcy filing and;

–  No willful evasion of the obligation to pay the tax occurred.

b.  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.

c.  Tax Penalty: The IRS hits you with all kinds of penalties related to income tax. The most common are failure to file a tax return on time and failure to pay the debt. These two penalties really add up and with interest can actually double the debt over time.  In a chapter 7 bankruptcy these two common penalties are dischargeable if they meet the three basic date rules.

–  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 didn’t meet one of these rules? The debt and the penalty would survive the bankruptcy. In a chapter 13 bankruptcy, the penalty and the interest on the penalty is treated as non priority dischargeable debt no matter it’s age.

3. YOU GET TO CHOOSE WHICH CREDITORS TO “INCLUDE”

This is a very common misconception and a dangerous one. The failure to list a creditor in the bankruptcy schedules is a serious matter. One purpose of the bankruptcy code is to treat all similarly situated creditors alike. When you leave one out and pay it, the others are getting shortchanged. When you file bankruptcy make sure and tell the attorney every debt you have.

4. AN AGREEMENT THAT SAYS THE DEBT IS NON DISCHARGEABLE MAKES THE DEBT NON DISCHARGEABLE

For the most part these types of clauses in contracts are not enforceable and are just a tactic used by creditors to scare them away from bankruptcy.

The bankruptcy filing severs obligations with most creditors. It severs the obligation that was the original result of the contract you signed that contained the non-discharge language.

5. YOU CAN LOSE YOUR JOB IF YOU FILE FOR BANKRUPTCY

There is a law for most everything and there is a law for this as well. That law says that if you can prove that the employer fired you because you filed for bankruptcy, the employee can sue the employer. However, if you are looking for a job, that new potential employer may be able to use the bankruptcy filing as a factor in deciding whether to hire you.

6. YOU HAVE TO BE REALLY BROKE TO FILE FOR BANKRUPTCY

The bankruptcy code doesn’t have a “really, really broke” provision. It does allow you to protect certain assets so that you have a place to live, a chair to sit on, a car to drive and some retirement money. It does this so that you don’t file for bankruptcy and than become a “ward” of the state. In Arizona the most common assets that are safe from the Bankruptcy Trustee and most of your creditors outside of Bankruptcy are:

  • Home – Equity to 150,000.00
  • Tax Qualified Retirement Accounts
  • Certain Whole Life Insurance Policy Cash Value Amounts
  • 1 Car per person up to $6000.00 in equity
  • Most household Furniture
  • Clothing, Wedding Rings, Gun
  • Six Months of Food Fuel and Provisions

Also, many people file for bankruptcy and have steady and “good” incomes. If the majority of all your debt is tax or business debt, it may not matter what you earn, you may still qualify to file a chapter 7 bankruptcy.

7. YOUR EMPLOYER WILL BE NOTIFIED WHEN YOU FILE FOR BANKRUPTCY

Filing for Bankruptcy doesn’t carry with it the requirement that you notify your employer. Bankruptcy filings are placed in the public record, most employers don’t go searching the public bankruptcy record on a regular basis.

8. MY CREDIT WILL BE TERRIBLE 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. We take the position that if the deciding factor in choosing to file bankruptcy is just your credit score hit, you really should re-think the decision to file anyway. Your situation may not be serious enough to warrant using bankruptcy.

9. I CAN JUST SELL THE MY BOAT, HOUSE, FANCY CAR TO MY COUSIN FOR 1 DOLLAR AND PROTECT IT FROM BEING LOST TO THE BANKRUPTCY TRUSTEE

Any transfer for less than market value made within 2 years prior to the bankruptcy case has to be disclosed to the court. It is considered fraud for bankruptcy purposes and can be reversed. It can also end up causing your to lose your bankruptcy discharge. There are other ways to deal with non-exempt assets that may be more beneficial.

10. I HAVE TO FILE BANKRUPTCY WITH MY SPOUSE

You may be able to file alone and in Arizona still give your marital community the benefit of the bankruptcy discharge i.e. protection from creditors. It is called the community discharge and you will need to talk to an experienced bankruptcy lawyer about it.

Tax Debt? You Have Options

little-boy-following-recipe-as-bakes-cake-reading-list-ingredients-to-be-added-to-eggs-his-mixing-bowl-42387048Tax Debt?  You Have Options

The following is a list of the most common legal ways to deal with large IRS tax debt. Some are obvious, some are difficult and require extensive planning and some only work best in combination with another option.

