Tax and BankruptcyUnsecured income taxes first due over three years before a bankruptcy is filed can be discharged in full in any chapter of bankruptcy if a timely and non-fraudulent tax return was filed. It is a myth that taxes are never discharged in bankruptcy.

Priority taxes are taxes first due within three years of the bankruptcy filing and taxes assessed within 240 days of the bankruptcy, or which are unassessed but assessable when the case is filed. These taxes are priority claims which are not subject to discharge. Priority taxes will survive a Chapter 7 discharge to the extent that the trustee does not have money in the estate to pay them.
In Chapter 13, such taxes must be paid in full through the plan; penalties associated with those taxes, however, can be treated as a non-priority claim and paid a fraction along with other unsecured claims. In Chapter 13, the tax does not continue to incur interest during the case; if the plan is completed, no post filing interest is due.

Taxes for which no income tax return has been filed are not dischargeable in bankruptcy.
If a return was filed late, for a year outside of the priority tax period, the return must have been on file for two years for the tax to be discharged in bankruptcy.

Five Rules to Discharge Tax Debts
If the income tax debt meets all five of these rules, then the tax debt is dischargeable in Chapter 7 and Chapter 13 bankruptcy petitions.
1. The due date for filing a tax return is at least three years ago. The tax debt must be related to a tax return that was due at least three years before the taxpayer files for bankruptcy. The due date includes any extensions. (It should be noted that all dates are subject to tolling events. This means that different circumstances may impact the time. For example, if you live outside the United States for six months or more you need to add this period to the time. It is best to speak with a knowledgeable local lawyer regarding your specific circumstances.)
2. The tax return was filed at least two years ago. The tax debt must be related to a tax return that was filed at least two years before the taxpayer files for bankruptcy. The time is measured from the date the taxpayer actually filed the return.
3. The tax assessment is at least 240 days old. The IRS must assess the tax at least 240 days before the taxpayer files for bankruptcy. The IRS assessment may arise from a self-reported balance due, an IRS final determination in an audit, or an IRS proposed assessment which has become final.
4. The tax return was not fraudulent. The tax return cannot be fraudulent or frivolous.
5. The taxpayer is not guilty of tax evasion. The taxpayer cannot be guilty of any intentional act of evading the tax laws

Some Tax Debts Not Dischargeable
Tax debts that arise from unfiled tax returns are not dischargeable. The IRS routinely assesses tax on unfiled returns. These tax liabilities cannot be discharged unless the taxpayer files a tax return for the year in question.

Other Tax Issues in Bankruptcy
Before a Chapter 13 bankruptcy can be granted, the bankruptcy petitioner is required to prove that the four previous tax returns have been filed with the IRS. The four previous tax returns must be filed no later than the date of the first creditors’ meeting in a bankruptcy case.

Additionally, bankruptcy petitioners are required to provide a copy of their most recent tax return to the bankruptcy court. Creditors can also request a copy of the tax return, and petitioners must provide a copy to them.

If you are expecting a tax refund and want to keep it must be listed as an asset and exempted. Otherwise the Trustee will take the refund for the benefit of your creditors.

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Bankruptcy Statement of Financial AffairsWhat does a SOFA have to do with bankruptcy? Part of the required paperwork is called the Statement of Financial Affairs or SOFA. The SOFA is a series of questions that must be answered. This is where everything that has not already been provided in the petition and schedules is listed.

The first page of the SOFA gives specific instructions. The first few questions deal with income. Unlike Schedule I which is for current monthly income or the means test which looks back six months, the SOFA asks for your year to date income and the past two years of your income. It asks for wages and money from business as well as all other income. All other income includes annuity payments, interest income, rents, investment income, unemployment compensation, worker’s compensation payments, spousal support, child support and lottery winnings to name a few.

The next are questions about debt payments. If the bankruptcy consists of mainly consumer debts, then any payments made in the 90 days prior to filing that equal or exceed $600 must be disclosed here. These are considered preference payments and the Trustee can choose to go after return of the payments and divide them among the other creditors. All payments to insiders, like your family members, made within the past year must be listed. If you are married and filing a sole petition you must also account for any payments made by your spouse. If significant payments have been made to family members and none to other creditors then it is wise to wait until one year has past to file a bankruptcy. Otherwise there is a very real risk that your relative will be sued by the Trustee for return of the payments.

Repossessions, foreclosures and returns are also listed on the Statement of Affairs. All assignments, receiverships, transfers and set-offs are also listed and fully described. The bargain you make when filing for a bankruptcy is full disclosure of your entire financial picture in exchange for discharge of all dischargeable debts.

