The No B.S. Truth About Using Bankruptcy to Solve a Tax Problem
Most of my clients do not file bankruptcy, but it’s really foolish to rule this solution out until you get all the facts. For some individuals and business owners suffering with tax debt, the decision to use the bankruptcy code is the best decision they will ever make.
So I urge you to get the truth about all tax solutions, including bankruptcy. Only when you have all the facts, will you be ideally positioned to make a wise choice and get a fresh start in life. Deal?
TIP: FICO is the credit score that 96% of all lenders use. FICO developed a “credit score card,” grouping consumers by common credit history. It’s like being graded in a class. Students in history class are graded against other history students, not algebra students. One credit score card is for bankruptcy filers. Another is for citizens with bad credit. By taking the right steps at the right time, you can use score cards to boost your score fast.
The Automatic Stay
Filing Chapter 7 or 13 bankruptcy triggers a federal court order called the automatic stay. IRS collection, garnishment, lawsuits, foreclosure, and any collection by any creditor must stop once the case is filed. Bankruptcy can be the equalizer for the honest citizen or business.
Timing is Key
Timing is everything when it comes to bankruptcy and tax relief. There are many rules that must be followed to eliminate tax debt. The rules can be confusing. Some taxes are dischargeable under the rules, and some are not. You can’t just file bankruptcy and expect the tax liability to automatically disappear. However, if you understand the rules under the bankruptcy code and correctly apply the rules, bankruptcy can utterly transform your financial situation and provide the fresh start that other tax solutions may not.
I urge you to get the right advice from the right professional who has complete command over the timing rules and has a proven track record of eliminating tax debt in bankruptcy. Your financial future depends on it. Here are some very simple examples:
Example 1: In order to qualify for a discharge of income tax debt through bankruptcy, assuming you file your tax return on October 15, 2007, you are eligible to file bankruptcy three years later on October 15, 2010.
Example 2: Your 2006 tax return’s filing due date was October 15, 2007, but the return was filed late on July 30, 2009. The income tax from this return will not be eligible for a bankruptcy discharge until July 30, 2011, because it’s the later date of two years from July 30, 2009, or three years from October 15, 2007.
Example 3: Your 2006 tax return’s filing due date was October 15, 2007, but it was actually filed late on May 15, 2008. The income tax from this return will be eligible for a bankruptcy discharge on October 15, 2010, because it’s the later date of two years from May 15, 2008 or three years from October 15, 2007.
Exceptions to the Rule. Audits, offers in compromise, non-filing, appeals, and other events affect the timing of filing bankruptcy. Candidly, your financial future is too important to get it wrong, so get the right tax advice from the right tax lawyer.
Chapter 7 Bankruptcy
Unsecured creditors are not paid under Chapter 7. IRS tax debts that qualify are discharged. Other unsecured debt, such as state income tax, non-trust fund employment taxes, credit card debt, medical debt, and bank loans are also discharged. Home loans and car loans can be “reaffirmed” so that the secured loans survive the bankruptcy and are paid according to the contract, or you can choose to surrender the property and pay nothing.
In order to qualify for Chapter 7, you must qualify under a “means test” that compares income to reasonable expenses. If at first you don’t qualify for Chapter 7, you may be able to file Chapter 13 and later convert to Chapter 7. If you have substantial non-consumer debt, such as business debt, you may be able to avoid the means test altogether.
The Means Test. The means test compares income to reasonable expenses and determines whether you qualify for Chapter 7. If at first you don’t qualify for Chapter 7, you may be able to file Chapter 13 and later convert to Chapter 7.
Avoiding the Means Test. If you have substantial non-consumer debt, such as business debt, you may be able to avoid the means test.
Chapter 7 Lasts about 100 Days. From filing date to discharge date, Chapter 7 lasts about 110 days. There is usually no court appearance required. You will meet with your attorney and trustee at a 341 hearing, which typically lasts about ten minutes, where you will be asked some very basic questions.
Property. 99% of my clients keep 100% of their property in Chapter 7. That’s because equity in personal property, real estate, and investments are protected by exemptions. For those who have excess equity, Chapter 13 is an alternative, as explained below.
Chapter 13 Bankruptcy
You pay creditors 0% or as much as 100%. What percentage you pay depends on two factors:
A. How much, if any, disposable income is left after deducting monthly expenses
B. The type of debt
In Chapter 13, unsecured “non-priority” debt, such as older income tax and credit card debt, may get paid a small fraction or nothing at all. Secured debt, such as a mortgage, may be paid as agreed. It’s also possible to surrender the property and pay the lender nothing.
Chapter 13 Offers Flexibility. An experienced tax attorney will work with the client to create a plan that spells out exactly who gets paid and how much. Under certain circumstances it may be wise to start in Chapter 13 and later convert to Chapter 7. For example, if foreclosure forces you to file Chapter 13 to stop the foreclosure lawsuit, it’s possible to modify the mortgage after the case is filed and dismiss the Chapter 13 case or convert to Chapter 7.
Emergency Filing. Remember, filing Chapter 13 creates an “automatic stay” where levies and other IRS collection must stop. In extraordinary circumstances, Chapter 13 is filed as a temporary measure to get the IRS off the taxpayer’s back. When a solution is formulated, the bankruptcy is dismissed.
Mortgage or Car Loan Problems. Chapter 13 forces lenders to wait 60 months to get caught up on loan payments. Chapter 13 instantly stops foreclosure or repossession. You make loan payments to a trustee who in turn pays the bank the monthly loan payments as well as monthly amounts to bring the loan current.
Choosing Chapter 13 Even if Eligible for Chapter 7. Under certain circumstances, it makes wise financial sense to choose Chapter 13 even if you qualify for Chapter 7. Here are some examples of when that could happen:
Example: Let’s assume you owe the IRS $100,000 in income tax for multiple years. $80,000 of your tax liability is old enough to discharge in bankruptcy, and $20,000 is not old enough. Even if you qualify for Chapter 7, you could file under Chapter 13 and discharge $80,000 of the tax and pay the other $20,000 over five years interest-free.
Example: Your house is in foreclosure. You also have older tax debt that could be wiped out in Chapter 7. Even though you qualify for Chapter 7, you could choose to file Chapter 13 instead to stop the foreclosure, save your home, and wipe out the tax debt.
As I said before, bankruptcy is not for everyone. Most of our clients suffering from tax debt do not file bankruptcy. However, it's vital you get a detailed analysis of how bankruptcy might help you as well as how other tax solutions might help you. We're here to do that for you.
Feel free to call me at 800 656 0525 or 414 771 9200 day or night, 7 days a week.