Despite the fact that a review of the list alone won’t solve the problem, it should provide you some additional knowledge about existing options and some hope that there may be a solution.

Here they are:

Pay the Debt

If the funds exist to pay the debt in full, it often makes sense to do so, paying the debt off at once or in a few payments, stops liens, levies and interest. Borrowing to pay it off at once or in a few payments, stops liens, levies and will often reduce interest.

However, if you are considering the use of retirement funds or home equity to pay the debt off or to borrow against in order to do so, some additional thought may be in order.

Use the Statute of Limitations to Your Advantage

Congress decided at some point, that it would make sense to limit the time the IRS has to figure out how to get paid. It does things right once in a while.

26 U.S.C Section 6502 provides the limit and as a result, the IRS has ten years to get it done.

This seems like a long time, but you would be surprised at how many people with serious tax debt are able to use this law to their advantage. In fact, the wise use of the Installment Agreement/Non-Collectible Status option combined with the statute is what I often call the “poor man’s”  offer in compromise. (see below for more about installment agreements and offers in compromise)

An example:

Imagine a tax debt of $100,000.00. Imagine that the IRS has let 7 years pass without attempting to collect the debt, but they are now at the doorstep. The debt has grown to $300,000.00 with penalty and interest over time, but the taxpayer can only afford to pay $100.00 per month toward the balance. If the taxpayer were able to negotiate such a payment, only $3600.00 of the $300,000.00 would be paid before the debt disappeared.

Filing an offer in compromise, bankruptcy or pursuing some other legal remedy in an attempt to slow down the collection, would stop the statute from running. So some serious thought would be required before doing so.

There are other statutes that limit time periods in which the IRS may act:

  1. Assessment: The IRS has only three years to assess a tax from the date a return is filed in most circumstances.
  2. Liens: Liens have the same 10-year statute as debt collection. I.e. if the IRS has not reduced the debt to judgment, the lien is no good once the statute on collection runs out.
  3. Payroll Tax Assessment: Only three years again to assess payroll tax withholding amounts from the date of the filing of the return or the date the return was due whichever later.
  4. Trust Fund Recovery Penalty Assessment: The IRS has three years to assess personal responsibility for corporate payroll withholding amounts from the filing of the applicable return.

Challenge the Tax Debt

The IRS screwed up. They assessed a debt against you that you know isn’t correct. Typically, this is the result of an audit gone bad or the creation of a tax return by the IRS, because you didn’t file it yourself. They don’t use correct deductions when they do that by the way.

IRS Audits that go badly can be appealed. If done right, they can be appealed all the way to tax court and beyond. If your audit result is wrong, you have a limited amount of time to bring the appeal, so call someone now.

Tax returns filed by the IRS come with appeal rights as well. Most people don’t respond in time and lose them, however. Thankfully, the assessment of the tax from the incorrect return can be challenged using the IRS audit reconsideration  process.

In English…you can file the correct return and use it to try and replace the incorrect return.

The ability to do this isn’t guaranteed and doesn’t come with appeal rights. Also, failing to file your own return before the IRS files a return can cause another big problem. Namely, the potential inability to discharge the debt in bankruptcy if necessary.

There are other things the IRS does to assess a tax that can result in incorrect debt amounts, like the assessment of the trust fund recovery penalty against a responsible  party.

Where the business has withheld the employee portion of the payroll tax, but used the money for advertising and rent payments instead of sending it in, the IRS can add the amount up and stick it as a penalty on the individual person who they consider to have been responsible for the diversion of the money.

There are defenses to this, however, and the assessment of the debt can be challenged as a result.

Sometimes the tax is correct but it just isn’t fair that the spouse should be stuck with it. The law provides the ability to challenge the debt based on some theories about innocent spouses.

Installment Agreement

26 U.S.C. Section 6159 allows the taxpayer under various and specific circumstances to pay the debt over time. These types of agreements are commonly called installment  agreements or plans.

There are various types of IRS installment agreements including:

  1. A guaranteed 3 year plan if the debt is less than $10,000.00
  2. A streamlined plan for debts less than $100,000.00/$50,000.00/$25,000.00 that is typically paid over 6 to 7 years and doesn’t require the submission of detailed financial information.
  3. A full pay plan that allows the taxpayer to use his or her actual/reasonable budget to determine ability to pay if the debt is paid over 6 years and;
  4. A partial pay installment agreement.