If anyone has sued you, there is a place to put the case information including case caption, case number and court. Any garnishments and repossessions are also listed.

Gifts to an individual or charitable contributions in the past year must also be listed with a few exceptions. All losses from fire, theft and gambling in the last year are described.

Payments to your attorney and for the credit counseling course are listed.

If you have a safe deposit box the contents are listed. If you are using anything that belongs to another person that is listed. Many people forget to list that DVR or cable modem that is rented or on loan.

If you live in California or any other community property state you must list your spouse if they are not filing with you.  If you have been divorced less than nine years, you must list the name of your former spouse.

If you have a business there are a number of questions that must be answered. The more complex the business the more questions that must be answered.

The SOFA is a lengthy and complicated series of questions that must be answered completely and correctly or your bankruptcy case could have problems. If the answers are not complete or don’t match with your tax returns and other materials that the trustee will review you will be challenged and may lose your discharge. Make use of a trusted and knowledgeable legal adviser to make certain that your case is well prepared.

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R is for ReorganizationA chapter 13 bankruptcy is often called a “reorganization.” In a reorganization you are allowed to catch up on mortgages or automobile loans over a period of time.

When a bank or other creditor is uncooperative you can force them to work with you by filing a chapter 13 bankruptcy case. As long as you can catch up under the plan you can force the creditor to let you keep the property while you make up the back payments. Depending on your situation you may be able to strip off an unsecured second or third mortgage. There must be no property value securing the loan and you must successfully complete your plan payments.

Chapter 13 cases also allow you to keep non-exempt property. In a chapter 7 you are allowed to keep only exempt property and non-exempt property would be sold for the benefit of the creditors. In the chapter 13, you can keep the non-exempt property if you pay for it over the life of the plan, usually a three to five year period.

Chapter 13 Eligibility

In order to qualify to file a chapter 13 you must be an individual with regular income and be within certain debt limits. As of the time of this writing, you may not have over $1,081,400 in secured debt (mainly consist of mortgages and car loans) and no more than $360,475 in unsecured debts (generally credit cards, medical bills, student loans, and income taxes). A corporation or partnership may not file a chapter 13.

You may not file a chapter 13 or any other chapter unless you have taken an approved credit counseling course within the preceding 180 days.There are very few emergency exceptions allowed.

You may not file under any chapter if within the preceding 180 days you had a prior bankruptcy petition dismissed due to your willful failure to appear before the court or comply with court orders, or was voluntarily dismissed after creditors sought relief from the bankruptcy court to recover property on which they hold liens.  11 U.S.C. section 109(g), 362(d) and (e).

Chapter 13 Plan

The plan is your description of when creditors will be paid, how much they will be paid and how they will be paid. After you pay your living expenses, the balance of your income goes into plan payments. Creditors can object if not all your disposable income goes into the plan or if they think they are being treated unfairly under the plan terms. The trustee will review your plan and make sure that it meets the legal requirements and that you have enough regular income to fund the plan. The trustee must approve your plan.

Many people make the mistake of waiting for trustee approval to begin making their plan payments. You must begin making these payments within 30 days of filing your bankruptcy case. The trustee will hold your payments until the plan is approved and then begin to pay them out to creditors. If you do not make your plan payments, your case will likely be dismissed.

Your plan can be modified if you lose your job or there are other changes. There is also a provision for a hardship discharge and you may convert your chapter 13 to a chapter 7 at any time.

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Q is for Qualified Written RequestA Qualified Written Request allows borrowers to obtain information from their servicer without having to file a lawsuit. You want to save your house and a foreclosure is looming but you’re pretty certain that the lender is claiming you owe more than you actually do. While not part of the bankruptcy code, 12 U.S.C. 2605 is a tool that may assist a debtor to keep their home with or without a bankruptcy filing.

It is common for a lender or mortgage servicer to claim that you owe more money than you think you do. Sometimes these accounting errors even cause you to default on your loan. Some of the common errors are:

  • Compounding interest when not allowed
  • Failure to make timely tax payments thus incurring late charges
  • Failure to properly apply payments made to your account
  • Improperly crediting payments you make
  • Charging impermissible late fees
  • Refusing to accept your payments because there is a difference in balance due and sum paid
  • Forcing insurance on you when you already have shown proof you carry it

Send a Qualified Written Request

The Real Estate Settlement Procedures Act (RESPA) provides for the Qualified Written Request (QWR). As Max Gardner says, “a reasonable QWR can provide the attorney for the Chapter 13 debtor with some of the very best discovery outside of a contested case or Adversary Proceeding.”The servicer must acknowledge your request within 20 work days of receipt and respond to your inquiries within 60 work days. You must include enough information in your request so that the servicer can identify your mortgage account. Usually an account number along with your name and the property address will work. You should also include any errors you believe occurred and clear requests for information.