The partial pay plan allows the taxpayer to pay only what he or she can afford each month even if the amount paid doesn’t pay the debt in full before the statute of limitations runs out on the collection of the debt. Again, a “poor man’s” offer in compromise. (see above)

Installment agreements stop levies as well, but they don’t necessarily prevent the recording of the notice of federal tax lien (unless the debt is less than $50,000 and the payment plan is set up in a certain way) or stop the assessment of penalties or accrual of interest. They also don’t prevent the IRS from demanding the use of assets to pay down the debt.

Offer in Compromise

26 U.S.C Section 7122 provides the basis for the settlement or one-time reduction of the tax debt. In essence, you would be making an offer to compromise and settle the back tax liability. But this isn’t horse-trading.

The amount that the law requires the IRS to settle for is based on objective criteria. This criterion is called the “reasonable collection potential” or the RCP.

In theory, the RCP is the amount that the IRS could collect from you before the statute of limitations period on collection runs out.

The vast majority of offers filed with the IRS fail primarily because the RCP calculation is rigged a bit in the IRS’ favor. They are allowed to use as a starting point for calculation purposes or a budget that is based on averages they have created.

For instance, they may have pre-determined that a family of four only needs $1650.00 per month to pay for all housing and utilities expenses. That family may be actually spending $2100.00 per month. If in the end, the IRS is able to use the $1650.00 figure to determine the RCP, then the amount of extra income per month by their calculation would be at least $450.00 per month.

If the statute of limitations period remaining on collections is 8 years than the RCP, just based on this number could be as high as $43,200.00

Successful Offers in Compromise, require much thought and planning as a result. They shouldn’t be entered into lightly.

There are two other types of Offers. One is used to dispute the underlying debt typically called an Offer in Compromise based on a doubt as to the liability. The other is made when the taxpayer may be able to afford the tax debt payment but it would be unfair to make him or her do so.

Some side notes about the Offer Process:

a. It stops IRS levy and other seizures.

b. The taxpayer is on probation for 5 years following the acceptance of the Offer. He or she must file all returns timely and pay all the tax due or else the offer is revoked.

Currently Non-Collectible Status

If the IRS is levying or otherwise, and the collection is causing an actual hardship on the taxpayer, the collection activity is supposed to stop. If the taxpayer can convince the IRS of the hardship status, a code can be placed on the account to designate the account as non-collectible.

The main benefit is obvious. There is a secondary benefit that is less obvious and that is that the statute of limitations period on collections continues to run while the status is in place.

The downsides of non-collectible status are that interest continues to accrue and if the change in circumstance is to the taxpayer’s benefit, i.e. income goes up, the status can be revoked.

Innocent Spouse

If you filed a return jointly with your spouse or ex-spouse, and a large tax debt exists as a result, you need to be at least aware of your potential rights as an innocent spouse.

There are three types of relief:

a. Innocent Spouse Relief “ Where your spouse or former spouse filed to report income correctly or claimed improper credits or deductions.

b. Separation of Liability “ The additional tax that exists as a result of the spouse or ex-spouse’s decision to not report something properly on the return may be allocated to that spouse.

c. Equitable Relief “ If you do not qualify under one of the theories above, the IRS may agree to relieve you of the debt based on fairness and equity.

The basic requirements to file for innocent spouse relief are these:

a. The taxpayer filed a joint return which has an understatement of tax due to erroneous items.

b. The taxpayer can establish that at the time he or she signed the return he or she did not know and had no reason to know that there was an understatement of the tax.

c. Taking into account all of the facts and circumstances, it would be unfair to hold the taxpayer liable for the understatement of the tax.

Collection Due Process

When a tax debt is assessed or entered into the government’s records as a debt, the IRS doesn’t need a Judge’s permission to collect. They can simply start the collection process. However, there are some limits on this ability. The most important are that you are entitled to due process . Therefore, the IRS must send you a notice of it’s intent to levy and give you thirty days to appeal it and ask for some alternate arrangement.

This appeal  is called a collection due process appeal and using it stops the collection process. Although the statute of limitations on collections stops running while the appeal is pending, the appeal typically provides the taxpayer the time to find a solution to the tax debt.

An offer in compromise can be made via this process and judicial review attaches to the process as well.

Collection Appeals Process (CAP)

Collection activities can be appealed  at any time. These types of appeals have different names like equivalency  hearing, and can in less powerful ways forestall the collection process. They do not come with the right to seek judicial review.

Bankruptcy

Bankruptcy and it’s relation to tax debt is misunderstood. Many people including attorneys believe that bankruptcy can’t resolve tax debt. Nothing could be further from the truth.

In fact, unless the IRS is able to prove that a taxpayer attempted to evade a tax or filed a false return, the treatment of the tax debt is not up to them. It is governed by the Bankruptcy Code.

Filing a bankruptcy petition will stop all tax collection activity by the IRS and erase taxes that meet the Bankruptcy Code’s definition of dischargeability.

I have helped many taxpayers rid themselves of tax and other debt through bankruptcy especially where one of the other solutions in this article didn’t make complete sense.

Pay and Sue for Refund

The U.S. District Court and the Court of Federal Claims hear tax cases only after the taxpayer has paid the tax (or a portion of it in district court) and filed a claim for a refund.

A taxpayer can file a claim for a refund if he or she believes that the tax paid was incorrect. Once the claim is disallowed by the IRS, the taxpayer can bring the suit.

The suit must be brought within a certain time period after the rejection of the claim.

Penalty Abatement

As a taxpayer, you have the right to request the cancellation of any IRS penalty. There are more than 140 penalty provisions and they all have a good faith  exception.

If you have been penalized for something like a failure to pay the tax on time, but you acted in good faith and there exists some reasonable  basis for the failure then the penalty can be removed along with interest. This removal often makes it easier for you to deal with the underlying debt.

9th Circuit BAP Reviews the Late Filed Return and Bankruptcy Issue

downloadKeith Fogg, at the terrific tax blog “Procedurally Taxing” has provided a short review of the Martin v. United States Case wherein the 9th Circuit Bankruptcy Panel (BAP) rejects the literal interpretation of Bankruptcy Code Section 523(a)(*).   You can read his review here.

If you have tax debt, and have been following the issue of whether it can be discharged in bankruptcy… if the underlying return was filed late, or filed after the IRS files a “substitute return”, this BAP case will be of interest to you.

As you recall, there are three circuit courts, the 1st, 5th and the 10th that have ruled that a return filed even one day late can never meet the requirements of a return filing for bankruptcy discharge purposes.  These Courts have primarily based their decisions on the literal reading of the language found in 523 (a)(*). 

The 9th Circuit BAP rejects the literal interpretation regarding whether a return is still a return if it is filed late, and does a good job in explaining why courts that have ruled that timeliness is an issue, make little sense.

The 9th circuit hasn’t ruled on the issue of tardiness, and in 2015 we were able to help our clients discharge several hundred thousand dollars of tax debt as a result.

Right now in Arizona, a late filed return is still a return for purposes of calculating the discharge dates and a return filed after the IRS has filed a substitute return will still be considered “not-discharged” by the IRS.

I expect a 9th circuit ruling in a case similar to the Martin case, within a few months.  That case is called Smith vs. United States.  The 9th Circuit may come to some of the same conclusions as the 9th Circuit BAP, potentially setting the issue up for the Supreme Court.  Or, it may side with the 1st, 5th, and 10th, and stick it to late-filers.

IRS Collection Statute Expiration Date – Why do we talk about it so much?

wallpaper-clock-detail-in-london-streetThe very first thing I do when a person with a large tax debt balance hires me, is to calculate the IRS Collection Statute Expiration Date or CSED for short.

I calculate the clock.

Why do I care so much about this bit of information and write about it all the time?  I mean come – on….blah blah blah – clocks are boring.

If you read this blog, I understand what you are feeling.  Lots of talk about clocks and time.  REALLY BOOORING.

BUT…If you have a tax debt that has been lurking around awhile – these articles about the CSED should be interesting and for some of you, actually exciting…old clocks and all.

Let me explain by category…once again.

CSED and Offer in Compromise

An IRS offer in compromise is as it sounds.  It’s a formal process that allows you to try to make a deal with the IRS and settle the tax debt.  There are two primary reasons why the CSED makes a difference in relation to the IRS offer in compromise.

Number 1 – The CSED Determines Whether You Will Qualify

Can you read that aloud again so that all can hear.

I mean really…what’s more important than “whether you will qualify”.

So…it goes like this; The IRS gets to determine how much money you need each month to survive.  It starts with these things called IRS Standards or IRS National Standards and works it’s way up from there, deciding whether to add to the budget with your claims about child support, and tuition and 401k loans and credit card payments etc. etc.

It then looks at your income.  What it has been, what it is, what it will be, and makes a decision about what it thinks you income will be.

It then subtracts one from the other and comes up with a number.