Ask for a complete transaction history of the loan including all payments and charges. Also ask for the transaction codes and definitions so you can understand the history. You’ll also want any Pooling agreements; the name and contact information of a person to speak with about your account; the name of the current holder of the note; and copies of all correspondence, communication and collection documents related to your account. With this information you will be able to find out what is happening to your account and who owns your mortgage.

What If My Lender Won’t Respond?

There is also a provision in 12 U.S.C. 2605(f) that allows for reasonable attorney fees and costs if the lender or servicer fails to comply with your request.

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Preference sounds good, right? Maybe, maybe not. If you pay child support or taxes before paying other creditors, that’s okay. If you make your house or car payment before paying your Visa bill, that’s okay. So what can’t I do?

Insider Preference Payments

You can’t pay your mom back that $2,000 she loaned you before you pay the Visa bill, if you do it within one year before you file for bankruptcy. It is considered a preference and the trustee can set it aside. In other words the trustee can sue your mom to recover the $2,000 payment. Why can they do that? Because it is considered unfair under the U.S. Bankruptcy Code. The code is concerned with fairness all around. Fairness to you the debtor and to all the creditors that you owe money to.

You can’t make any preferential payment to a friend or family member in the year before filing bankruptcy or the trustee can recover it. So be careful of repaying your uncle, sister, brother, mother, father or friend in the one year period before filing for a bankruptcy. Your brother would likely be upset to find out that the money you gave him to repay your loan will be taken by the trustee. Either wait to file the bankruptcy so a full year passes, or wait to make the payment until after the bankruptcy case. There is nothing in the law that stops you from paying back a loan after it has been discharged in bankruptcy.

What About Other Creditors?

Any payment over $600 to a credit card company or other creditor (medical provider, personal loan, other loans) within 90 days of filing bankruptcy is also a preference payment that can be set aside.

A preference payment doesn’t have to be cash, check or money. It can also be a transfer of your property. For example, you owe a friend some money and they agree to take your bicycle in trade. Talk to a knowledgeable local bankruptcy lawyer about your payments. They’ll ask you questions and dig into your facts so you can avoid any unpleasant surprises.

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O is for Organize

Organizing is something that may be hard to do. Many of my clients have been putting their heads in the sand and leave mail unopened and unorganized until they see me. It is a normal tendency to ignore things that feel out of control. When those bills and collection letters come flooding into your mail, it can be overwhelming.

The first step to getting a handle on things is to tackle organizing those bills and other unopened mail. It doesn’t matter what is in there for now. It could be unopened mail, opened mail, or all mixed up. You need to find and organize all your financial information before you can file a chapter 7, or chapter 13 bankruptcy.

Set aside a block of time, even if it is only a twenty or thirty minute window. Gather up all that paper and find a place to begin to sort it. Somewhere you can leave the project and return to it is ideal. Have several bags or boxes handy. You may want one for trash, one for recycling and one for documents that need to be shredded. Label each bag or box.

Start with the steps below and get as far as you can in your scheduled time. When you are ready set aside another block of time and continue through the steps. Repeat until complete.

Organizing Mail Steps

  1. Open it everything. Use a letter opener or some other tool to make it easier. Toss all the envelopes that the bills and statement arrived in into your recycle bag. There is no need to keep that extra outside wrapper.
  2. If you are unable to pay the bills and are planning to file bankruptcy, or you pay your bills online, you can also toss the return envelopes into your recycle bag.
  3. Sort by type – medical in one pile, credit card bills in another. Utility bills and ongoing household expenses in another, etc.
  4. Sort each type file by creditor or sender. All PG&E together, all Chase cards together and all Aunt Susie’s letters together. Put all Chase collection letters (from agencies and lawyers) with the original Chase bills.
  5. If you have more than one account with a creditor (like two separate American Express card accounts) separate those accounts in different piles.
  6. Organize each creditor pile by date with the most recent on the top.
  7. Finally, place each stack into a file folder and label the folder with the creditor name and the last 4 digits of the account number. In my office we prefer that you do not use staples. If you bring in paper we will scan it and return it to you and staples only slow down the process.

Congratulations! Your bills are now organized and ready to work with whether you are looking at debt consolidation plans, a bankruptcy or just want to know how much you owe. For some tips on charting your financial future click here to read Cathy Moran’s article.

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