It takes that number and MULTIPLIES IT BY THE CSED.   Example:  Number = $500.00 and CSED = 100.  or $50000.00

The IRS then calculates your asset value.  Example:  $50000.00.

The two are added and called the “reasonable collection potential” or RCP.  The RCP is compared to the debt amount. Example: Debt Amount –  $75000.00

RCP – $100,000.00

DEBT – $75,000.00

The offer in Compromise fails because the RCP is greater than the Debt.  BUT what if the CSED were only 20 months.  Would the RCP have been less than the debt?  Yes.

Number 2 – The CSED Tells you whether you should bother with the OIC

Once you understand how offers in compromise are calculated and what the CSED is and WHY IT’S SO IMPORTANT…you begin to see that sometimes you can just be wasting your time.  Pun intended.

Example – Waiting out the clock

Mr. Wonderful owes the IRS a big bucket of money.  He owns a home that has $150,000.00 in “quick-sale” equity, but he can’t borrow against it because he has bad credit, primarily due to the IRS’ lien but also because he buys too many suits and steak dinners on credit.  

The IRS wants to get paid, but realizes he can’t borrow against the home.  So, it agrees to put him in a partial pay payment plan, or a plan that doesn’t pay the entire debt off before the CSED is over.  It does this because it agrees he can’t afford to pay more than that every month.  

There are 4 years left on the CSED and he is paying the IRS $100.00 per month.  If everything stays the same, he will have paid the IRS $4800.00 over the next 4 years and his home will have increased in value. IF he files an offer in compromise, the offer amount will have to include the quick-sale value of his home and the CSED will stop running while he is in the offer.  

When he comes out the other end and is unsuccessful…the CSED will be waiting where it was left.  Mr. Wonderful chooses to stay in the payment plan.  Not Dumb. 

CSED and BANKRUPTCY

Much of what was written above applies here as well.  I won’t simply repeat it…thank goodness right?

But…be aware that the CSED matters in other ways as well when it comes to bankruptcy. The most important way it matters is in it’s calculation.  No…not in calculating the bankruptcy, but in calculating the CSED.  Why?  Because the CSED stops running when you are in bankruptcy.  Sometimes over a 10 year period people file for bankruptcy more than once.

So…sometimes people call me and say…”hey mike, I have this really old income tax debt and the IRS just levied my account.  I read about this CSED thing and I don’t understand why they are still collecting on me”.  My response…”have you ever filed for bankruptcy?”

The bankruptcy is the stickler.  What if a chapter 7 bankruptcy was open for 2 years?  Understanding the CSED is important.

CSED and PAYMENT PLANS

There are several areas where the CSED and the calculation of an IRS payment plan intersect, but the most common way is when a person owes the IRS less than $50,000.00 and wants to avoid filing a 433 financial statement.  IF the CSED has 72 months or more left on it, the IRS will usually agree to simply divide the debt by 72 months and put that person into a “streamlined” payment and IF no lien notices have yet been filed it won’t file them.

Great huh?

But what if the CSED only has 40 months remaining.  Will the IRS still allow the payment over 72 months?  No.  It should allow it over 40 months.

What if the debt is $50,000.00 even.  Over 40 months that’s $1250.00 per month.  Over 72 months – 695.00.  Which would you prefer?

In a strange way, higher income earners with less than $50,000.00 in tax debt want the CSED to be longer…usually.

We hinted at another example above.  The Partial Pay scenario and Mr. Wonderful.

To re-state it a bit.

In certain circumstances – the CSED can really hurt.  Even if the payment plan you negotiate with the IRS is “small”.  If the CSED is large, you run a much greater risk of problems. TIME isn’t your friend.

Example – Partial Pay vs. Chapter 7 Bankruptcy

Ms. Nositall owes the IRS $30,000.00 as a result of some unpaid taxes on a cashed out retirement plan.  She has long since spent the money and has taken a job making $25.00 per hour.  She isn’t a good offer candidate based on the RCP, but she has been able to convince the IRS to put her into a monthly payment of $395.00 per month.  It’ painful, but better than a wage garnishment.  THE PROBLEM is that she has 6 years remaining on the CSED and she plans on making more money at this job in the coming year and beyond. She is also struggling to pay some credit card debt.  She speaks to her attorney and learns that when the IRS sees the higher income (new w-2 or tax return) it will want to re-negotiate the payment plan and bump it up quite a bit.  She qualifies now to file a bankruptcy, and the entire tax debt qualifies to be discharged along with her credit card debt.  Her choice: Bankruptcy.  

Clocks are important and sometimes interesting.  They keep track of time… and if you have a large tax debt, time is of the essence.

Chapter 13 Bankruptcy and IRS Debt – Giving the IRS a Haircut

crazy haircutTHE PROBLEM(S)

1.   IRS Offers in Compromise Don’t Work for Most People

Most people with serious tax debt just can’t make an IRS Offer in Compromise work.  Success is based on a formula and that formula is based on a number of facts about the taxpayer’s income, budget, assets in the past, the present and the future.

The formula uses a pre-determined budget and subtracts it from income.  The difference plus asset value is used to determine whether the debt can be paid over the remaining 10 year period on the statute of limitations for collection.

According to the formula most people who file offers in compromise can afford to pay the debt in full before the statute runs and for many who are able to show they can’t there are a number of other reasons why the offer in compromise doesn’t work.

In 2013, 58% of all offers in compromise cases filed – failed.  More from that year will fail as well because of the post acceptance requirements placed on successful deal-makers.

2.   IRS Payment Plans Are Like a Ferris Wheel That Never Stops

Many taxpayers are stuck in a ferris wheel that doesn’t let them off for 10 years or until the statute runs out.

They can’t afford to pay the debt in full, they aren’t good Offer in Compromise candidates for various reasons, so they struggle with what is often a very painful payment each month while they watch interest and penalty accrue on a debt that goes nowhere.

A SOLUTION – CHAPTER 13 BANKRUPTCY

What is Chapter 13 Bankruptcy?

A Chapter 13 is really just a debt repayment plan subject to the approval of a bankruptcy judge. It can repay tax debt, consumer debt and business related debt.

It can also be used to do other things like save a home from foreclosure by stretching out the arrears over 3-5 years, stop IRS penalties and interest from accruing, or stripping away second mortgage and judgement liens.

Depending on the chapter 13 filer’s situation, it can do something else that is misunderstood if not completely overlooked.  It can give the IRS and other creditors a serious haircut.

What does Chapter 13 do to the IRS?  

1.   Cramdown – Here is the Haircut

Chapter 13 bankruptcy does more than stop the IRS interest and penalty from adding up.  It can, in many situations, reduce the amount the IRS is getting paid in installment agreements.

The bankruptcy code requires that creditors receive less than the full amount of the bill depending on it’s priority status.  Credit Cards are low priority and taxes start out with a high priority, but can end up in a low priority situation depending upon their type and age.

If the tax is income tax and is $75,000.00 and the card debt is $25,000.00 and all of the income tax is low or non-priority AND the Bankruptcy Judge determines that you can only afford $250.00 per month toward the tax and credit card debt,  $250.00 per month would be all you paid on those debts for 36-60 months depending on your income level, and at the end of the plan the rest of the debt with it’s penalty and interest would be discharged.

An example to make the cramdown clear:

If you have $75,000 in credit card debt, $60,000 in non-priority IRS and state taxes, and according to the Bankruptcy Code – $300 per month of “disposable” income.  You will only pay $300.00 per month for at most 60 months toward the $135,000.00 total.

You say wait just a minute—how can $300 per month pay back $135,000.00?

In this example – it doesn’t.  The debt is all non-priority and the Judge says you can only afford to pay $300.00 toward non-priority debt for 60 months.  You would only pay $18000.00 of the overall debt as a result.

Here’s where the cramdown makes the most sense. Since all the debts are non-priority, the creditors have to accept payment of $300 per month. The remainder is discharged when the case is over.

Even in cases where the situation requires the Judge to order a much higher payment, the chapter 13 filer is often better off in a chapter 13 case because the penalty and interest stop accruing.

In sum, the chapter 13 cramdown allows low- priority debts to be repaid at a fraction of what was originally owed and this can even include the IRS.

 

2.   Timeframe Shortened

As mentioned above the Chapter 13 case can also shorten the length of repayment.  The IRS has 10 years or 120 months to collect a debt and this time frame is extended anytime appeals are filed, offers in compromises are filed and in other cases.

An installment agreement at $300.00 per month at the beginning of this 120 month period will linger for 10 years assuming the debt is greater than about $36,000.00.

A Chapter 13 lasts between thirty-six to sixty months.

3.   Stops Accrual of Penalty and Interest

The second most common question I get is, “can you get rid of my penalty and interest?”

A chapter 13 bankruptcy stops both from accruing.  An IRS payment plan doesn’t.  Generally, interest and penalty will double the debt amount every 5 years making it difficult to pay the debt off before the 10 year mark.

In a chapter 13, the payment goes toward what is owed not the interest and penalty.

 

Photo Credit: cctv.org

I am in IRS Not Collectible Status, will it resolve my tax debt?

No, IRS Not Collectible Status (NCS) does not resolve the liability – by itself.

Some explanation:

IRS Currently Not Collectible Status

Contact Our Experienced Mesa Arizona IRS Attorney To Help Resolve Your Tax DebtThere are several ways to deal with IRS debt.  The most common are the Offer in Compromise, Bankruptcy, Payment Plans of various types, and Placement in Non-Collectible Status.

IRS NCS is a “designation” the IRS will place in it’s system that stops enforced collection.  It is used because you are able to prove to the IRS that your expenses are as much as or exceed your “allowable” expenses, and there is no available asset equity.

If you are placed in NCS, the penalty (if not fully applied) and interest continue to grow.  If your income improves, the IRS will see the improved income and pull you out of the Status and demand a new disclosure of your income, budget and assets to see if your ability to pay toward the debt has improved.  The IRS typically reviews your financial situation after each year.

Why IRS Not Collectible Status doesn’t get rid of debt all by itself

NCS has nothing to do with the debt.  It ‘s only “ability” is to stop IRS collection activity until your situation improves.

However, many people use it in combination with other legal options to reduce or “resolve” the liability.

The two most common legal options used in combination with the Non Collectible Status are:

1.  IRS Statute of Limitations on collection

The IRS has 10 years to collect tax debt from the date it is created or “assessed”.  This 10 year period can be extended by the period of time you are doing something that prevents the IRS from collecting, like filing a bankruptcy or an Offer in Compromise.

If the Statute Period runs out the debt goes away unless the IRS has reduced the debt to a Judgement (which is unusual)

Many people have serious tax debt and have just a few years left before the Statute Period runs out.  They are also good candidates to be placed on NCS.  In these situations, it usually makes sense to use the it with any eye toward the Statute Period to eliminate the Tax Debt.

2.  Bankruptcy

If you are a candidate for NCS and can convince the IRS to place you there…and if the Statute of Limitations Period is a several years away..Bankruptcy may be an option.  Part of the difficulty in qualifying for a Bankruptcy is making sure that certain time periods have elapsed between assessment and the date the Bankruptcy is filed.

These Bankruptcy time periods are stopped or “tolled” as well when you do things that stop the IRS from collecting.

The NCS doesn’t stop any of these Bankruptcy time periods from running.  It can be used as a result to stop collection activity while the tax debt continues to “become dischargeable”.

Video: Attorney For Tax Michael Anderson
Explains IRS Not Collectable Status

Conclusion

Whether you should use NCS as opposed to Bankruptcy or an Offer in Compromise or whether you should use it in conjunction with the IRS Statute of Limitations on Collection or Bankruptcy are questions that will require a careful review of the facts and your goals in order to reach an answer.

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

I should qualify for an Offer in Compromise, so why Bankruptcy?

IRS Offer in Compromise vs. Bankruptcy

Kiss for mum.This is a great question and there is really a one sentence answer to it… that goes like this.

If your debt problem is primarily the result of tax debt, and if you qualify for an offer in compromise in every way, and if you can find the money to pay the settlement amount, an Offer in Compromise is a no brainer.

Lets break that down a bit more.  One sentence is never enough for me.

First, let’s tackle the “primarily tax debt” issue.

There aren’t very many of us that have tax debt and tax debt alone.  Many people with tax problems have other debt that would benefit from a good run through the Arizona Bankruptcy machine.  It is often the case as well, that certain tax debt… especially income tax debt, can be made “dischargeable” in bankruptcy just like a credit card debt, and if it isn’t entirely dischargeable, it is often partially dischargeable with some planning.

As a result, whenever I review a case with some serious tax and other debt problems, I weigh the Offer in Compromise vs Bankruptcy.  Sometimes, we do an Offer in Compromise first and a bankruptcy later.  Sometimes, vice versa and sometimes, one and not the other. Rest assured, that wherever there is other consumer debt acting as a real burden to our client, bankruptcy is a topic of discussion, not just the Offer in Compromise.

Second, do you qualify for an Offer in Compromise in every way

Do you remember that old Clint Eastwood Movie, “Every Which Way But Loose”?  I suppose the phrase “in every way” made me think of that movie, or maybe it could have been the tremendous impact the Orangutan had on my life.

Seriously, that movie was really about nothing.  Clint Eastwood was a good fighter, wins an Orangutan in a card game? and gets jilted by a pretty woman who he chases around between fights and hi-jinx.

Why did I watch that?

Now…if you don’t qualify every which way for the Offer in Compromise, you will be thinking that it was really about nothing too.. and wondering why the CPA or EA let you do it in the first place.

That was a reach…wasn’t it?

Qualifying for an Offer in Compromise doesn’t just mean that you fill out some papers and show the IRS that you don’t have a lot of money left over at the end of the month.  There is much more to it…and it ‘s called proving to the IRS that your reasonable collection potential is less than the tax debt and that you are filing the offer in what I call “good faith”.

Determining what the Reasonable Collection Potential (RCP) is, can be confusing because there is a formula that determines it.

Even if you meet this RCP formula, the IRS can reject the offer for all sorts of reasons.  Based on your past history, it may decide that you have the ability to make more money that you are now, or it may just think you acted in bad faith in the past, and don’t deserve the settlement.

If the Offer doesn’t work out, you will have stopped the statute of limitations on collection from running, given the IRS a bunch of money you probably didn’t have, stopped certain time frames from running that are necessary to turn your income tax debt into a dischargeable debt in bankruptcy, wasted the fee you gave to someone to help you do it, and ended up right back where you started.

Which reminds me of a song…mmm..on to the last part of the question,

Finding the money

Doesn’t it always just come down to this.  You work hard and have a little of it and everyone else wants it.  Some people earn your dollar by providing a great product that you feel is worth the trade, some people just take the dollar, squander it on “do-gooder” projects that make the situation worse….

Don’t get me started.

Anyway…finding money, yes.

An Example:

“Jack” owed the government a tidy sum with interest and penalty.  He had taken a different job that paid less than he was accustomed to, and really had no way to pay it.

Perfect candidate for an Offer right?

But…the RCP made things a little rough for him.  The IRS was going to say that he had the equivalent of 1000.00 per month leftover after he paid basic living expenses.  He had few assets and so the Offer amount from a cash standpoint was going to be about 20,000.00.  He needed $4000.00 upfront and than the remainder in 5 installments when the offer was accepted.

He didn’t have the $4000.00 and he couldn’t save it easily because the budget the IRS was going to use to calculate that $1000.00 ability to pay per month amount, wasn’t his real budget.

To repeat…the “formula” budget used to calculate the Offer amount wasn’t his real budget.

The IRS’ RCP formula disallows lots of stuff.  Let’s just say that one of the things it would have disallowed as a budget item was something he couldn’t easily stop paying.

And….”Jack” had no rich Uncle.

He just couldn’t figure out how to come up with the money to pay the offer amount without causing other serious problems in his life.

So what did he do?  Instead of taking the chance he simply decided to file a bankruptcy case.

His income tax debt met the date criteria for discharge, and because the tax debt was the majority of all his tax debt, he didn’t have to take the means test to qualify to file the bankruptcy case.

Summary

If an Offer in Compromise may be in your future, make sure that it is going to work in every which way before you file it.

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

401k Should Be Safe In Bankruptcy

401k and Bankruptcy

Bankruptcy is still considered by most people to be a last resort, and I don’t necessarily disagree, but thinking that way can result in a big mistake.

In an effort to avoid bankruptcy, the honest, hardworking, debtor sees his or her 401k as a way to stay afloat in the hope that things will turn around.  Funds are borrowed from the account initially and then it is often just cashed out.  Penalties and tax are withheld and the remainder goes to living expenses and debt payments.

The problem becomes apparent when things haven’t turned around and the 401k money is gone.  The debt still exists, a lawsuit or two is filed and thoughts of bankruptcy loom large.

When the Debtor visits with the Bankruptcy Attorney, he learns, often for the first time, that the funds in the 401k account were safe from creditors the entire time and would have been safe from the Bankruptcy Trustee had the filing been done with the 401k still intact.

In fact, funds in a 401k are not even property of the Bankruptcy Estate.  The Supreme Court has held that most retirement plans that contain enforceable “anti-alienation” clauses, aren’t property of the bankruptcy estate and aren’t subject to the jurisdiction of the Bankruptcy Court.

In 2005, this protection was extended to include a very large portion of Individual Retirement Accounts (IRA) as a result of the  Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 or BAPCPA.

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